Reclassification of capital gain into earned income

Case 1: Earn-out

1. facts of the case

X. has built up a successful consulting company (X. AG). In May 2023, he sells this to a competitor for CHF 10 million. It is agreed that a further CHF 5 million purchase price is owed over the next 3 years if certain sales targets are achieved.

X. will continue to work for X. AG for three years and will be compensated in line with the market.

Questions

• What is the tax treatment of earn-out payments?
• How would the case be assessed if X. did not work for X. AG would be active?

Case 2: Continued work of the salesperson with lower salary

1. facts of the case

X. has built up a successful M&A consulting company (X. AG). In the years 2020-2022, X. was able to generate an average profit of CHF 2 million, which he paid out to himself in the amount of CHF200,000 as a dividend and CHF 1.8 million as a salary or bonus (variant1: CHF200,000 salary and CHF 1.8 million dividend; variant 2: CHF200,000 salary and CHF 1.8 million were retained in each case).

In May 2023, he sells X. AG for CHF 20 million (variant 2: CHF 20 million plus retained earnings). He undertakes to continue to work for 3 years as Managing Partner of X. AG for 3 years, for which he is compensated with CHF 600,000.

Question

• How should the sales price of CHF 20 million be treated for tax purposes?

Case 3: Asymmetric purchase price

1. facts of the case

The trustees X. and Y. together run a successful trust company (XY AG) with numerous employees. They have two different "profit centers". They draw their respective profit share mainly through bonus payments. X. was entitled to a total profit share of CHF 3 million in the years 2020-2022, Y. to a profit share of CHF 1.5 million.

In May 2023, XY AG is sold to a financial investor for CHF 15 million. In accordance with their profit shares for the years 2020-2022, X. will receive CHF 10 million and Y. CHF 5 million.

X. and Y. undertake to continue to work for XY AG in an advisory capacity for three years, for which they will be compensated in line with market conditions.

Questions

• Can X. and Y. realize a tax-free capital gain?
• Variant: How would it be if X. and Y. (or one of them) would not continue to work for XY AG?

Case 4: Compensation for non-competition

1. facts of the case

X. has built up the advertising agency X. AG, which he sells to a competitor in May 2023 for CHF 10 million. In the purchase agreement, he undertakes not to work as an advertiser in the Zurich metropolitan area for 5 years.

Option 1: The purchase agreement states that CHF 2 million of the purchase price of CHF 10 million is attributable to the non-competition clause (Option 2: The compensation for the non-competition clause is stated in the purchase agreement at CHF 100,000).

Question

• How should the sales price of CHF 10 million be treated for tax purposes?

Case 5: Sweet Equity

1. facts of the case

In 2016, a financial investor subscribes for 8,000 ordinary shares (common shares) of X. AG at CHF 100 per share (par value CHF 10), for a total of CHF 800,000.

The top management of X. AG can acquire a total of 2,000 ordinary shares also at CHF 100 (private assets), thus a total of CHF 200,000.

In 2016, the financial investor also subscribed for CHF 60 million in preference shares. The preference shares have a fixed yield of 7% p.a.

Subsequently, X. AG acquires a participation for approximately CHF 60 million.

In 2022, X. AG can be sold for a net amount of CHF 300 million. The proceeds of the sale will be distributed as follows:

• CHF 85 million Preference shares
• CHF 172 million ordinary shares Financial investor
• CHF 43 million Ordinary shares Manager

Question

• What is the tax treatment of the capital gain realized by management on the sale of its 2000 shares of common stock?

2. variant

A financial investor subscribes for 8,000 shares of X. AG at CHF 1000 per share (par value CHF 10).

The top management of X. AG can acquire a total of 2,000 shares also at CHF 1,000 (private assets).

There is only one class of shares. The financial investor grants X. AG a loan in the amount of CHF 40 million in 2016, which bears interest at 8% p.a. (final maturity).

Subsequently, X. AG acquires a participation for about CHF 50 million. Four years later, X. AG can be sold for CHF 150 million.

Case 6: Taxation of excess profit on employee shares

1. facts of the case

X. AG is a company domiciled in the Canton of Zurich, which was founded by X. on February 15, 2018 with a share capital of CHF 100,000 (variant 1: he acquires the shares of a "shelf company" already founded in 2016 from a trustee).

In June 2018 (variant 2: December 2018, after he returns from a world trip), his childhood friend Y. joins X. AG, which was already planned (and documented) from the beginning. However, Y. still had to "serve" a notice period. X. sells him (as agreed for a long time) 30% of his shares at a nominal value of CHF 30'000.

In January 2019, Z. is employed by X. AG as CFO. X. sells him a 10% share in X. AG (nominal value: CHF 10,000) at the formula value (= tax value according to KS 28) of CHF 40,000 (variant 3: at the nominal value of CHF 10,000).

In 2023 (signing: May; closing: September), X. (60%), Y. (30%) and Z. (10%) sell their shares in X. AG to a PE company for CHF 20 million and leave the company. At the time of the sale, the value of the shares according to KS 28 amounts to CHF 2 million.

Question

• How are the proceeds of the sale treated?

Variant A

In June 2019, Y. receives an interesting job offer in New York and therefore stops working for X. AG. He sells his 30% shares in X. AG back to X. at the net asset value (CHF 120,000) (variant 1: at the nominal value of CHF 30,000). The shareholders' agreement stipulated that Y. must sell his shares back to X. at the net asset value (or par value) if he no longer works for X. AG.

In May 2023, X. (90%) and Z. (10%) sell their shares for CHF 20 million. At that time, the value according to KS SSK 28 of X. AG amounts to CHF 5 million.

Variant B

Y. sells its 30% stake to a financial investor in May 2023 for CHF 3 million.

In May 2025, X. (60%), Z. (10%) and the financial investor (30%) sell their shares to a PE fund for CHF 20 million.

• How should the disposal of Z. be treated?

Variant C

In September 2023, only X. and Y. transfer their shares to the PE fund. Z. does not sell his 10% share until January 2024 (i.e. after the 5-year period has expired).

Variant D

X. AG makes an IPO with a capital increase in May 2023. The shares held by Z. in X. AG have a market value of CHF 8 million on the first trading day, but are still blocked until May 2024 (lock up period). In May 2024, he sells half of his shares for CHF 3 million.

The formula value of the shares held by Z. in May 2023 is CHF 1 million and in May 2024 CHF 1,200,000.

Variant E

There is neither a third-party sale nor an IPO. In May 2024, Z. sells his 10% share (variant1: 15%) in X. AG (variant2: to X.) at a price of CHF 900,000 (formula value at this time is CHF 600,000).