Federal Ministry of Finance: payment of salary and pension to directors at the same time

Pension commitments have become an established way for owner-directors to build up a pension plan if they expect little or no state pension. 

Alongside this, it is also common for owner-directors to continue working for the company beyond the retirement age agreed in the pension commitment. These cases raise the question of how remuneration should be dealt with after retirement age has been reached and how the parallel payment of salary and pension benefits is to be assessed for tax purposes. 

Previous evaluation by the tax authorities

In the tax authorities’ opinion, parallel payment of a director’s salary and pension to owner-directors leads to hidden profit distribution if the salary is not offset against the pension. A hidden profit distribution was deemed to exist regardless of the total amount of salary and pension. 

Example of the view until now: 

An owner-director receives a pension commitment that does not require him to leave the company on reaching the age limit of 65 in order for the pension and payments from the company pension to start. The owner-director remains employed full-time as a director at the company after turning 65 and continues to receive a monthly salary of 15,000 euros. After reaching retirement age, he also receives a monthly pension of 6,000 euros. 

In order to avoid a hidden profit distribution, the salary must be set off against the pension payments. Since the salary is higher than the pension, only the salary of 15,000 euros remains after offsetting.

If the owner-director were to receive the pension of 6,000 euros in addition to his salary of 15,000 euros, an amount of 6,000 euros per month would constitute a hidden profit distribution. 

BFH changes its view on the offsetting of salaries 

In the case in question, an owner-director left the company on reaching the retirement age as agreed in his pension commitment. A few months later, he resumed his active role as an owner-director. The owner-director’s previous salary for full-time employment was reduced considerably. Alongside this, he also received benefits from the pension commitment. The total of salary and pension benefits amounted to only 26 percent of his previous total remuneration. 

The tax authorities assumed a hidden profit distribution equal to the amount of the pension. In its judgment of 15 March 2023, however, the Federal Fiscal Court ruled that receiving a pension and a salary at the same time was for business purposes and at arm’s length and established new guiding principles for treating salary when pension benefits are being received at the same time. 

The principle continues to apply that a prudent and conscientious director would always demand that, in the case of receiving a salary and pension in parallel, either the income from continuing to act as a director should be offset against the pension or the agreed start date of the pension should be postponed until the beneficiary has finally ceased to act as a director. 

New: BFH defines non-detrimental cases 

No hidden profit distribution is deemed to exist if receiving a salary and pension in parallel is for business purposes and at arm’s length. Dealing at arm’s length exists if the total of the reduced salary and the pension benefits does not exceed the amount of the full salary that was paid before the start of pension payments. 

So, in the above example, it would be possible to pay the owner-director an additional salary of 9,000 euros without having to offset it if the owner-director received pension benefits of 6,000 euros. This parallel payment would no longer lead to a hidden profit distribution. Under these conditions the nature of the pension payment as a provision for old age is fundamentally preserved. 

According to the previous view, this situation would have led to a hidden profit distribution of 6,000 euros. 

The Federal Fiscal Court also states that further or subsequent employment at reduced working hours/responsibilities can entail that the difference between the pension and the last full salary cannot be fully exhausted without triggering a hidden profit distribution. Rather, a pro rata reduction of the (“non-detrimental”) amount is required. 

Assessment by the tax authorities: critical cases remain 

On the one hand, the tax authorities are adopting the new Federal Fiscal Court guidelines, according to which parallel payment of a salary and pension to an owner-director does not lead to a hidden profit distribution if the total of the two does not exceed the last salary paid before the start of pension payments.

However, the Federal Fiscal Court’s view on part-time work, which was not relevant to the decision, was not implemented in the Federal Ministry of Finance circular of 30 August 2024. The BMF argues that this view is not to be endorsed. It maintains the view held by the tax authorities till now, that part-time work is not compatible with the duties of an owner-director. This presumably means that, in the tax authorities’ opinion, the parallel payment of pension and salary will lead to a hidden profit distribution as before, irrespective of the total amount. 

Conclusion

The new guidelines on the parallel payment of salary and pension in full-time employment are very welcome, since a payment can be made up to the amount of the full salary without being offset. 

Since the tax authorities have not followed the view of the Federal Fiscal Court regarding part-time work, which was not relevant to the decision, these cases prove problematic in practice if a hidden profit distribution is to be avoided. 

The new guidelines of the BMF circular of 30 August 2024 are to be applied to all open cases. 

Practical ways to structure

• Postponed retirement potentially with arm’s length actuarial surcharges due to later retirement

By postponing retirement, a full salary can continue to be paid without having to make adjustments for tax purposes due to the pension. 

• Self-employment

Another option to avoid parallel payment of salary and pension would be to continue the role in a self-employed capacity instead of as an employee. However, classifying an activity as self-employed or employed involves many pitfalls and requires detailed advice. 

• Declaration of hidden profit distribution

There is also the option of knowingly accepting the consequences of a hidden profit distribution and declaring it in the tax return. 

In all these structures, the effects on pension provisions under commercial and tax law should also be taken into account. Consequences on income tax for shareholders must also be included in the structuring. Finally, social security aspects may also need to be considered.

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