Many companies face the question of whether restructuring is necessary in the course of their existence. In particular, it is about the way in which the conversion should take place in order to generate the greatest possible advantage for the company. For example, the outsourcing of fixed assets from a real estate GmbH to an independent GmbH & Co. KG comes into consideration. The conversion law constitutes the legal framework in civil law. What reasons and advantages a conversion can have is described in our article, as well as the different types of conversion, as well as the tax and other resulting consequences.

In the first part on conversions and their tax relevance, we explain the different possibilities for converting companies.

There are several circumstances that lead to a transformation of a company. The conversion law distinguishes here four types of conversion, namely by merger, by division, by change of legal form or by transfer of property. A division in turn includes the possibilities of splitting, spinning off or spinning off individual divisions of a company. Capital transfer, on the other hand, is a special form of the other variants. In addition, other forms of conversion are also possible, which take place without application of the conversion law. However, since they have no relevance for companies, we do not present them.

The conversion of a company is therefore the subject of the conversion law established under civil law. This must be distinguished from the conversion tax law, which deals with the tax effects of the conversion of a company.

In some cases, situations may occur which are assessed differently in the sense of the conversion law, but which have the same tax consequences under the conversion tax law.

A merger is when two or more companies are merged. This means the classic case of a merger. Both the continuation of one of the undertakings involved in the merger and the merger for new creation are possible.

2.1.2 Benefits and other reasons for merger

The advantages of a merger can be many. On the one hand, this is an opportunity to give the parties to the merger a competitive advantage by gaining market power or using synergies more efficiently. Further reasons for a merger may be of a legal nature. It should also be noted that the conversion of a company is often more advantageous from a tax point of view than a sale. Even personal reasons, for example, on the part of the entrepreneur or management can lead to a merger of companies. Even political reasons, such as Brexit, can be the impetus for a merger.

2.1.3. The four main types of merger

The four main forms of merger include the merger of a partnership to a partnership (e.g. OHG to KG), a partnership to a capital company (e.g. KG to GmbH), a capital company to a partnership (e.g. GmbH to OHG) and a capital company to a capital company (e.g. GmbH to an AG).

2.2.1. Splitting

In a split, an existing company is divided into two or more companies. The existing company is wound up without being wound up by transferring its assets to the resulting companies. In return, the shareholder of the dissolved company receives shares in the newly created companies. This process is thus in a sense the counterpart to the merger.

2.2.2. Separation

However, if a company only wants to transfer a partial operation to an independent company, it is called a spin-off. This therefore means that the previously existing company will continue to exist after the spin-off. Thus, only a partial transfer of its assets takes place. In return, the shareholder of the divestiture will receive a shareholding in the companies resulting from the divestiture.

2.2.3. Derivation and transfer

Very similar to the separation is the case with a spin-off. However, here the shareholdings are transferred instead to the divestiture company. For example, a part of a GmbH could be spun off to a GmbH & Co. KG. In this way, the spin-off creates a subsidiary. The spin-off part of the GmbH is transferred to GmbH & Co. KG.

Of course, a spin-off to a subsidiary can also be reversed. This can be achieved by introduction. The transferring subsidiary is then essentially merged with the parent (merger of subsidiaries to parent). Therefore, the conversion law considers such a transfer to be a merger rather than an independent form of conversion. In our above example for spin-off, GmbH & Co. KG would then be merged into Mutter-GmbH by transfer.

A change of legal form of a company takes place. Since the company remains in existence, there is no change in the legal entities. The owners are therefore the same after the change of form as before. A typical example is the conversion of a KG into a GmbH.

The transfer of assets is the general term for situations in which a merger, division or change of legal form takes place, in this case from a consideration which does not consist in company rights such as money or economic goods. Such an exception, in which no liquidation takes place when a company is dissolved, usually takes place only in the case of assets in public hands. This is the case, for example, if companies of the Federation or the Länder are to be sold. The conversion law therefore provides for an independent form of conversion.

Having presented the types of conversion relevant for companies, we now come to the tax implications. This is primarily governed by the conversion tax law. However, civil aspects of the conversion law must also be considered.

The conversion of a company is of course also relevant in terms of income tax. For example, a change of legal form from a trading company to a corporation requires a change in the type of income for the shareholders. For example, the shareholders of an OHG earn income from business operations, while GmbH shareholders have to tax income from capital assets, for which in turn other taxation standards apply.

As a rule, conversions do not lead to any consequence in sales tax. However, the requirements of the VAT Act must be observed. Only so-called business divestments in their entirety (GiG) are affected. If, on the other hand, a conversion affects only parts of a company that are dependent on other parts, the conversion will also have an impact on the VAT.

In connection with a conversion, input tax can often also be taken into account. This applies in particular to the consultation in the preceding plans.

