027. Constructive Dividends - Salary Increases for Shareholder-General Managers

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Past pay increases for general managers of GmbH's who also hold any share in the GmbH, even a small one (shareholder-general managers) should be reviewed and confirmed by the end of this year by shareholder resolution where necessary.

The reason for this is a 1991 holding by the Federal Court of Justice (BGH: GmbH-Rundschau 1991, 363) that amendments to the employment contract of a general manager require approval by shareholder resolution. An amendment cannot be validly entered into for the GmbH by a second general manager, even if the second general manager is otherwise authorised to represent the GmbH individually.

All transactions between a corporation and its shareholders pose the problem of possible constructive dividends. Even if it is on terms to which unrelated parties dealing with one another at arm's length would have agreed, a transaction can still lead to constructive dividends if these terms are unclear or were not agreed on in advance, or if the transaction is not based on a valid contract enforceable at law.

Here the latter requirement is involved. The Federal Ministry of Finance issued instructions in May of 1994 stating that all salary increases of shareholder-general managers which have not been approved in advance by shareholder resolution will be disregarded in the future for tax purposes and lead to constructive dividends. An exception exists only when the articles of incorporation of the GmbH expressly empower someone other than the shareholders to agree to changes in the employment contract of a general manager.

However, the directive also provides that the above will only be enforced starting with salary payments made in the years 1996 or thereafter. The deadline for passing necessary shareholder resolutions will thus soon expire.

It should be noted that a shareholder resolution is required to conclude an employment contract between a GmbH and its general manager or to terminate it by mutual agreement, as well as for all amendments thereto (unless the articles provide otherwise).

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