equity according to fiscal balance sheet | 95,000 €

./. tax deposit account according to § 27 KStG i. V. m §§ 28, 29 KStG | 55.000 €

= Remuneration within the meaning of § 7 UmwStG | 40.000 €

Value with which the assets are to be taken over | 95,000 €

./. Cost of transfer of assets | 10,000 €

./. acquisition costs of the shares in the GmbH | 25.000 €

= Takeover profit first stage | 60,000 €

./. Remuneration according to § 7 UmwStG | 40.000 €

= second stage acquisition profit | €20,000

If you want to start a company as an individual entrepreneur, the choice of a sole proprietorship as a legal form often makes sense, because the establishment is very simple. However, it also often happens that at a later date the GmbH is more suitable as a legal form. This is in particular due to the limitation of liability, which as a sole proprietor only too much would like to implement for the protection of private assets. But if the idea of a company sale gradually comes to the fore, from a tax point of view, the individual company may prove to be more advantageous. If such a plan takes concrete form, this can mean that one tries to return to the old legal form by converting the GmbH into a sole proprietorship. The transformation of a GmbH into a sole proprietorship differs significantly from the opposite case. What special features the transformation of a GmbH into a sole proprietorship reveals is described in the following article.

I. Introduction

In today’s business world, many entrepreneurs strive to flexibly adapt their corporate structure to current requirements. This can be done for both civil and tax reasons. One of the most common adjustments in this context is probably the conversion of a sole proprietorship into a GmbH in order to limit personal liability to the company assets. This makes perfect sense if a company grows and, for example, a high liability risk arises. However, you can still see today that the sole proprietor with a share of approx. 59.2% is the most frequently chosen legal form in Germany.1 Of course, this is also because it is the easiest legal form to establish. However, there is also the question of what advantages a sole proprietorship may offer as opposed to a corporation. For example, especially if a sale of the company is planned and the entrepreneur the 55. has completed the year of life, tax advantages for the sole proprietor. However, many find it difficult to adapt their legal form to their current business circumstances. This is often due to the fact that entrepreneurs do not know what consequences could occur in such a conversion of the legal form, especially with regard to tax treatment. Therefore, there are certainly occasional questions for sole shareholders of a GmbH, for various reasons, as to whether such a conversion into a sole proprietorship should also be carried out tax-neutrally.

In order to answer this question and to get a better overview of this topic, I have examined in detail the transformation of a GmbH into a sole proprietorship in the following. Initially, this work will provide more insight into the form in which such a transformation is possible and the reasons for such a transformation. In particular, there is talk of conversion by merger. Furthermore, the tax treatment of a conversion from a GmbH to a sole proprietorship is examined in detail. Both the tax retroactive effect and the effects on the transferring GmbH and the acquiring individual company are examined in detail.

II. General

1. conversion methods in the context of GmbH into individual companies

In the case of a transformation from a GmbH into a sole proprietorship, the aim is that the operation of the GmbH is continued by the previous shareholder and the legal entity does not remain in existence.2 One might think that this is possible, on the one hand, through a change of legal form and, on the other hand, through a merger into a sole proprietorship that already exists or is to be set up. However, a conversion to a sole proprietorship acc. § 3 Abs. §§ 120 – 122 UmwG only possible through a merger. This can also be seen in § 226 UmwG, since it does not mention the possibility of a change of legal form from a limited company to a sole proprietorship. Although the change of legal form does not constitute a possible conversion, there are three different alternatives for the merger to a sole proprietorship.

a) Merger into an existing sole proprietorship

As a rule, the merger mainly takes place in this way and therefore represents the most common type in practice. In this case, the natural person already leads a sole proprietorship in addition to the GmbH. Legally, this is referred to as merger by acquisition, since the assets of the transferring entity are merged with the assets of an existing entity.3

b) Merger into a sole proprietorship

Here, the assets of at least two legal entities, for example two GmbHs, are transferred to a newly founded sole proprietorship in accordance with the provisions of the Commercial Code. The transferring legal entities are dissolved and only the newly created legal entity remains in accordance with § 20 para. 1 No. 1 and 2 UmwG. In principle, they do not lead to any real difference, but the merger with the new entity can be advantageous, for example, if two or more equally strong transferring entities cannot agree on who should become the assuming entity.4 A disadvantage in turn exists in relation to the real estate transfer tax, since both transferring legal entities transfer their real estate to the receiving legal entity and thus higher real estate transfer tax can be incurred.5

c) Merger into a sole proprietorship of freelancers

First of all, the third possibility seems a bit more complicated, since it is a merger to a non-merchant. This applies in particular to freelancers who do not operate a trade and are therefore not obliged to register as a merchant according to §§ 1 ff. Thus, it is not the registration of the sole proprietorship that gives effect to the merger operation, but the registration of the merger in the register of the registered office of the merging limited liability company acc. § 122 Abs. 2 UmwG6

