Management equity structured as so-called 'hurdle shares' has attracted increasing attention in German private equity and venture capital deals. In a directive dated May 28, 2026 (S 2332.1.1-29/4 St36) [1], the Bavarian State Tax Office (Landesamt für Steuern Bayern) clarified when a participation with a negative liquidation preference gives rise to employment income and confirmed that a properly designed and priced structure should neither trigger an upfront wage tax charge on grant (a 'dry' tax charge arising before management receives any cash) nor turn the exit proceeds into fully taxable employment income.

Background

A hurdle share is structured so that management participates only in future value growth, rather than in the business’s existing equity value at grant. The shares are generally issued at nominal value and carry a negative liquidation preference, giving management a subordinated entitlement to proceeds. The other shareholders receive the preference amount first, and management participates only in proceeds (dividends, sale proceeds) above that threshold. The preference is typically set at the difference between a share’s fair market value and the price paid by management (often just nominal value). Similar principles generally apply to other structures using a negative liquidation preference, including growth shares.

The Two Potential Taxable Events

The directive distinguishes between two separate taxable events: the grant of the shares and the subsequent receipt of proceeds.

At grant, employment income arises only where the shares are transferred below fair market value. The key point is that the negative liquidation preference itself reduces that fair market value. For example, where a share worth EUR 10,000 carries a EUR 9,999 preference, its adjusted value is EUR 1 – so a manager paying EUR 1 receives no discount and therefore no taxable benefit. This example shows why a robust contemporaneous valuation matters. The directive does not specifically state this, but it strongly implies that no separate valuation of the hurdle share itself (e.g., using an option-pricing model) is required for wage tax purposes. Instead, it appears sufficient to deduct the agreed liquidation preference from the fair market value of an ordinary share (which should be derived from the company’s current equity value).

When proceeds are received, any gains should generally qualify as a return on an independently held investment taxed under the general rules for shareholdings and capital assets. The Bavarian tax authorities confirmed that the negative liquidation preference alone does not make the proceeds employment income, which is particularly important in practice. That only follows where additional circumstances point to the employment relationship, for instance, where management lacks beneficial ownership in the shares, the participation is not properly established or implemented, management receives more than fair market value, or the participation lacks economic substance (e.g., proceeds accrue only while services are rendered). Standard leaver rules (i.e., terminating the participation when employment ends) do not, by themselves, prevent the participation from being treated as an independent investment.

Conclusion and Outlook

The directive largely follows the direction of the Federal Fiscal Court (BFH, decisions of 14 December 2023 – VI R 1/21 [2] and 21 October 2025 – VIII R 13/23) [3], and that confirmation is valuable in itself. Although it is legally binding only for the Bavarian tax authorities, it should also be helpful for discussions with tax authorities in other federal states. 

For sponsors and management teams, the takeaway is that hurdle share and growth share structures can be a practical and tax-efficient way to incentivize management. As always, implementation and documentation remain important. The valuation of the company, whether based on recent third-party transactions or future earnings expectations (e.g., discounted cash flows), should be robust. Although a separate valuation of the specific hurdle share class (e.g., based on option pricing models) does not appear necessary, the equity participation should be properly established and implemented, and leaver and profit-allocation mechanics should be checked against the “special circumstances” highlighted by the Bavarian tax authorities.