German MEP income should be taxed as capital gains

Income derived by managers in German management equity programs is likely to be taxed as capital gains in the future, not income, following a ruling by the country’s Supreme Tax Court.

In a test case a manager in an MEP successfully appealed a decision made by the German authorities to tax this money as income.

The court said provided the manager has paid fair market value for its investment at entry there should be no income tax from wages on entry, and no “tainting of the entire income earned under the management equity program as fully taxable income from wages.”

It said the chance to make a capital gain from the underlying investment should not be based on the employment relationship, and should be balanced by the risk of the manager losing the capital invested.

“The Court took the view that an investment into the employer group can be an independent source of income for each participating manager which, on an isolated basis, is not automatically triggered by their employment relationship,” law firm Latham & Watkins said.

Following the court's decision, it will be far more difficult for the tax authorities to continue taxing income derived by managers in MEPs as income.

“For management tax payers, the decision marks a highly positive development. In the recent past the tax authorities have been increasingly trying to levy taxes with respect to management participation on a doubtful legal basis,” law firm Hogan Lovells said.

Although the treatment of management participation gains for tax purposes will continue to be a matter of fact in each individual case, the court's decision clarifies the relevance and irrelevance of certain factors typical in management participation programs, the firm added.