Definition and Legal Classification of Profit Sharing
Die Profit Sharing is a term from civil and employment law and describes a financial remuneration, the amount of which is based on the economic, financial, or operational results of a company, a department, or a specific project. Profit sharing is used both in employment relationships and in partnership agreements, distribution agreements, and with freelancers as well as managing directors. The legal structure is diverse and exists at the intersection of contractual types, tax regulations, and employment law.
Types of Profit Sharing
Profit Sharing in Employment Law
Contractual employment regulations
In an employment relationship, profit sharing can be agreed upon as part of the remuneration (§ 611a BGB). It can be addressed to individual employees or groups and can take various forms, including:
- Profit Participation: Share in the company’s profit, usually distributed annually.
- Revenue Sharing: Share of the revenues generated.
- Employee Participation: Often as long-term programs, for example in the form of stock option plans.
- Bonus/Premiums: One-off payments upon achievement of targets.
Profit sharing must be distinguished from gratuities, as it is directly linked to the economic development or individual performance. The arrangement is made through individual contractual agreements, company practice, or collective agreements via works agreements.
Co-determination and Works Constitution
If profit sharing is introduced collectively and for several or all employees of a company, the works council has a right of co-determination under § 87(1) No. 10 Works Constitution Act (BetrVG) regarding the design of remuneration principles. This particularly affects the assessment, timing of payment, and distribution key.
Profit Sharing in Company Law
Partnerships and Corporations
In partnership agreements, profit sharing can be granted to shareholders (such as in an OHG, KG, GmbH or AG), often as a profit share (§ 722 BGB, §§ 29 ff. GmbHG, §§ 58 ff. AktG). Allocation is based on the partnership agreement, the German Commercial Code (HGB), or the German Stock Corporation Act (AktG), and may contain different participation quotas.
Management and Third Parties
External managing directors or other third parties, for example in the context of silent partnerships (§§ 230 ff. HGB), can also be granted performance-based remuneration. Profit sharing is also commonly found among venture capital or private equity investors as “carried interest”.
Profit Sharing in Distribution and Commercial Agency
Commercial agents according to §§ 84 ff. HGB regularly have a claim to performance-based remuneration, the commission (§ 87 HGB). Contracting parties may add further performance-based components, such as bonuses. These claims arise upon the successful conclusion of business in accordance with the contractual or statutory provisions.
Legal Requirements and Design Options
Contract Drafting
For the effectiveness of performance-based remuneration, a clear and unambiguous wording in the contract is essential. Unclear regulations may result in invalidity or supplementary contract interpretation. In employment law, the principles of transparency and equal treatment (§ 307 BGB, AGG) must be observed.
Typical Provisions:
- Basis of assessment (e.g., profit, revenue, achievement of targets)
- Method of profit determination (commercial law, tax law, IFRS, internal key performance indicators)
- Calculation period and payment mode
- Conditions for accrual and maturity of the participation
- Clawback or subsequent payment provisions, e.g., in case of later corrections or balance sheet adjustments
- Impacts on other performance-related remuneration components
Transparency and Verifiability
Profit sharing arrangements usually require disclosure of certain company figures. Obligations to provide information, disclosure, and audit are therefore often part of participation agreements. Especially in company law or sales-related participations, the duty to report key performance indicators is anchored.
Forfeiture and Suspension of Claims
In employment law, special regulations may apply if the employment relationship ends before the profit sharing becomes due. As a rule, there is a pro-rata claim if the requirements for entitlement were met during the existing contractual relationship. Deviating agreements are subject to content control, especially under § 307 BGB.
In company law, settlement arrangements as well as post-liability and additional contribution obligations must be reviewed.
Tax Treatment of Profit Sharing
Employees
For employees, profit sharing is considered taxable employment income (§ 19 EStG). This applies to all forms – from profit sharing and bonuses to stock options. For social security purposes, they are generally part of the assessable employment income.
Shareholders
Shareholders in a corporation declare their profit share as income from capital assets (§ 20 EStG); in partnerships, it is declared as commercial income (§ 15(1) sentence 1 no. 2 EStG). The specific tax liability depends on the type of participation and the shareholder’s status.
Third Parties and Freelancers
For freelancers and other third parties, taxation is based on the contract design, either as income from self-employment (§ 18 EStG) or as other income. The distinction mainly depends on self-responsibility and independence from instructions.
Profit Sharing and Social Security Law
According to the Social Code, profit sharing is generally subject to contributions, provided it is deemed employment income (§ 14 SGB IV). Special rules apply to special and one-time payments, particularly regarding the total gross income subject to contributions.
Case Law on Profit Sharing
Courts regularly review the transparency, equal treatment, and reasonableness of profit sharing regulations. The respective supreme court jurisprudence (such as Federal Labor Court, Federal Court of Justice) particularly emphasizes the necessity of clear criteria, proper calculation, and traceability of the underlying performance indicators.
Distinction from Other Compensation Models
Profit sharing differs from fixed compensation and pure bonuses in that it is directly linked to company or division performance. Unlike stock options or other participation programs, it is not necessarily associated with rights to participate in or co-determination within the company.
