para. | paragraph

Art. | Article

BFH | Bundesfinanzhof

EStG | Income Tax Act

Fusion Directive | Fusion Directive

according to

GmbH | Company with limited liability

GmbHG | Law concerning limited liability companies

GrEStG | Property Transfer Tax Act

i.S.d. | in the sense of

i.S.v. | in the sense of

i.V.m. | in conjunction with

KStG | Corporate Tax Act

No | Number

paragraph | recital

S. | Page/Sentence

SEStEG | Law on tax accompanying measures for the introduction of the European company and the amendment of further tax legislation

UmwG | conversion law

UmwStG | Conversion Tax Act

UStG | VAT Act

Anyone who wants to convert a sole proprietorship into a holding structure should know some special features of conversion law and conversion tax law. For example, it should be clear in advance that after the conversion of the sole proprietorship into a holding structure, both operative GmbH and the holding company have a seven-year blocking period. If a sale occurs within this blocking period, taxes are subsequently incurred. But because they offer many advantages, including tax, conversions of individual companies into holding structures are still very popular.

In practice, the holding structure is a popular and increasing design option for achieving tax and limited liability optimization. Therefore, one is increasingly confronted with inquiries from clients who want to convert their individual company into a holding structure. In most cases, a company already exists in the form of a sole proprietorship, as this is easy and fast to set up. Later, when the company is established and making profits, there is often a desire to reduce the tax burden and liability risk. The present work on the topic of “conversion of a sole proprietorship into a holding structure” is intended to explain how a sole proprietorship can be turned into a holding structure and in particular to address the tax specificities.

The first section of this seminar paper first explains what a holding structure is. In order to explain the advantages of such a structure below.

The second section of this work describes how a sole proprietorship can be brought into a GmbH. For this purpose, the civil transfer possibilities are first discussed in order to further illuminate the tax view, divided into income tax, sales tax and real estate transfer tax.

Finally, in the last section, it will be explained how the operating company created in the previous section can be transferred to a holding company in a tax-neutral manner in order to create a holding structure.

The discussion of the aforementioned sections is intended to bring readers closer to the legal and tax peculiarities of the integration of a sole proprietorship into a holding structure and, above all, to sensitize them to the peculiarities and pitfalls of such a conversion.

The term holding company is short for holding company. A holding company is a commercial company, which is usually managed in the form of a corporation. The role of the holding company is to hold and manage the assets and shares in other companies. Accordingly, as a rule, the holding company does not itself become entrepreneurial, but only holds shares in other companies and directs the business of the subsidiaries. As a rule, a holding structure consists of the merger of two limited liability companies in which Holding GmbH holds 100 percent of the shares in operative GmbH (subsidiary) and the shares in the holding are held by one or more natural persons. The holding company is the oldest form of formation of groups of companies. At that time, as today, the aim was to keep and manage the investments in companies – alone or with others – in a company. However, the establishment of a holding company based in Germany was only permitted in Germany since 1993. Today, the holding companies are indispensable and gain increasing popularity. The increasing popularity of holding structures is due, among other things, to the tax advantages, the taxation of profit distributions and the capital gains of shares at the level of the holding company. [1] The profit distributions received in the holding company are in accordance with § 8 para. 1 KStG i.V.m. § 20 Abs. 1 No. 1 S. 1 EStG at the level of the holding company, insofar as the participation in the company is not a scattered participation, with less than 10 percent of the share capital in accordance with § 8 b para. 4 KStG. For business tax purposes, the minimum shareholding, for tax exemption of profit distributions, is 15 percent of the share capital. [2] However, the profit distributions are not completely exempt from tax, according to § 8 b Abs. 5 KStG 5 percent of the emoluments from the participation are considered to be expenses which, when determining profit, are not considered to be operating expenses which may be deducted. Accordingly, the remuneration from a participation of more than 10 or 15 percent in another corporation to 95 percent tax-free. Regardless of the shareholding ratio, the profits from the sale of shares of the other corporation at the level of the holding company according to § 8 b para. 2 KStG tax-free. However, as with the distributions, according to § 8 b Abs. 3 KStG 5 percent not deductible as operating expenses. The tax exemption of the Corporate Income Tax Act enforces trade tax, whereby 95 percent of the capital gains are exempt from corporate and trade tax. [3] The same applies if the shares in the other corporation are not sold in the form of a share deal, but all assets are sold individually in the form of an asset deal. This is not only much more complex, but also fully taxable. [4] Therefore, in a subsequent sale, attention should be paid to the type of sale. However, the tax benefits only have an effect if the profits remain in the holding company and are reinvested. If the profits are to be transferred to the private assets of the shareholder, the holding structure may result in a higher tax burden. In addition to the tax advantages, the design possibilities should not be underestimated. The holding structure makes it possible to separate the assets from the operative business and to use the basic principle of limitation of liability at a GmbH. Often, the holding model is also extended and used to separate individual operational functions into legally independent units in order to divide the liability risk and the organization into individual sub-areas. [] 5]