2nd reason for conversion into a sole proprietorship

The conversion of a GmbH into a sole proprietorship is not the most common type of conversion, but there are reasons why it is important to consider converting your GmbH back into a sole proprietorship. In all cases, it must be assumed that the GmbH is managed by a sole shareholder. As the first and probably most obvious reason for the time being, but not the most common, here are the obligations of a GmbH regarding the accounting and the publication of the business balance sheets. Those commitments would be likely to be mitigated or less substantial if converted into a sole proprietorship. A further consideration for a conversion into a sole proprietorship arises if, for example, the limited company is over-indebted on the balance sheet and compensation can be achieved by discovering the hidden reserves. This is often referred to as renovation conversion. Now we come to what is probably the most frequent reason for conversion into a sole proprietorship, namely the possibility of avoiding often lengthy and sometimes undesirable liquidation procedures in the event of the dissolution of a limited liability company. Nevertheless, it should always be borne in mind in all these considerations that it is advisable only if there are no liability risks for the sole shareholder. After the merger of the GmbH into a sole proprietorship, the shareholder is liable for the liabilities of the previous corporation in full with his entire private assets.7

III. Tax consideration of a merger from a GmbH to a sole proprietorship

In the following, the tax aspects of the merger of a GmbH to a sole proprietorship are considered in detail. In particular, it will be discussed whether such a merger can proceed in a control-neutral manner and what needs to be considered.

1st Tax Retroactive Effect

Before starting the tax consideration of income and assets, however, it is important to clarify in which period such a conversion is even possible. First of all, it is assumed that this is directly regulated in § 2 UmwStG, which is also partly true, but in order to find out the exact period, one has to check another paragraph. § 2 UmwStG does not specify a deadline for retroactive effect, but only links the tax transfer date with the reference date of the balance sheet, which forms the basis for the transfer of assets.8 The retroactive effect of the transfer of assets for tax purposes on the date of the commercial balance sheet acc. § 17 para 2 UmwG fictitious. In the case of a calendar year which corresponds to the marketing year, this would be 31.12. of the respective year.9 Notwithstanding the fact that at this point the assets in rem has not yet been transferred and the transferring GmbH has not yet been dissolved, § 2 UmwStG for income tax, corporation tax and business tax considers the transfer of assets and the dissolution of the corporation to be completed on expiry of the tax transfer date. This is therefore a tax fiction in which the GmbH already expires on the tax transfer date due to the merger and the sole proprietorship is fictionally created at this time, although it may not yet exist under civil law.10 The period during which this tax fiction may exist and therefore applies retroactively is a maximum of eight months. This results from the fact that according to § 17 Abs. 4 UmwG the commercial balance sheet must have been drawn up no more than eight months before the relevant date for the application.11

Effects on the transferring GmbH

Basically, the valuation of the assets to be transferred, including intangible assets acquired free of charge and intangible assets created by the company acc. § 3 Abs. 1 UmwStG, with the common value.12 The common value represents the price which the economic good in question would obtain in the ordinary course of trade if sold.13 Approaching the common value results in the realisation and, consequently, taxation of hidden reserves. This ensures the legislator that even in the case of cross-border conversions, the taxation of hidden reserves takes place in Germany.14 However, since not every conversion is cross-border and the legislature also wants to offer a tax-neutral possibility for a conversion to come into question at all, there is a right to vote, which can be exercised.

a) Selection on request

This right of choice includes the possibility that the transferred assets can be valued either with the book value or a so-called intermediate value, i.e., a value between the book value and the common value, on request in the tax final balance sheet.15 The right of choice is not exercised by an agreement in the merger agreement, but as a rule by the recognition in the tax final balance sheet.16 However, the conditions acc. § 3 Abs. 2 S. 1 No. 1-3 UmwStG are fulfilled and the application must be submitted at the latest according to m. § 3 Abs. 2 S. 2 UmwStG until the first submission of the final tax balance sheet to the tax office responsible for the GmbH. In the following, two of the three conditions are dealt with. The third condition, according to which no consideration may be granted, is automatically fulfilled in this case, since it is only a shareholder.

