payments to employees of third parties - taxable income from employment
A commentary on the decision of the Federal Supreme Court of 15 March 2019 2C_703/2017.
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In successful company sales, payments by the seller to selected employees are frequently encountered01 and confront the parties involved with various tax questions: Is it a salary or a gift? If the payment is borne by the target company (employer), the question arises as to whether the expense is justified on business grounds or represents a payment in kind (in favour of the seller / shareholder). In both cases, the social insurance law treatment as well as the practical handling (e.g. via the employer's payroll accounting) must be clarified.
The income tax assessment of a payment by the seller and sole shareholder was the subject of a Federal Court ruling dated 15 March 2019 (2C_703/2017).
2. facts of the case
The sole shareholder of D. AG, which held all the shares in E. AG, sold its shares in D. AG at the end of 2010 and, from 2010 onwards, made payments from his private assets to the plaintiffs (married couple and both employees of E. AG) under the heading "seniority gifts". The plaintiffs declared the donation of CHF 32,250 as a tax-free gift. In contrast, the cantonal tax office of Aargau qualified the payment as taxable income. This qualification was protected in appeal proceedings, before the Special Administrative Court of Aargau, the Administrative Court of Aargau and, most recently, by the Federal Supreme Court.
The Federal Supreme Court initially relies on the general clause of the concept of income (Art. 16 para. 1 DBG02Article 7(1) StHG03) and states that the benefits in dispute are covered by the general clause irrespective of their classification as income from employment (E.3.1). The only decisive factor is whether an exemption - in this case as a gift - can be considered under Art. 7 para. 4 lit. c StHG or Art. 24 lit. a DBG.
Payments from third parties (i.e. not the employer) may also constitute taxable income. However, the Federal Supreme Court rejects the view of the lower court that benefits from third parties in connection with an employment relationship are always taxable income if the connection to the employment relationship is sufficiently close.
Taxability applies only if there is an economic link between the service which the taxable person receives from third parties and the activity of the latter; that is to say, if the service is the consequence of the activity and the taxable person receives the service in relation to his activity. The Federal Supreme Court makes a distinction here, e.g. with regard to payments made by colleagues on the occasion of the departure of a colleague or tips that do not constitute a significant part of the salary (E.3.2.3). In the present case, however, the position of the sole shareholder ("economically the former employer") indicates that the donation was not made as a gift without consideration, but that it does not compensate the work performed, but at least the loyalty or many years of cooperation, which was also reflected in the value of the company for the seller (E. 3.3.5). The fact that the payment was made without any obligation does not in itself speak in favour of a gift, since Article 17(1) DBG explicitly also covers gifts of seniority and anniversary, i.e. benefits to which there is no contractual entitlement (E.3.3.4).
As in previous cases, a gift was denied in the case of employee benefits by the shareholder.04 A connection between the employees' work activities and the payment by the seller/shareholder should - as in the present case - be a regular occurrence. A relationship can also exist directly with the employer if the latter makes a payment to employees, e.g. for special efforts due to the additional burden of the sales process, for retention reasons or to motivate them for future employment (under the new owner).
Here, the distinction between payments in the interest of the employer, where these payments represent business-related expenses, and the seller's interest in the highest possible purchase price or successful sale is often not easy in practice. However, the tax consequences of a payment in kind by the employer in favour of the shareholder are considerable (and also economically relevant for the purchaser):
- no deductible expense for the employer,
- Withholding tax at the employer and
- Taxation by the shareholder as a hidden profit distribution with the risk that the shareholder cannot reclaim the withholding tax due to a lack of declaration.05
In the case of payments by the seller himself (instead of the employer) this problem does not arise, but the employer is concerned with the question of correct declaration in the wage statement and the treatment under social security law. The statement of the Federal Court (E.3.1 "Taxable income from gainful employment may also be present even if no contributions are to be levied under AHV law") must not lull into a false sense of security here that there is no AHV obligation. The guideline on the relevant salary in the AHV, IV and EO (WML 2019) states that it is irrelevant whether the salary is paid by the employer or by third parties.06 The WML 2019 also explains that not only direct remuneration for work performed is part of the relevant wage, but also, in principle, all payments to the employee that are economically linked to the employment relationship, regardless of whether this relationship has been terminated or whether the payments are made voluntarily.07 According to the WML 2019, it is therefore quite possible - which was not the subject of the proceedings - that an AHV contribution obligation may exist with regard to third-party contributions.
01 cf. e.g. https://www.blick.ch/news/wirtschaft/nach-gegluecktem-boersengang-von-stadler-rail-peter-spuhler-zahlt-seinen-bueezern-25-millionen-franken-id15347608.html (accessed on 14.07.2019).
04 cf. Administrative Court Aargau, 29.3.2007, StE B 22.1 No. 5.
05 Cf. IFF Seminar on Corporate Taxation 2016, Cédric Hofer / Susanne Schreiber, Tax consequences of indirect enrichment of companies, Case 6: Direct benefit to sellers.
06 WML 2019, marginal no. 1016.
07 WML 2019, marginal no. 1008.