Germany’s top tax court has tightened the tax framework for shareholder-financed occupational pension commitments, with implications for managing directors and closely held companies.
In November, the Bundesfinanzhof (BFH) ruled that pension promises granted to managing directors and financed exclusively through salary conversion are tax-deductible, provided the company does not bear a significant risk of having to co-finance future entitlements, for example by guaranteeing an interest rate above the low-risk market rate.
The court also clarified that a direct pension promise granted to a shareholder-managing director based on deferred compensation is “not seriously agreed upon”, and therefore not tax-deductible, if the future pension claim is not protected against the company’s insolvency.
According to Claudia Veh, partner at Deloitte, companies not subject to statutory insolvency protection via the Pensions-Sicherungs-Verein VVaG (PSVaG) must ensure alternative safeguards.
“Private insolvency protection must be ensured”, for example, through contractual trust arrangements (CTAs), to avoid jeopardising tax deductibility, she said.
In a separate December ruling, the BFH sided with two shareholder-employees of a limited liability company in a dispute over the tax treatment of a 6% interest rate applied to pension promises funded through salary conversion.
The tax office had classified the interest component above 3% as a hidden profit distribution and disallowed the corresponding pension provisions. The court disagreed, stating that, in principle, mixed-financed pension promises remain tax-deductible if the overall benefits are reasonable.
In practice, this requires companies to assess the total benefit level when structuring such commitments.
Veh said the distinction between pure salary conversion and mixed financing – where the employer assumes additional financing risk, for example, through an above-market interest guarantee – is “objectively justifiable”, but increases the complexity of valuations.
“In the case of mixed-financed pension promises, which are generally financed through salary conversion, but where the employer bears a financing risk, for example through a promised interest rate that is higher than that of a low-risk investment, the accounting of both parts must be carried out separately,” she explained.
She added that companies should review whether pension promises funded via deferred compensation include an implicit employer-financed element, particularly where returns exceed those of low-risk investments such as money market funds.
“In this case, when valuing the pension promises for tax purposes, it’s important to note that the special rule ‘present value-partial value comparison’ only applies to the share financed through deferred compensation. It would need to be clarified what constitutes a low-risk interest rate in the specific case,” she said.
For Veh, the rulings underline that the arm’s length principle remains central in assessing the business purpose of pension arrangements for managing shareholders.
