What taxes are involved in the sale of a business?
When planning business succession and transfer, a multitude of financial, economic, organizational, and—in particular—emotional questions arise: To whom, in what manner, under what circumstances, and with what intention will the business be transferred? Will the business be handed over to the next generation, or should—or perhaps must—it be transferred outside the family? What are the implications of the wide range of options for employees, customers, and suppliers, as well as for other business partners and stakeholders?
Business succession planning is a complex process that requires consideration of a wide range of perspectives—and the tax implications of selling a business are often given secondary consideration, or none at all, especially at the outset of the planning process.
However, this can lead to significant pitfalls, untapped potential, and consequently, (negative) economic consequences as well as missed opportunities. Various types of taxes play an important role in the transfer of a business and should be viewed comprehensively and holistically and given appropriate consideration in the decision-making process.
Why is comprehensive planning of tax issues so important?
Income tax, business tax, corporate income tax, inheritance and gift tax, value-added tax, real estate transfer tax, …—it’s important to keep track of all these.
Let’s take a look below at various types of taxes and their significance.
First and foremost are the seller’s personal income tax—or, in the case of a sale by a corporation, corporate income tax—as well as trade tax. These taxes apply to the capital gain from the sale of the business, which is calculated,for example,¹ as:
The actual taxation of the capital gain calculated in this way depends in particular on the legal form of the seller as well as that of the business itself.²
Accordingly, a prior analysis of the options for ending one’s business involvement (a so-called “exit”) is and remains essential—the tax treatment and optimization of these options can have a significant impact on the tax burden on the capital gain. Ultimately, this raises the question of how much of the sale price remains “net” for the business owner after paying taxes.
Two examples to illustrate this: In both cases, a business is to be sold.
In the first case, an individual owns a sole proprietorship and wishes to sell it. The gain on the sale is subject to income tax at the individual’s personal tax rate, which can be as high as45%³. Trade tax should generally not apply upon the complete dissolution of the business; however, this depends on the specific circumstances of each case. If certain conditions are met, special rates and tax exemptions may also apply, which reduce the tax burden accordingly.
In the second scenario, the business being sold is a corporation held by a natural person through another corporation (a holding company). The sale of the business in the legal form of a corporation triggers corporate income tax (15%⁴) and trade tax (typically between 12% and 17%—depending on the regional trade tax assessment rate) at the level of the selling holding corporation. However, 95% of the capital gain from this sale is effectively tax-exempt, so that, as a result, the capital gain is subject to only approximately 1.5%⁵ in corporate income tax and trade tax.
However: In this second case, the proceeds from the sale remain within the holding company and do not go to the individual—so how does the money reach the individual’s personal account?
A transfer of the liquid funds triggers further taxation, for example, in the form of a profit distribution from the holding company to the individual. Personal income tax (tax rate up to 45%) on the income from the profit distribution must also be taken into account here; however, 40% of this income is generally tax-exempt, so the effective tax rate amounts to up to27%⁶.
What does this mean in concrete terms for the tax burden?
In this case, the difference in the tax burden resulting from the exit amounts to T€ 211. This illustrates how significantly the tax burden of a business transfer can vary and, consequently, have a material impact on the entrepreneur’s cash inflows.
It should be noted that this is an illustrative example that cannot be directly applied to individual cases; however, it gives an idea of the importance of considering tax aspects. Depending on individual circumstances, the sale of a sole proprietorship by an individual may, in some cases, represent the more tax-efficient option. Through forward-looking planning and consideration of tax aspects in business succession, it is possible to pursue the most advantageous path for the business transfer on an individual basis.
Family Succession and Gifts
If the business is not sold but is transferred within the family (through inheritance or anticipated succession) or by way of a gift —and thus without consideration—other issues generally arise, particularly those related to estate and gift taxes, the amount of which depends, among other factors, on the degree of kinship as well as the number and value of the estate(s) or gift(s). Tax exemptions and benefits may be claimed—these typically require, for example, the continued operation of the business, particularly in the case of business transfers.
Additional Tax Considerations
Value-added tax (VAT) issues must also be taken into account during a business transfer and can, in some cases, represent a surprising cost factor—for example, caution is advised regarding the (co-)transfer of real estate and its treatment for VAT purposes.
If the business includes real estate, buildings on third-party land, and/or rights equivalent to real estate (such as hereditary building rights), the real estate transfer tax must be taken into account as a transfer tax. Depending on the federal state, this tax amounts to up to 6.5% of the market value or the tax-assessed value of the property. Particularly in business transfers involving multiple steps, there is a risk of triggering real estate transfer tax multiple times. As a rule, real estate transfer tax is borne economically by the buyer of a business—however, according to the wording of the law, the seller or the property-owning company itself is often also an (additional) taxpayer liable to the tax authority—which demonstrates that the issue of real estate transfer tax should always be kept in mind.
Conclusion
Our experience shows that, when it comes to business succession and transfer, foresight in addressing tax issues is essential; failing to consider tax issues can cost you money.
Tax considerations should be integrated from the outset into a holistic strategy alongside other important, non-tax-related issues—thorough preparation pays off. Bring an experienced tax advisor on board to help you navigate the complexities of various tax issues right from the start.
Footnotes
1 For the sake of simplicity in illustrating how to calculate the capital gain for tax purposes, example values were used.
2 In addition, the seller’s personal circumstances, such as age and marital status, can also play a significant role.
3 In addition , the solidarity surcharge and, where applicable, church tax may apply; for the sake of clarity, these are not listed separately in the text that follows.
4 See footnote 3—the solidarity surcharge is also applicable.
5 Assuming a combined tax rate for corporate income tax and trade tax of 30%; multiplied by the taxable portion of 5% = effective tax burden of 1.5%.
6 In principle, a more favorable tax treatment may apply, resulting in a tax rate of 25% plus the solidarity surcharge and church tax. Profit distributions are generally subject to a 25% capital gains tax plus the solidarity surcharge and church tax; this tax is withheld by the distributing corporation and remitted to the tax office. The recipient of the profit distribution may have this capital gains tax credited against their personal income tax—or, through the more favorable tax treatment test, it may have a final settlement effect (in lieu of personal income tax).
7. Case: Sale of a sole proprietorship by a natural person—assumed tax rate of 45%; Case: Sale of a corporation by a holding company—assumed tax rate of 30% consisting of corporate income tax and trade tax, with a 95% tax exemption on the proceeds, i.e., an effective tax rate of 1.5%.
8 See footnote 7; in principle, a 25% capital gains tax plus the solidarity surcharge and, if applicable, church tax is levied on profit distributions; in this example, the calculation was based on 26.375%, thus excluding church tax.
