When starting a business, there are various factors to consider in order to find the supposedly “right” legal structure. Entrepreneurs based in Germany often choose a limited liability company (GmbH), not least because its very name implies limited liability. Of course, there are also a number of other reasons why a GmbH might be the best choice.
If a company takes over an existing GmbH as part of a business succession—whether through a purchase or anticipated inheritance—the initial decision regarding the legal form is effectively taken care of. Choosing a GmbH as the legal form is likely to be the right decision in many cases—in particular, it is a first step toward the “exit readiness” discussed here, that is, the state in which the groundwork has been laid for a tax-optimized sale of the business.
On the path to selling a business, the ongoing taxation of a GmbH is quite attractive: The GmbH’s income is generally subject to corporate income tax, the solidarity surcharge, and trade tax. If the GmbH conducts a significant portion of its business in a municipality with a tax base rate of 400%, the GmbH’s profits are generally taxed at a rate of approximately 30% (corporate income tax, solidarity surcharge, and trade tax).
However, the taxation of a GmbH in the event of an exit—that is, the sale of shares—is far more interesting: If a shareholder of a GmbH who holds more than a 1% stake in the company decides to sell their GmbH shares, the capital gain (sale price minus transaction costs and acquisition costs) is subject to the so-called “partial income method.”
This means that 40% of the capital gain is tax-free, and the remaining 60% is taxed at the individual tax rate of the taxpayer-shareholder. In the case of a very successful exit, the individual tax rate is, of course, particularly high, reaching a peak of approximately 28.5%. When determining the taxable capital gain, however, it should also be noted that both transaction costs and acquisition costs may each be deducted at only 60%.
Given that the acquisition costs for founding shareholders are typically limited to their proportionate share of the GmbH’s share capital—that is, up to 25,000 EUR—this deduction is not particularly significant in any case.
Even more interesting for many company founders or shareholders of a GmbH is the sale of their GmbH shares through a holding corporation. That is, they do not hold their GmbH shares directly, but only indirectly through another corporation—namely, the holding corporation. This structure offers the advantage that the capital gain from the sale can generally be received tax-free by the holding corporation, and only 5% of the capital gain is treated as so-called non-deductible business expenses, so that the effective tax rate is typically around 1.5% (simplified summary: 30% (corporate income tax, solidarity surcharge, and trade tax) × 5% = 1.5%).
An exit utilizing a holding corporation (UG or GmbH) offers the particular advantage that the virtually tax-free capital gain can be used by the holding corporation to establish new investments or finance existing ones—ideally in the legal form of subsidiary corporations. Profit distributions from the holding corporation are subject to a flat withholding tax rate of 26.375% for its shareholder, provided that the shares are attributable to the shareholder’s private taxable assets.
If a company founder’s objective is focused on a sale from the very outset of establishing the company—a goal that startup founders often pursue from the very first steps of their venture—a holding corporation should first be established, which will then set up the actual operating GmbH. In addition, it is also entirely possible to insert a holding corporation at a later stage, particularly if the company founder holds more than a 50% stake in his or her GmbH.
However, the tax regime—which allows for a 1.5% tax rate upon exit—is only fully realized after a seven-year waiting period in the case of a subsequent “interposition” of a holding corporation, because the tax authorities do not wish to automatically exempt the taxable GmbH shareholder from the partial income procedure described above.
Over the course of seven years, the GmbH shareholder can “grow out of” the partial income regime by taking certain corporate and tax law measures through the “interposition” of a holding corporation, with an improvement in status of 1/7 occurring each year after the intermediary measures are taken, meaning the partial income regime gives way to the preferential tax rate of approximately 1.5%. Capital gains of the operating GmbH that arise during the seven-year period are also subject in full to the 1.5% tax rate at the level of the “interposed” holding corporation.
Thus, there are good reasons to assess “exit readiness” when incorporating a company—or even later—in order to take timely action, especially when long (seven-year) transition periods must be taken into account.
