Entrepreneurs with a GmbH: what level of salary will the tax authorities accept for a sole director?

January 25th, 2016 by Matthias Keil

As the sole director and shareholder of a company with the GmbH legal form, you are in a position to determine for yourself how you want to get paid: via a dividend or via a director’s salary.  The latter is generally more fiscally advantageous, but it regularly causes issues with tax inspectors.  If the salary level is set too high, the excess salary can be deemed to be a hidden dividend and subject to retrospective taxation.  As such, it is important to find the right balance.  The Federal Tax Court (the Bundesfinanzhof) has clearly ruled that the decision is to be based on an acceptable overall package.

Objective comparative measures

The appropriate figure is determined by what an ordinary, diligent chairman would pay to an external director.  There are no hard-and-fast rules in this respect.  A good benchmark, however, can be what comparable businesses pay to their directors for comparable services.  When examining whether a payment is appropriate for tax purposes, the tax authorities’ practice is to be guided by the circumstances that apply to the individual case and/or comparative figures from recognised compensation studies.  In all cases, the profit amount remaining for distribution after deduction of the director’s compensation will be decisive.

Salary components

Overall remuneration includes all salary and all monetary benefits that the chairman and chief executive receives from the GmbH: this includes all fixed annual remuneration including bonuses such as holiday and Christmas bonuses, and special or extra payments (including non-monetary compensation such as private use of a company car or payments into an occupational pension), as well as variable components such as profit sharing.  These are regularly viewed as appropriate if the total amount is made up of 75% fixed payments and no more than 25% of profit-related (and therefore variable) elements.

Directors’ salaries for companies in crisis

Shareholder-directors of GmbH companies can be obliged, in the event of a long-term crisis (in excess of two years) or in the face of a substantial threat, such as impending insolvency, to agree to a deferred remuneration.  Failure to comply with this obligation can result in the director being personally liable to pay compensation.

In a crisis situation, regularly review the level of your remuneration as well as the company’s financial situation.  You can opt to refuse payment of salary, in whole or in part, at any time.  The tax office will also recognise a deferred salary on the condition that, once the company’s economic situation improves, you make up for the deferred payments.

Without a watertight contract, you’re heading for trouble

Where the director’s salary reduces the company’s operating profit, a contract of employment must be agreed in advance and in writing.  There is also a strict requirement for changes of any kind to be in writing.  Any agreed change that is only documented retrospectively will not be recognised for tax purposes.

  • A shareholder-director may only conclude contracts with himself, i.e., via an agreed salary, if the company’s articles of associations grant him an exemption from the general prohibition on self-dealing and this exemption is recorded with the Register of Companies.
  • Shareholder-directors with a controlling interest, unlike directors who are also shareholders but who do not control the company, are not subject to social security insurance.
  • In the absence of a clear, contractually binding agreement, all aspects of compensation, including any ancillary provisions such as permission to use a company car for private purposes, reimbursement for expenses incurred as a result of managing the business, or pension contributions, will give the appearance of a hidden dividend distribution.

Work with us to check your overall level of compensation, and carry out an external comparison exercise to avoid allegations of hidden dividends.

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