- · Earn-outs are widely used in Swiss SME transactions to bridge valuation gaps, but they carry a material tax reclassification risk that is frequently underestimated at the negotiating table.
- · The Swiss Federal Tax Administration (ESTV) may treat contingent payments as taxable employment income rather than tax-exempt capital gains if the earn-out structure is linked to the seller's continued employment or personal performance.
- · ESTV Circular No. 37 and cantonal case law provide the primary interpretive framework, and the consequences of adverse reclassification include income tax and social security contributions on what the seller expected to receive free of tax.
- · Protective drafting, independent valuation support, and a pre-closing cantonal tax ruling (Steuerruling) are the principal tools available to manage this risk.
Earn-outs have become a routine feature of Swiss SME transactions. When a buyer and seller cannot agree on a single headline number — which, in businesses where forward revenues depend heavily on the founder's ongoing relationships, is more often than not — a contingent payment tied to post-closing performance offers a commercially rational bridge. The seller retains upside exposure to results they believe in; the buyer limits day-one valuation risk. The logic is clean.
The tax position, however, is considerably less tidy. Under art. 16 para. 3 of the Swiss Federal Direct Tax Act (FDTA, also known as the DBG), gains realised by private individuals on the sale of shares held in their private assets are generally exempt from federal income tax. For many Swiss SME founders, this exemption represents the financial centrepiece of their succession plan. The assumption — often unexamined — is that the earn-out, as a deferred portion of the purchase price, shares in that exemption.
The Swiss Federal Tax Administration does not always agree.
The ESTV does not operate from a dedicated bright-line circular governing earn-out classification. Assessment is conducted on a fact-specific basis, drawing primarily on ESTV Circular No. 37 (covering employee participations, last updated 30 October 2020) and an evolving body of cantonal case law. Circular 37 treats benefits that are economically connected to an employment relationship as taxable Lohnnebenleistungen — fringe benefits constituting Erwerbseinkommen — reportable on the salary certificate (Lohnausweis) and subject to ordinary income tax rates as well as social security contributions.
The critical question, then, is whether an earn-out payment is more accurately characterised as deferred consideration for a share transfer or as compensation for services rendered. Swiss tax authorities approach that question by examining the economic substance of the arrangement, not merely its contractual label.
According to commentary published by TaxPage (valfor.ch, May 2025) and cantonal practice documented via steuerpraxis.tg.ch, a series of factual conditions elevate reclassification risk to a material level. If the earn-out is conditional on the seller remaining employed through a post-closing period, the payment begins to resemble a retention bonus. If the payout formula is explicitly tied to the seller's personal sales activity or operational metrics, the connection to the seller's labour — rather than the intrinsic value of the transferred shares — becomes difficult to rebut. A material reduction in the seller's post-closing salary compounds the problem, raising the inference that the earn-out is substituting for compensation the market would otherwise expect to be paid as salary.
Differential earn-out structures present a particularly acute signal: when sellers who are required to remain employed receive materially higher contingent payments than those who depart at closing, the correlation between employment tenure and earn-out quantum is precisely the pattern that tax authorities identify as indicative of compensation rather than capital gain. Purchase agreements that do not clearly demarcate the earn-out from consulting fees, non-compete arrangements, or transitional service payments create further ambiguity that an assessor is entitled to resolve against the taxpayer.
The Zurich Administrative Court decision SR-2021-00017 (25 May 2022) illustrates the seriousness with which cantonal courts engage these distinctions. The broader body of Swiss cantonal practice confirms that the reclassification risk is not theoretical — it is an active feature of the assessment landscape.
Understanding reclassification risk at a conceptual level is necessary but insufficient. What matters for practitioners and their clients is identifying the specific contractual and structural choices that determine exposure.
The employment relationship is the primary fault line. A seller who exits cleanly at closing, with no ongoing employment contract, presents a materially different risk profile than one who continues in a management role. When employment persists, every aspect of the earn-out arrangement requires heightened scrutiny. The earn-out should not be expressed as conditional on continued employment; if it is, the ESTV has a straightforward argument that the payment is employment-contingent and therefore falls within the Lohnnebenleistung category.
Performance metrics deserve equal attention. Metrics that depend on third-party verifiable outcomes — aggregate revenue growth confirmed by audited accounts, receipt of a regulatory approval, achievement of a contractually defined client retention threshold measured against objective criteria — provide a more defensible basis for capital-gain treatment than metrics that track the seller's personal activity. "Company EBITDA exceeds CHF X" is categorically different from "seller completes Y client visits generating Z revenue." The former is a business outcome; the latter is a description of the seller's labour.