If a property is also affected during a conversion, real estate transfer tax may also apply. If a conversion also entails a change of legal entity, real estate acquisition tax is also payable on the real estate affected by the conversion. An example where a conversion triggers a real estate transfer tax is the merger of two companies (Immobilien-GmbH & Co. KG on GmbH).

If a change of legal form takes place in the context of a conversion in which both a partnership or individual enterprise and a corporation are concerned, corporate tax is also relevant. A possible example of this is the change of shape from an OHG to a GmbH.

Business tax must be taken into account in particular in situations where a company changes its commercial character. This is the case, for example, with a freelance lawyer who wants to convert his law firm into a GmbH.

A conversion in which no consideration is given constitutes a gift. In such cases, a gift tax is therefore also to be expected. The following example would be conceivable: Parents would like to leave a part of their GmbH to their child, so that they gain experience from the self-responsible management of a small company. This may be planned in preparation for the future takeover of the entire parental business. For this purpose, the parents split off the planned part of the business in the form of a UG and give it to the child, whereby this process triggers gift tax.

If the conversion takes place in conjunction with foreign companies, the provisions of international tax law are also relevant. Current examples are the cross-border mergers of an English Limited to a German GmbH that take place as a result of Brexit.

In addition to the direct tax implications of a conversion, indirect effects can also be added. There are regulations for this in the conversion law as well as in the conversion tax law and in other regulations.

One of the many aspects of a conversion can concern the utilization of a loss carry forward. Whether an existing loss is lost as a result of the conversion process depends in particular on the form of company of the undertakings affected by the conversion. For example, a change of legal form from a corporation to a partnership entails the cancellation of any loss carry-forwards for both corporate and business tax.

In the conversion law, the legislature has created the legal basis for a retroactive conversion. This allows backdating of the conversion process by up to eight months. However, this shall be subject to the submission to the competent registry of a final balance sheet documenting the date of conversion less than eight months ago. This is then also recognized as a tax transfer date by the conversion tax law.

Incidentally, conversions can also be dated back to a date when a company concerned did not even exist. Lawyers speak of a fiction, i.e. of a situation that is regarded as given solely on the basis of the legal requirements and is treated accordingly for tax purposes.

To illustrate this in more detail, the following example is constructed: A GmbH is founded on 01.03.2019. On 31.08.2019, operating assets will be transferred to the GmbH. This is to be asserted retroactively for eight months, i.e. on 31.12.2018. Even if the GmbH did not exist at that time, this is possible through legal requirements.

A balance sheet shall be drawn up at the reference date of the conversion. Therefore, if you want to use the balance sheet of the previous year for the conversion of a company, you must initiate the retroactive conversion at the latest by 31.08. of the following year. In this example, however, we assume that the marketing year corresponds to the calendar year. If the marketing year follows another arrangement, the eight-month period should also be adjusted accordingly. However, if this deadline is not met, a separate conversion balance must be established for the relevant date of conversion. Although neither a profit and loss account nor an appendix is required in this case, this still leads to additional costs that would be avoidable by meeting the deadline.

A balance sheet to the reference date is to be prepared. Therefore, a retroactive effect of eight months is usually claimed, so that by 31.08. the notary must initiate all necessary steps for conversion. It is sufficient to submit the regular balance sheet of 31.12.2018. Finally, the conversion balance sheet is subject to the condition that it has been drawn up in accordance with the general rules which also require the regular balance sheet to be drawn up for the annual accounts.

Conversions can also affect those valuation measures that are freely selectable by the companies concerned. As part of the conversion, however, appropriate applications must be made to the competent tax offices. For example, only an application for continuing book value guarantees the desired tax neutrality of a merger.

Finally, it should be noted that the conversion of companies often also requires a notarized deed. In principle, two basic conditions for the requirement of a notarial deed can be distinguished here: conversions which necessarily provide for a notarial deed and those which require a notarial deed by general formal rules. However, conversions are also possible which do not require mandatory certification.

4.5.1. Conversions requiring mandatory notarisation

This includes transformations by change of form and by merger. For example, a notarized notarization is required for a change of form from a KG to a GmbH. Exemplary for a notarized deed by merger is the merger of a GmbH to an AG.

4.5.2. Indirect requirements of a notarial deed for conversions

On the other hand, a conversion may indirectly require notarization. This is necessary, for example, in situations where rights in a property are affected by the conversion. The principle of § 311b (1) BGB applies here that transfers of real estate require notarial deed. If a GmbH transfers a property to a GmbH & Co. KG, then the transfer of the property must be notarized.

Furthermore, the general principle applies that amendments to the articles of association of corporations are notarized. For example, the amendment of the articles of association of a GmbH to the incorporation of a GmbH other than a shareholder leads to an amendment of the articles of association which, according to the GmbHG, requires a notarized deed.