The Simplified Capitalised Earnings Method: How the German Tax Office Values Your Company

When a company in Germany is given away or inherited, the tax office needs a value. If no other evidence is available, it calculates under the simplified capitalised earnings method of §§ 199 ff. BewG (the German Valuation Act) — and the result is regularly well above what a buyer would pay in the market.

Where a figure has to hold up in front of a buyer, a bank or a court, our approach to company valuation explains how we arrive at it.

For owners handing their business to the next generation this is not an academic question. The value determined this way is the tax base for inheritance and gift tax. It helps decide whether the handover holds together fiscally or triggers a tax charge the business first has to earn. This article explains the mechanics behind the tax calculation. It is not a substitute for tax advice.

When the method applies at all

§ 11 (2) BewG sets a clear order of precedence. First: if the fair value can be derived from arm's length sales concluded less than a year ago, that price governs. A genuine market price beats any formula.

Where no such sale exists — the normal situation in a family-internal handover — the value has to be determined by reference to earnings prospects or by another recognised method that is also customary in ordinary business dealings. That is exactly where the simplified capitalised earnings method comes in: § 199 BewG permits it as a workable shortcut, provided it does not lead to obviously incorrect results.

In practice it is therefore the default route. Not because it is the best one, but because it is the simplest — and because nobody commissions an expert report as long as the result does not hurt.

The calculation in four steps

Step one: the average earnings. Under § 201 BewG, the operating results of the three financial years ending before the valuation date are added together and divided by three. A year not yet completed can replace the oldest one if it is more indicative of future earnings.

Step two: the adjustments. § 202 BewG cleans up the taxable profit. Added back are, among other things, investment deduction amounts, special depreciation, one-off disposal losses, extraordinary expenses and the income taxes actually paid. Deducted are one-off disposal gains, extraordinary income — and an appropriate salary for the owner, where the owner has so far drawn none or too little.

Step three: the flat tax deduction. A flat 30 per cent is deducted from the positive operating result for the income tax burden. Without any examination of whether the actual burden is higher or lower.

Step four: the capitalisation. The sustainable annual earnings figure arrived at this way is multiplied by the capitalisation factor, which under § 203 BewG is 13.75.

A worked example

The figures below are purely illustrative and do not replace a calculation in the individual case.

Item	Amount
Average operating result after adjustments	EUR 500,000
less 30 % flat income tax	−EUR 150,000
Sustainable annual earnings	EUR 350,000
× capitalisation factor 13.75	EUR 4,812,500

Almost EUR 4.8 million as a tax base, on an operating result of half a million. Whether a buyer would pay that price is, at first, of no concern to the tax office.

Why 13.75 is the real sticking point

A factor of 13.75 corresponds arithmetically to capitalisation at around 7.3 per cent. For an owner-managed mid-sized company with key-person risk, customer concentration and limited scalability, that is a remarkably friendly assumption. Buyers in this size bracket work with considerably higher return requirements — and therefore arrive at lower values.

The factor has been fixed in law since inheritance tax was reformed in 2016. Before that it was tied to the base interest rate and, during the low-interest years, climbed to levels well above 13.75. Fixing it was a defusing measure — but not an adjustment to the market. A rigid factor reflects neither sector nor size nor risk. Why exactly that is the core of any serious valuation is shown by the comparison in capitalised earnings versus DCF.

The net asset value as a floor

There is a floor beneath the valuation: the net asset value — the sum of the fair values of all assets less liabilities — may not be undercut. This affects asset-heavy businesses with weak earnings above all. A company with substantial property or machinery and thin profits is therefore taxed on its substance, even where the earnings value falls below it. What gets counted is explained in the net asset value method.

The emergency brake: obviously incorrect results

§ 199 BewG only permits the simplified method where it does not lead to obviously incorrect results. That clause cuts both ways — the taxpayer can also rely on it and demonstrate a lower fair value, for instance through an expert report prepared under a recognised method such as IDW S1.

That costs money and is not always worth it. But where earnings fluctuate sharply, where the last three-year period was unusually good, where the business depends heavily on the owner, or where the sector is in upheaval, the gap between the formula value and the expert value can quickly run into six figures. The arithmetic is mundane: the cost of the report against the tax saved.

What this means for succession planning

The valuation date is the day of the transfer. And because the formula reaches back to the last three completed financial years, timing is part of what determines the tax burden. Three strong years before the handover push the value up; a year of investment with a depressed result brings it down.

This is not an invitation to suppress profits — it is an argument for planning the handover early and with an eye on the numbers. How the value then works through in tax terms depends on the Verschonungsregelung, the relief that can exempt 85 or 100 per cent of qualifying business assets. Only both calculations together give the full picture. The framework for that is set out under business succession.

And in Austria?

In Austria the question does not arise in this form, because inheritance and gift tax were abolished. Valuation questions surface there in other contexts — in settlement payments, shareholder disputes, or real estate transfer tax on property. The methodology is similar; the fiscal pressure is different.

Real value emerges in negotiation, not in a formula. For a realistic, independent assessment: IGCP Capital Partners.

FAQ

Is the tax office's figure the value I would achieve in a sale?

No. The simplified capitalised earnings method is a fiscal standardisation, not a market price. The sale price emerges in negotiation with a specific buyer and, for mid-sized companies, frequently sits below the tax figure — and in rare cases, where there is strategic interest, above it.

Can I decline to use the simplified method?

The method is an option, not an obligation. You can base the valuation on another recognised method from the outset. That makes sense whenever the formula produces a value that is clearly too high.

Which three years exactly count?

The three financial years ending before the valuation date. A year already under way and not yet completed can replace the third-oldest if it is more indicative of future sustainable earnings.

Why does the capitalisation factor matter so much?

Because 13.75 corresponds to capitalisation at roughly 7.3 per cent, which is a friendly assumption for an owner-managed business carrying key-person risk and customer concentration. Buyers demand considerably higher returns, so their values come out lower.

What is the net asset value floor?

The sum of the fair values of all assets less liabilities. The valuation may not fall below it, which mainly affects asset-heavy businesses with weak earnings — they are taxed on substance even where the earnings value is lower.

When is an expert valuation report worth commissioning?

Where earnings fluctuate sharply, the last three years were unusually good, the business depends heavily on the owner, or the sector is in upheaval. In those cases the gap between formula and report can run into six figures, and the cost of the report has to be weighed against the tax saved.

Does this method apply in Austria too?

Not in this context. Austria abolished inheritance and gift tax, so valuation questions arise there in other settings, such as settlement payments, shareholder disputes or real estate transfer tax. The methodology is similar; the fiscal pressure is not.