Simplified capitalized earnings method in german practice
Company valuation for inheritance and gift tax and other purposes in Germany
There are various approaches and methods for the valuation of companies and shares in Germany. The simplified capitalized earnings method plays a significant role, especially for the determination of tax values, but also in german civil law.
According to the german valuation law (§§ 199 et seq. BewG) the simplified capitalized earnings method is a possible method for the valuation of sole proprietorships, partnerships or corporations in Germany. Like all capitalized earnings methods, the simplified capitalized earnings method assumes that the value of a company results from its ability to generate future surplus income.
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Basic methodology in german practice
In principle, the simplified capitalized earnings method multiplies the sustainably achievable annual income by a capitalization factor. In determining the annual income to be generated in the future, the results of the last three completed financial years are used as a basis. The basis for this is the profit as defined by the German Income Tax Act, which is converted into a corrected operating result by adding certain factors - such as special depreciation or non-recurring extraordinary expenses - and reducing them - for example by non-recurring capital gains. The average value of the operating results determined in this way for the last three financial years results in the sustainably achievable annual earnings.
In order to extrapolate this annual income into the future and thus determine the capitalized earnings value of the company, the calculated annual income is multiplied by a capitalization factor, which is the reciprocal of a capitalization interest rate. This is made up of a variable base interest rate calculated annually by the German Central Bank and a flat-rate risk premium.
It must be taken into account that from the determined capitalized earnings value of the german company
- the assets not required for operations,
- investments in other companies and
- assets invested for the short term
must be recorded separately and stated at their fair value, i.e. the value that would normally be achieved on disposal.
Practical significance for business valuation in Germany
The simplified capitalized earnings value method plays an important role, particularly in the area of german inheritance tax law. In the area of inheritance tax or gift tax, it is used if there are neither stock market prices nor values from sales within one year prior to the reference date (inheritance, gift) for the company to be valued.
Corrections are made under tax law if the simplified capitalized earnings value method leads to obviously incorrect results. Often, a valuation according to the simplified capitalized earnings value method actually leads to high company values with corresponding consequences for taxation. In german practice, it is then the task of the tax advisor or tax lawyer in particular to refute these values using other methods.
Outside of german tax law, however, the simplified capitalized earnings value method can also be found in company agreements as a reference value, for example for the compensation of a departing shareholder.
In the area of corporate transactions (M&A) as well as in court, for example in the case of a dispute about the calculation of the compulsory portion, the gain or a severance payment, the more accurate capitalized earnings value method IDW S1 dominates in german practice.