Settlement of a pension commitment does not always lead to a hidden distribution of profits

The (premature) settlement of a pension commitment granted to a (controlling) shareholder-managing director can have different tax consequences depending on the underlying circumstances. In some cases, it leads to a hidden profit distribution, while in others, the settlement is recognized as a business expense for tax purposes. There are no clear criteria for determining whether the premature capitalization of pension entitlements is based on operational or corporate law considerations. Legal disputes are therefore inevitable, particularly in the context of external tax audits, as demonstrated by the decision of the German Federal Fiscal Court (Bundesfinanzhof; BFH) of September 17, 2025 (case no. VIII R 17/23).

In the case in question, a limited liability company (GmbH) granted its controlling shareholder-managing director a pension commitment in 2002 comprising a monthly retirement pension, disability pension, and survivor’s pension. The GmbH took out reinsurance to finance this commitment. In 2009, the GmbH got into financial trouble, and by September 30, 2012, at the latest, it was facing insolvency. The shareholders therefore decided to cancel the pension commitment granted to the controlling shareholder-managing director as of December 1, 2012, reached an agreement on the settlement of pension entitlements, and terminated the existing reinsurance policy. The agreed settlement was paid to the controlling shareholder-managing director with his December 2012 salary. Taking into account previous BFH case law, the tax office assumed that this was a so-called spontaneous settlement and assumed a hidden profit distribution in the amount of the settlement paid. The tax court and the BFH disagreed.

This is because the payment made to the controlling shareholder-managing director for the settlement of the pension commitment was not based on the corporate relationship, but – at least in part – on operational reasons according to the overall assessment, and therefore did not constitute a hidden distribution of profits.

A prudent and conscientious external managing director – serving as a benchmark – would also have approved the severance agreement on January 1, 2012, in the interests of the GmbH. The settlement of the pension commitment and the associated termination of the reinsurance policy as part of a package of restructuring measures served, among other things, to avert the imminent insolvency of the GmbH and to alleviate its serious economic crisis, as it led to a reduction in current expenses on the part of the GmbH. As a result, no liquid funds were withdrawn from the GmbH. On the contrary, the controlling shareholder-managing director of the GmbH had provided liquidity by granting a further loan.

A prudent and conscientious third party would also have agreed to the agreement as the beneficiary of the pension commitment (so-called double arm’s length comparison). This is because the beneficiary has an interest in the early payment of claims in connection with retirement benefits, regardless of the economic situation of the GmbH. In the present case, the agreed severance payment was lower than the entitlement already earned from the (valuable) part of the pension entitlement. However, the severance agreement also served to preserve the employer and thus to secure the job in the future.

There were no reasons for a violation of the formal arm's length principle that would indicate a hidden distribution of profits.

Notices:

The BFH decision is welcome insofar as a (premature) settlement of a pension commitment may, under certain circumstances, be justified on operational grounds if the company is in financial difficulty. This is because settlements and the (partial) waiver of existing pension commitments by (controlling) shareholder-managing directors are an important tool for restructuring the company in times of crisis.

However, the BFH does not establish any generally applicable principles. It neither elaborates on the requirements for legally secure agreements in the case of companies at risk of insolvency nor clarifies whether there may also be operational reasons in other constellations, such as in the case of the sale or liquidation of the company. Unfortunately, the legal certainty that would be desirable in practice is still lacking.