aa) Operating assets and ensuring taxation of hidden reserves

The transferred assets must become the business assets of the natural person and later still be subject to taxation with income tax or corporation tax. This includes not only the commercial assets, but also the agricultural and forestry assets as well as the assets of the independent work.17 An exact statement about the time at which the assets must be available at the acquiring sole proprietorship is made in § 3 para. 2 UmwStG not taken. However, one can assume here the tax transfer date, since on this date the assets are transferred for tax purposes and valued.18 In addition, the taxation of the hidden reserves must be ensured by this date, otherwise an appraisal to book or intermediate values is excluded. It is important to mention that they are not necessarily subject to domestic income and corporate tax, but also a comparable foreign tax is recognized.19

bb German taxation law

The second condition, i.e. the safeguarding of the taxation right for the Federal Republic of Germany, relates only to the capital gain of the transferred asset. Therefore, it does not matter to whom the right to tax the proceeds from the use of the assets accrues after the merger.20 The safeguarding of the right to taxation is primarily understood in accordance with § 3 para. 1 No. 2 UmwStG, that the law of the Federal Republic of Germany is not limited or excluded.

b Possibility of trade tax deregulation

An important aspect, which is regulated in addition to the valuation choice law in § 3 UmwStG, but is not so consciously noticeable, is the option of trade tax deregulation of hidden reserves. This possibility arises from the above-mentioned fact that the transfer of assets is not limited exclusively to commercial assets, but can also be made to assets for agricultural, forestry and self-employed work. For the book or interim value approach, there is thus expressly no prerequisite for a continued trade tax involvement of business assets.21 A concrete example of this is the conversion of a tax consultancy GmbH, which has so far achieved commercial income due to its legal form, into a sole proprietorship tax consultancy. In this case, the sole proprietorship tax consultancy generates income according to § 18 Abs. 1 no. 1 EStG and is therefore not subject to trade tax liability.22 Of course, there is something to consider in this procedure. If the company were to be sold, discontinued or even partially sold within five years of the conversion, § 18 para. 3 UmwStG the profit from the sale or cessation of trade tax is subject to.

c Transfer profit

Another profit that can arise and is also in principle fully subject to business tax and corporate tax is the transfer profit. It arises as soon as the assets of the transferring GmbH are valued at an intermediate value or the common value in the fiscal balance sheet and thus trigger the discovery of the hidden reserves.23 This must be considered if one wants to have a higher depreciation volume in order to reduce the current profits of the acquiring individual company. It is particularly advantageous if accountable loss carry forwards are still present. These are in accordance with § 4 Abs. 2 S. 2 UmwStG with the conversion below, whereby the date of the transfer is the last opportunity to use the losses and convert them into depreciation potential. If existing loss carry forwards are used, however, the minimum taxation according to § 10d Abs. 2 of the Income Tax Act. Therefore, despite sufficiently high loss carry forwards, there may be a taxation of the transfer profit.24

3. impact on the acquiring individual

a valuation approach

The assets in the acquiring sole proprietorship are acc. § 4 Abs. 1 S. 1 UmwStG with the values of the tax balance sheet of the transferring GmbH. Indeed, there is a strict value link, irrespective of whether the assets are valued at book value, intermediate value or common value. This linkage ensures that the hidden reserves not yet discovered in the final balance sheet will later still be subject to taxation on the part of the acquirer.25 Therefore, it does not matter to what extent the legal entity exercises its commercial-balance-sheet option according to § 24 UmwG, since the principle of the relevance of the commercial balance sheet does not apply to the tax balance sheet.26 The only case in which a change in the final-balance values can occur is if there are changes due to an audit. In this case, the values of the opening balance of the acquiring sole proprietorship must also be adjusted, as this can have an impact on current taxation.27

b Tax status

The acquiring sole proprietorship not only takes over the assets to the recognition in which they are in the tax balance sheet, but also enters into conformity with § 4 para. 2 S. 1 UmwStG additionally also into the tax status of the transferring GmbH.28 For example, the acquiring sole proprietorship is obliged to maintain the depreciation method applied to date.29 Once again, the obligation to assume the usual operating life for the acquiring sole proprietorship has not yet been clarified. However, the tax administration is of the opinion that in the event of a book value increase, the remaining useful life should also be revalued.30 However, there is a provision for the tax base of deduction for wear in the case of recognition of an intermediate or common value in the fiscal balance sheet. Because according to § 4 Abs. 3 HS. 1 UmwStG is in the cases of § 7 Abs. 4, p. 1 and par. 5 of the EStG, i.e. for the depreciation of buildings at a higher value than the book value, the previous tax base is decisive. This shows that increases should have no impact on the amount of the AfA and that the previous book value should continue to be used as a benchmark. However, if the full deduction within the actual period of use is not achieved, the AfA can also be adapted to the remaining period of use. In the case of all other economic goods and buildings, in accordance with § 7 Abs. 4 S. 2 EStG after the actual period of use, is according to § 4 Abs. 3 HS 2 UmwStG the book value, increased by the difference between the book value and the value in the final tax balance sheet, as a basis for assessment.31

