New Federal Court decision significantly restricts young entrepreneurs
If you sell your own company as a capital gain, the transaction is generally tax-exempt. The Swiss Federal Court recently made a decision which qualified this principle, and raised many questions.
New Federal Court decision
If a company owner sells his/her private shares in a company, this is in general tax-exempt (art. 16, para. 3, Swiss Federal Law on Direct Tax (DBG)). However, in its judgement of 3 April, 2015 the Federal Court held that the entire capital gain must be taxed as income from employment (BGer 2C_618/2014 and 2C_619/2014). This classification qualifies the existing principle of tax-free capital gain and raises many questions.
Profit from sale of a company is income from employment
In the relevant decision, a partner in a financial company swapped out part of his business to a new company. The partner sold the newly issued company shares to a bank one month later. The purchase price for the shares was paid in four tranches. The first tranche fell due when the contract was concluded, and the bank was to pay the following three tranches in subsequent years, but always under the condition that the selling partner continued to work at the company. The Tax Office qualified the profit achieved through the partner’s sale of shares as taxable income from employment. The partner denied this, opining that it was a tax-exempt capital gain, as he had held the shares as part of his private assets.
The Federal Court upheld the decision of the Tax Office that the profit should be qualified as taxable income from employment. The Court justified its decision by saying that the purchase price for the shares actually represented a reward for future work to be performed by the partner. In this case, no purchase agreement was concluded in relation to the transfer of ownership of the shares, because payment of the purchase price was dependent on the continuation of the partner’s employment relationship with the company.
The Court objected that the goodwill paid by the bank was only set up in this way to ensure that the talented partner continued with the company and created more profits. From an economic perspective, this was a combination of a payout (first tranche) and loyalty rewards (second to fourth tranches), which clearly represented a salary component.
The Court therefore qualified the principle of tax-free capital gain. Thus, for every corporate sale in which the seller undertakes to remain employed in the company, there is a legal risk that the profit may be reinterpreted as taxable income from employment. Further employment within the company is very popular with start-ups, however, as the founders are often the driving creative force behind the company. By selling, new capital is generated which allows young companies to continue to grow and conquer new markets.
Therefore, for future sales of their company shares, young entrepreneurs should make a clear distinction between the amount which reflects the value of the company, and the amount which relates to continued employment within the company.
This post is based on the judgement review by Andrea Opel and Barbara Stillhart-Zimmermann in the Neue Zürcher Zeitung on June 25, 2015.