Summary
Profit sharing is a versatile compensation instrument with high legal relevance. It plays a significant role in employment law, company law, and tax and social security law. The key is clear, transparent contractual design that considers all foreseeable eventualities as well as the protection of the parties involved. Arrangements regarding profit sharing are an integral part of modern contracts and require careful drafting to avoid conflicts and legal disputes.
Frequently Asked Questions
Which legal principles must be observed when drafting profit sharing arrangements?
Profit sharing in Germany is mainly governed by employment law, tax law, and, if applicable, company law. The employment contract usually forms the basis, where individual or collective agreements can be made. Supplementary rules are often found in collective bargaining or company agreements. Additionally, the requirements of the Verification Act (§ 2 NachwG) must be observed, as the agreement on profit sharing is a material contractual term and must therefore be recorded in writing. Special provisions apply if the profit sharing is variable remuneration based on target agreements: then, the stipulations of the Part-Time and Fixed-Term Employment Act (TzBfG) as well as Federal Labor Court (BAG) case law, particularly concerning transparency and determinacy, also apply. For certain company forms—such as managing directors of a GmbH or board members of an AG—company law regulations such as § 87 AktG or §§ 611a ff. BGB must also be taken into account. For tax purposes, the distinction between salary and capital components is relevant, as this leads to different taxation types (wage tax vs. capital gains tax).
How are profit sharing arrangements classified under employment law compared to regular remuneration?
Profit sharing, if agreed individually or collectively, generally counts as remuneration within the meaning of § 611a BGB. It is therefore subject to the same principles as fixed pay and is part of the statutory remuneration claim. This also means it falls under the protection of § 615 BGB (default of acceptance) and §§ 850 ff. ZPO (protection against attachment). A distinction exists if the profit sharing is based solely on a company law agreement (e.g. for shareholders) or is granted on a purely voluntary basis without a legal claim as a so-called “gratuity.” In such cases, these are considered special grants, for which the principles of voluntariness and reservation of withdrawal according to § 305 BGB become relevant as regards the creation or removal of claims. Statutory specifics may also arise from tax and social security regulations.
Is profit sharing subject to social security contributions?
As a rule, profit sharing is subject to social security contributions, provided it constitutes remuneration within the meaning of § 14 SGB IV. This is true in most cases since profit sharing is an additional payment for the work performed. Only participations based on a separate company law basis (e.g., in the case of true ownership in the company as a shareholder) are exempt from social security. Amount-dependent specifics, such as additional earnings limits for marginal part-time employees (§ 8 SGB IV/minijob), and payment dates as regulated by the applicable collective agreement or individual agreement, must also be taken into account.
What co-determination rights do the works council or staff council have regarding profit sharing?
Profit sharing and its design are generally subject to the co-determination right of the works council under § 87(1) No. 10 BetrVG (“questions of company pay structure, including performance bonuses and allowances”) and may not be unilaterally changed without the involvement of the works council. The works council has co-determination rights, for example regarding the calculation principles, assessment methods, and payout periods. If profit sharing is regulated by a works agreement, its provisions must be strictly observed. For the public sector, the relevant provisions of the Staff Representation Act and the associated participation or co-determination rights apply.
Can an employer cancel or restrict payment of an agreed profit sharing arrangement?
A unilateral cancellation or restriction of a contractually agreed and firmly promised profit sharing arrangement is legally only possible to a limited extent. Changes generally require a change notice or a mutual contract amendment. Only in the case of voluntariness or withdrawal clauses can a reversal be made under certain legal conditions, whereby the clause must meet the requirements for transparency as per § 307(1) sentence 2 BGB and be sufficiently specific (BAG, judgment of 12.10.2011, 10 AZR 756/10). A profit sharing arrangement can also be adjusted if the company’s economic situation has fundamentally changed, but an objective reason and a balancing of interests (proof of unreasonableness) are required.
How is profit sharing treated for tax purposes?
Profit sharing is generally treated as “other remuneration” (§ 39b(3) EStG) and must be taxed as income. It is subject to wage tax, the solidarity surcharge, and, if applicable, church tax. The time of inflow is decisive; depending on the payment date, the tax deduction amount may vary. For stock options or participation programs, special rules may apply regarding taxation, particularly the difference between employment income and income from capital assets, which affects the obligation to register and withhold capital gains tax (§ 20(1) No. 1 EStG). Tax exemption may apply to certain participation models under § 3 No. 39 EStG up to an annually set amount.
What rights do employees have if there are uncertainties or disputes regarding payment of profit sharing?
In the event of a dispute, employees can claim payment of profit sharing through the labor courts. The prerequisite is that there is a clear legal claim by virtue of contract, company agreement, or collective agreement. Where there is ambiguity in interpretation, §§ 133, 157 BGB (interpretation of declarations of intent and contracts) apply. In the case of standardized contract terms, doubts are often to the detriment of the employer (so-called ambiguity rule; § 305c(2) BGB). In addition to judicial clarification, employees have recourse to company complaints mechanisms, such as under § 84 BetrVG. If there are indications of discrimination, a review under the standards of the General Equal Treatment Act (AGG) is also warranted. A works council can provide support as part of its supervisory duties (§ 80 BetrVG).