Pricing discipline matters as well. Where the overall purchase price substantially exceeds independently supportable market valuation, tax authorities are entitled to treat the excess as disguised compensation. An independent valuation conducted on arm's-length principles, obtained prior to closing and retained in the deal file, provides meaningful evidentiary support for the position that the price — including the contingent component — reflects genuine asset value.
The good news for advisors is that the reclassification risk, while real, is largely manageable through careful drafting and pre-transaction structuring. Several measures, taken together, substantially improve the probability of preserving capital-gain treatment.
The purchase agreement should define the earn-out unambiguously as a contingent component of the consideration for the share transfer. That language should appear in the recitals, the definitions clause, and the payment mechanics section — redundancy in this context is a feature, not a defect. Any employment, consulting, or non-compete arrangements should be documented in separate instruments, priced independently, and structured to reflect what an unrelated third party would charge for equivalent services. The earn-out and the employment arrangement should not cross-reference each other in ways that suggest economic interdependence.
Salary continuity merits specific attention during term-sheet negotiations. Where a seller intends to remain employed post-closing, advisors should resist pressure to reduce the seller's salary in a manner that could be read as transferring compensation into the earn-out. Pre- and post-closing salary levels should be documented and, if a reduction is commercially necessary, it should be explained and evidenced on grounds unrelated to the earn-out mechanism.
The most reliable form of pre-closing protection remains the Steuerruling. A binding tax ruling obtained from the competent cantonal tax authority — explicitly covering the earn-out's characterisation as deferred purchase price and confirming the application of the art. 16 para. 3 exemption — eliminates assessment uncertainty for the seller. The ruling process requires preparation and lead time, but for transactions where the earn-out represents a material proportion of total consideration, it is difficult to argue that the investment in obtaining one is disproportionate.
The reclassification risk is not a Swiss idiosyncrasy. Comparable distinctions between capital gains and employment compensation exist in most developed tax jurisdictions, and cross-border transactions introduce the additional complexity of treaty interactions and residence-change timing. Within Switzerland specifically, advisors must also maintain awareness of the indirect partial liquidation provisions under art. 20a DBG. Where earn-out structures create the appearance of post-closing extraction of corporate substance — rather than genuine performance-linked consideration — a separate analytical overlay applies, adding further structural discipline to the design of these arrangements.
The debate over how contingent income should be taxed does not exist in isolation from wider public discourse on the relationship between high earners and tax systems. Internationally, the question of what constitutes fair taxation of business proceeds is far from settled.
Last week was tax day… I paid the government probably almost 60% of what I earn. That's a lot. And I… wouldn't mind if Bernie Sanders would stop saying the rich don't pay taxes.§ @Trump47News
The sentiment, whatever its political context, reflects a genuine tension experienced by many high-income founders: the gap between nominal tax rates and effective outcomes can be dramatic depending on how income is legally characterised. In Switzerland, that gap is particularly consequential, because the distance between zero — the rate applicable to tax-exempt private capital gains — and full marginal income tax rates on Erwerbseinkommen can be substantial. Whether an earn-out sits on one side of that divide or the other is not a question of fortune; it is a question of structuring discipline exercised well before closing.
The broader macro context also bears on how sellers think about deal structuring. Data on the diminishing share of economic output flowing to labour income raises legitimate questions about how tax systems treat different forms of return.
Out of every dollar the US economy earns, how many cents land in paychecks? Do like to have a lower salary every year? 51.0 cents as of Q1 2026. That is the lowest in the quarterly records, which go back to 1947. In 1970 it was 58.4.§ @stockdatamarket
For Swiss SME founders, the practical implication is that the structure of their exit consideration has direct and material consequences for the net proceeds they retain — consequences that are determined not by market forces but by tax characterisation choices made at the drafting table.
The earn-out reclassification risk is a structuring problem, and structuring problems respond to technical attention. Sellers approaching a transaction involving a contingent payment component should engage tax counsel at the term-sheet stage, not after the purchase agreement has been substantially negotiated. The risk factors identified in Swiss cantonal practice and ESTV Circular 37 guidance are well-documented; the task is mapping the specific transaction facts against those risk factors and making deliberate choices about structure, language, and documentation before the deal closes.
Advisors acting for buyers should be alert to the mirror-image dimension: a seller who faces income tax and social security liability on earn-out proceeds they expected to receive tax-free may revisit headline price expectations, seek indemnity provisions, or restructure the payment mechanism in ways that alter deal economics for both sides.
The earn-out is not inherently a problematic instrument. Used with structural precision and adequate tax analysis, it remains a commercially sound tool for bridging valuation uncertainty. The trap is not the instrument itself — it is the assumption that its tax treatment follows automatically from its commercial description. In Swiss tax practice, that assumption has a measurable cost.
This post is a market observation and does not constitute tax advice or legal counsel. Readers should obtain independent professional advice in relation to their specific circumstances.