c) Determination of the acquisition result

Now we come to the core part of the transformation process of a GmbH into an individual company. So far we have discussed that the conversion at the level of the transferring GmbH can take place tax-neutrally to book values. Unfortunately, this is usually not the case at shareholder level. However, this approach seems to make sense, since the conversion eliminates a level of taxation. On the one hand, therefore, the open reserves must be taxed according to the legal consequences, as they would have applied in the event of distribution. On the other hand, in the case of tax-related company shares, the hidden reserves present in them must be cleared and combined with the hidden reserves of the transferring business assets.32 In the following, the determination and taxation of the open reserves will first be discussed, since this is fundamental in order to be able to further trace the determination of the total takeover profit or loss, which takes place in two stages.33

aa. Determination and taxation of still outstanding reserves

To the taxation of open reserves acc. To understand § 7 UmwStG, it is first important to clarify how open reserves are treated if no conversion would take place. In this case, they would be taxed as a distribution of profits and the shareholders as income in accordance with § 20 para. 1 no. 1 EStG. If one is aware of this, one recognizes the basic idea behind § 7 UmwStG, namely that a fictitious full distribution to the shareholder takes place as a result of a conversion. This is treated in the same way as any normal distribution of profits and must also be treated as income from capital assets in accordance with § 20 para. 1 no. 1 EStG are taxed.34 In the next step we consider the concrete procedure for determining the open reserves. According to § 7 UmwStG, this is the equity capital shown in the tax balance sheet, reduced to the stock of the tax deposit account according to § 27 KStG, which is subject to the application of § 29 para. 1 KStG. The relevant capital is determined on the basis of the closing balance sheet of the transferring entity at the date of the transfer. The equity capital is influenced by the valuations in the tax balance sheet. This is because, in contrast to the book value approach, equity increases accordingly if it is applied to common values or intermediate values. As a consequence, this can lead to a higher fictitious distribution amount.35 Furthermore, the stock of the tax deposit account must be checked. The circumstances prevailing at the tax transmission date are also relevant here. This includes all deposits made that were not made into the nominal capital and are therefore shown in the tax deposit account.36 In addition, however, acc. § 7 UmwStG also the application of § 29 para. 1 KStG to be observed. Accordingly, the nominal capital of the transferring GmbH is deemed to be in full pursuant to § 28 para. 2 p. 1 KStG reduced. This provision provides that the special account is first reduced at the end of the previous marketing year and any surplus is credited to the tax deposit account. This fictitious capital reduction means that the nominal capital, unless a special statement acc. § 28 Abs. If, for example, we have an equity capital of € 95,000, a tax deposit account of € 30,000, a special statement of € 0 and a nominal capital of € 25,000, the open reserves would be calculated as follows:

Thus, 40,000 € would still be as income from capital assets acc. § 20 para 1 no. 1 EStG.

bb Determination of takeover profit/loss

A takeover profit or loss of the so-called first stage i. S. d. § 4 para. 4 sentence 1 UmwStG results from the difference between the value with which the transferred assets are to be taken over, including the surcharge for neutral assets, less the costs for the transfer of assets and the book value of the shares in the transferring GmbH.38 The value approach of the transferred assets is, as already discussed above, clearly defined in § 4 para. In the case of assets for which Germany had no right of taxation at the level of the GmbH, these are so-called neutral assets. This mainly concerns permanent establishments in a country with which there is a double taxation agreement with exemption method. In these cases, the German taxation law ag. § 3 Abs. 2 UmwStG initially not limited, which is why the assets can be recognised at the book value or an intermediate value. Ultimately, however, in determining the takeover result acc. § 4 Abs. 4 S. 2 UmwStG the recognition of these assets is to be carried out with the common value.40 In the case of conversion costs, a distinction must first be made between costs incurred by the entity to be converted and costs incurred by the assuming legal entity. Nevertheless, all non-object-related costs of the assuming and the transferring legal entity are eligible as costs of the transfer. Examples of conversion costs which may be considered are, inter alia, expenses incurred in drawing up and registering the contract of merger, the merger report, the registration and registration in the commercial register and the drawing up and auditing of the final balance sheet.41 The last element, the value of the shares, can be easily determined in the conversion into a sole proprietorship. This concerns the acquisition costs of the participation in the transferring corporation.42 Thus, all aspects for determining the transfer profit/loss of the first stage have now been clarified. Therefore, we now come to the determination of the second stage takeover profit or loss. In order to determine the result of the second stage, it should only be noted that § 4 Abs. 5 sentence 1 UmwStG reduces a takeover profit of the first stage and increases a takeover loss of the first stage by the open reserves according to § 7 UmwStG.43

