1. Initial situation
Under German tax law, service as a member of a supervisory board is regarded as self-employed activity for income tax purposes, and the member of the supervisory board generates income from self-employed/independent activities (section 18 para. 1 no. 4 German Income Tax Act (Einkommensteuergesetz)). A supervisory board is a body that is entrusted by the company’s articles of association with supervision of the company’s management.
Because of their self-employed status, members of the supervisory board have always been regarded as entrepreneurs within the meaning of the German Value Added Tax (VAT) Act (Umsatzsteuergesetz) for VAT purposes. Based on decisions of the Federal Fiscal Court (FFC), the federal tax authority has taken the view that qualification as an entrepreneur depends on the income tax qualification, and the activity as a supervisory board member is expressly mentioned as an independent activity in the VAT Applications Decree (Umsatzsteueranwendungserlass) (A 2.2 para. 2 p. 7 old version). The supervisory board member is also explicitly named as an entrepreneur in the determination of the location of other services in section 3a para. 4 sentence 2 no. 3 VAT Act.
2. Change in jurisprudence
Judgment of the European Court of Justice of 13 June 2019 – C-420/18.
In a judgment of 13 June 2019 in a case concerning the supervisory board of a Dutch foundation, the European Court of Justice (ECJ) ruled that a supervisory board member who, although hierarchically subordinate to neither the management board nor the supervisory board, does not perform her supervisory board activities in her own name, for her own account and on her own responsibility, but for the account and under the responsibility of the supervisory board, is not to be regarded as self-employed – and thus not an entrepreneur for VAT purposes – if she does not bear the economic risk of her activities. In the opinion of the European Court of Justice, in the case at hand, lack of economic risk was shown by a fixed remuneration and the fact that any potential damage caused by the board member due to negligence had no effect on her remuneration.
Judgment of the Federal Fiscal Court of 27 November 2019 – V R 23/19
With reference to the aforementioned ECJ ruling, the German FFC adjusted its previous view in its ruling of 27 November 2019 and decided that a supervisory board member is not self-employed and thus does not qualify as an entrepreneur if he does not bear any economic risk.
In the case to be decided, the FFC denied the economic risk – comparable to the decision of the ECJ – on the grounds that the supervisory board member received a fixed remuneration of the same amount each year without variable remuneration components and any negligent conduct had no direct influence on the remuneration. The FFC expressly left open the circumstances under which activity as a member of a supervisory board is still to be regarded as conducted in an entrepreneurial capacity.
Reaction of the Federal Tax Authority – Circular Dated 8 July 2021
In response to the aforementioned FFC ruling, the federal tax authority amended the VAT guidelines regarding the treatment of supervisory board members. Now, a supervisory board member is not to be regarded as self-employed (and thus as an entrepreneur) if she does not receive – to some extent – a variable remuneration. In the case of fixed and variable remuneration components, the variable component must amount to at least 10% of the total remuneration for the activity of the supervisory board member to qualify as self-employed. If a person holds several supervisory board mandates, the question of qualification as entrepreneurial activity must be examined separately for each mandate.
According to A 2.2 para. 3a sentence 13 VAT Application Decree (Umsatzsteueranwendungserlass), these regulations apply to all members of any other body which does not serve to exercise, but rather to control, the management of a legal entity or association of persons.
3. Effect on advisory boards in private equity structures
Advisory boards in private equity structures can be established at different levels within the structure and are not subject to any predefined legal form. They may be structured like a supervisory board, in analogy to section 52 of the German Limited Liability Companies Act (GmbH-Gesetz) and thus have as their main task the supervision of the management of an entity or association of persons. They may also be structured on a contractual basis only, in which case they generally have a more advisory character.
Supervisory Board Analogous to Section 52 GmbH Act
In the case of boards structured analogously to section 52 of the German Limited Liability Companies Act (GmbH-Gesetz), which thus primarily have the task of monitoring the management of a company, the change in jurisprudence likely will apply. The federal tax authority at least seems to hold this view (cf. A 2.2 para. 3a sentence 13 VAT Application Decree (Umsatzsteueranwendungserlass).
In the case of advisory boards which primarily have the task of advising management, it is questionable whether the change in established jurisprudence applies. The argument against this is that a board having a solely advisory role is not a body of the corporate entity, and therefore follows different rules. The federal tax authority has not yet commented on this construct.
It remains to be seen what effects the change in established jurisprudence on the VAT treatment of supervisory board remuneration will have on advisory boards in private equity structures. As far as supervisory boards are concerned, the principles laid down by the federal tax authority must be considered. It is unclear to date whether the federal tax authority will apply the new view only to future cases or to past circumstances as well. The circular from the federal tax authority dated 8 July 2021 does not provide for a transitional period.
In the case of advisory boards, the amendment of the VAT guidelines should not have a direct application, but further developments should be closely monitored. In any case, the change in case law should be taken into account when setting up new advisory boards, so that the parties can support each other if it subsequently emerges that the VAT treatment was incorrect.