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A successful succession plan must not only ensure the future leadership of the company but also avoid tax-related pitfalls in order to safeguard the company’s financial stability. This article highlights key tax and legal aspects of business succession and outlines possible structuring options, which should always be discussed with a tax advisor in light of the company’s individual, case-specific situation.
1. The Importance of Business Succession
In Germany, a significant proportion of companies will face the challenge of finding a succession plan in the coming years. According to a study by the Institute for Small and Medium-Sized Enterprise Research (IfM) in Bonn, approximately 27,000 businesses are transferred each year, affecting around 400,000 jobs. Proper planning is therefore important not only for the business owner but also for the economy as a whole.
2. Tax Challenges
Inadequate or suboptimal succession planning can lead to significant tax burdens. The most important tax issues related to business succession are:
a) Inheritance and Gift Tax
When a business is transferred as part of an inheritance or gift, inheritance or gift tax is generally due. The tax base is determined by the fair market value of the business, although higher tax exemptions can be utilized in the case of a gift. However, the law provides for special benefits for business assets
Standard Settlement
Option Extension
b) Income Tax
If the business is transferred as part of a sale or a transfer for consideration, income tax is due on the capital gain. In this case, business owners may utilize the exemption under Section 16 of the Income Tax Act (EStG)
c) Real Estate Transfer Tax
If real estate is also transferred as part of business succession, real estate transfer tax may apply. However, exemptions may be available under certain conditions, particularly if the transfer takes place within a family group.
3. Legal Considerations
The fundamental decision regarding the legal structure of the transaction is the choice between a share deal and an asset deal. The latter is the only option for sole proprietorships, as the legal entity of the sole proprietorship is identical to the business owner. The owner holds both the liquid assets and the liabilities of the business, and is entitled to the receivables from invoices issued to customers, since he is the contracting party for all customers and creditors.
Since a seller of a business generally wishes to transfer all existing obligations, liabilities, and debts upon ceasing business operations, and the buyer generally wishes to assume existing contracts with customers and suppliers on a one-to-one basis, the share deal is generally the preferred method of business transfer for corporations. This is particularly important when it is not expected that a buyer would be able to enter into contracts with customers that are equivalent in scope and value to existing ones. This is typically the case when a company, for example, holds large volumes of standard contracts, as is often the case with providers of telecommunications equipment or consumer contracts for energy supply and similar services.
If such a business transaction were structured as an asset deal, the acquirer—since it would then be a new legal entity—would have to renegotiate each existing contract individually with all customers. It goes without saying that, with thousands of customers—especially under the same terms—this would be highly unlikely. The same applies, incidentally, when companies have “valuable” supplier contracts with large corporations—such as automotive or medical technology groups—where the supplier number is tied to the company’s legal entity. If this legal entity is not transferred, all supply contracts would have to be restructured—often as part of complex bidding and certification processes. It is difficult to imagine that it would be possible to continue all customer contracts unchanged with a new supplier number in this manner.
Therefore, where possible, a share deal—a form of transaction in which, under a “share purchase agreement,” only the ownership interests in the legal entity are transferred—is generally the preferred method for transferring the business. Of course, each individual case must be examined as part of the due diligence process, and encumbrances—such as the unwanted assumption of pension provisions owed to the former managing director or shareholder—may indicate that other forms of transfer should be chosen. However, in the interest of brevity and clarity, it is not possible to go into all the details here.
4. Tax Planning Options
There are various models and approaches for structuring business succession in a tax-optimized manner. These require careful and well-thought-out planning:
a) Anticipated Succession
A popular model is anticipated succession, in which the business is transferred to the next generation while the owner is still alive. This allows the tax burden to be better planned and distributed. In addition, gift tax exemptions can be utilized, and the successors have the opportunity to familiarize themselves with the company’s management later on.
b) Family Holding Company
Another option is the establishment of a family holding company, in which the business is consolidated and the shares are gradually transferred to the successors. This model offers various tax advantages, including the use of the so-called “partial income method” for profit distributions.
c) Sale of the Business
By far the most common form of business transfer is the sale of the business. Only about 32% of family businesses are still transferred within the family when the business owner retires; the majority of companies are sold on this occasion. If the business is a sole proprietorship or a partnership (oHG, GbR, KG, PartG) and the owners have reached the age of 55, , they have a one-time opportunity, pursuant to Section 16(4) of the Income Tax Act (EstG), to deduct a capital gains exemption of up to €45,000 and thus avoid having to pay tax on the full amount of the capital gain. This provision does not apply to shareholders of corporations.
d) Foundation Solutions
Especially for large family-owned businesses, establishing a foundation can be a sensible option. A foundation used as a succession planning tool can ensure that the business is preserved in the long term and continues to be managed by the family without incurring tax burdens from inheritance or gift taxes.
e) Buy and Build, MBI, MBO
Last but not least, there are also hybrid forms between the traditional sale of a business and retaining ownership through an equity stake. Structuring options here can include, for example, buy-back arrangements or “buy and build” structures, equity models involving a manager from within the company (MBO), or the partial sale to external MBI candidates, with whom earn-out clauses or seller loans can be agreed upon in the purchase agreement. Their tax implications also vary greatly: while a seller’s loan results in a tax liability owed directly to the tax authorities upon the sale of the company, the tax liability for an earn-out arises only in the future and depends on the actual earn-out amount, which is agreed upon in advance based on earnings or revenue. Here, too, tax considerations—particularly the financing of the acquisition—play a major role.
5. Conclusion
Business succession is often a complex issue—not only emotionally, but also in terms of legal procedures and tax implications. Business owners should discuss the various tax pitfalls and structuring options with experts to successfully transition the business to the next generation in a tax-optimized manner. Careful planning and taking advantage of statutory benefits can help minimize the tax burden and ensure the company’s continued existence
Business succession is more than just the transfer of a business—it is about securing the future of a lifetime’s work.