Assuming that our assets are transferred to a book value i.e. EUR 95,000, the cost of the conversion is EUR 10,000, no surcharge is made for neutral assets, the acquisition costs of the shares in the GmbH are EUR 25,000 and the open reserves are EUR 40,000 according to our previous calculation, the calculation of a takeover profit or loss could be as follows:

d) Taxation of takeover profit

A takeover profit, as in the previous example, is fundamentally like a profit from the liquidation of a GmbH to tax.44 Gem. § 4 Abs. 7 S. 2 UmwStG shall apply to a takeover profit attributable to a natural person, § 3 No. 40 EStG and § 3c EStG.45 This means that the takeover profit shall be taxed in accordance with the partial income procedure. He is therefore regularly taxable at 60% and tax-free at 40%.46

e) Treatment of a takeover loss

Not infrequently a takeover loss arises, since often a positive takeover profit of the first stage is still transformed into a takeover loss of the second stage by the deductibility of the emoluments according to § 7 UmwStG.47 If there is a takeover loss, this is in the case of a conversion to a sole proprietorship acc. § 4 Abs. 6 S. 4 UmwStG 60 %, but not more than 60 % of the remuneration of § 7 UmwStG deductible. However, if the share in the GmbH was acquired in return for payment within five years before the tax transfer date, § 4 Abs. 6 S. 6 Alt. 2 UmwStG the restriction that the previously deductible takeover loss cannot be claimed. This scheme was put in place to prevent potential misuse of design, where the shareholder uses the cost of the participation to remunerate the outstanding reserves. This would lead to a tax-free collection of the reserves in connection with § 7 UmwStG, which the legislature wanted to avoid. However, this decision is not entirely understandable, since the difference between the acquisition costs and the book value of the transferred assets does not necessarily have to correspond to the reserves available when acquiring the shares. In addition, the feared effect can still occur if reserves are distributed and the distribution is used as the basis for a partial value write-off.48 No misuse of design, on the other hand, is a merger with the motive to protect the GmbH from bankruptcy and to avoid the use of privately granted collateral. In this case, a loss incurred is deductible.49

IV. Conclusion

The transformation of a GmbH into a sole proprietorship is a complex topic, which deals primarily with the processes of tax retroactive effect, the valuation of the assets to be transferred and the tax determination of the open reserves and the takeover result. In the course of this work, I have listed the reasons for conversion into a sole proprietorship and the three different forms of merger, since the legislature does not provide for conversion as a change of legal form into a sole proprietorship.

In the further course, I discussed the tax retroactive effect, making it clear that it requires a precise timeline for the conversion, since it must be completed within eight months. In this context, the focus is also on the valuation of the assets to be transferred and transferred. The elaboration has shown that a tax-neutral transfer of assets to book values is possible, but subject to certain conditions. In addition, I have pointed out that, in certain circumstances, trade tax unbundling of hidden reserves is possible, but respect must be given to a five-year blocking period after conversion.

In the final part of my work, I covered the most complex part of the conversion, namely the identification and taxation of outstanding reserves and the takeover result. By looking at and illustrating an example in detail, it became clear how to determine the outstanding reserves and the takeover result. It has also been established that open reserves resulting from the deduction of the tax deposit account are taxable as income from capital assets and that any transfer profit after the deduction of open reserves is subject to the partial income procedure.

Overall, it can be said that the transformation of a GmbH into a sole proprietorship is a demanding matter that requires specialized knowledge and professional expertise. However, the application of the conversion into a sole proprietorship can be particularly useful especially for the sole shareholders of a GmbH in the course of a restructuring, since in this way, for example, a lengthy liquidation can be circumvented or possibly the burdensome obligations of a GmbH can be terminated. It is therefore recommended to work closely with professionals who understand the legal requirements and possibilities in order to carry out a smooth transformation of a GmbH into a sole proprietorship.