A sole proprietorship is brought into a holding structure in two steps. First of all, the sole proprietorship must be brought into a GmbH and that preferably at book values, so that no tax burden arises. In the second step, another GmbH must be founded, which acts as a holding company and the operative GmbH must be brought into the Holding GmbH by exchange of shares in order to complete the holding structure. Both for the sale of the shares in the holding company and in the subsidiary, the conversion creates a blocking period of seven years during which the shares may not be sold. If the shares are sold within the blocking period, the carrying forward of the book value is no longer possible and the hidden reserves are subject to taxation at the time of conversion.

3.1.1 Civil law

From a civil law point of view, there are two ways to bring a sole proprietorship into a GmbH. On the one hand, it is possible to transfer the sole proprietorship in the form of universal succession by divesting one or more parts of the business assets, if the sole proprietorship has been entered in the commercial register. Regardless of whether the sole proprietorship has been registered or not, the operation may alternatively be transferred to the company by way of individual succession.

3.1.1.1 Separation (overall succession)

The conversion tax law according to § 123 Abs. 3 UmwG the division of a legal entity by transfer of one or more assets. In practice, individual undertakings are regularly transferred to a new legal entity in the form of a spin-off. [6] The separation is according to m. § 152 S. 1 UmwG only possible if the sole proprietorship is registered in the commercial register as a merchant. [7] It is sufficient if the registration of the sole trader is requested and the registration is completed before the segregation takes effect. [8] According to § 152 S. 2 UmwG, the hive-off cannot take place if the liabilities of the individual merchant exceed his assets (active-liable examination). The registry court of the transferring registry court shall be provided with a final balance sheet drawn up not more than eight months before the date of filing. [9] In practice, therefore, the 31 August is often recorded as the latest possible date for the commercial register application, if the marketing year corresponds to the calendar year in order not to have to draw up an interim balance sheet.

3.1.1.2 Integration (individual succession)

In contrast to the hive-off, the assets of the holding to be transferred are transferred to the company in the form of individual rights succession. In the case of integration, one speaks of the material foundation, in which the individual assets are listed individually and put into the company. In practice, the material formation is considered extensive and complicated compared to the “cash formation” with subsequent contribution of the assets.[10] According to § 20 para. 8 S. 3 UmwStG, in the case of a contribution in kind, the contribution may be referred back to a day which is not more than eight months before the date of conclusion of the transfer agreement and not more than eight months before the date on which the transferred assets are transferred to the limited liability company.

3.1.2 Tax law

3.1.2.1 Income tax

Unlike civil law, the tax assessment does not distinguish between individual and universal succession. In order to be able to make a conversion in the form of a contribution tax-neutral, without revealing the hidden reserves, according to § 20 para. 1 UmwStG in the event of a transfer of a business or part of a business to an unlimited corporation tax liability corporation, new shares in the company can be granted for this purpose. According to the 2011 UmwSt Decree, new shares within the meaning of § 20 UmwStG only arise in the event of the company being founded or a capital increase. [11] Accordingly, the contribution of a sole proprietorship to a GmbH can be made tax-neutral either in the form of a material incorporation or in the form of a contribution to an existing company with a share capital increase (capital increase in kind) – at least 1 €. The sole proprietorship is brought into the company as a classic contribution in kind, in compliance with the provisions of the GmbH Act for contributions in kind. [12] Particular attention should be paid to the determination of the value of the object and the nominal amount of the share. In case of material foundation, this must be in accordance with § 5 Abs. 4 GmbHG in the social contract. In the case of a capital increase with contribution in kind, the values according to § 56 Abs. 1 GmbHG in the capital increase decision. Furthermore, care must be taken that in the case of a contribution in kind, irrespective of whether it is a creation in kind or a capital increase in kind, according to § 8 para. 1 no. 5 GmbHG in any case a proof of impairment must be provided, which confirms that the value of the contribution in kind reaches at least the nominal amount of the shares taken over for it. [13] If a sole proprietorship is transferred to an existing GmbH, this is not a problem, as only a proof of 1 € must be created and no evaluation of the company is necessary. In the case of a transfer in the form of a material foundation, this is already much more difficult, since now a proof of 25,000 € must be created and the objects to be transferred or the individual company must be evaluated. In practice, because of the increased effort, it is regularly recommended to first set up a GmbH - with cash - and then, after registration of the company and receipt of a tax number, to bring the sole proprietorship with a capital increase in kind into the GmbH. The contribution of a business or part-business within the meaning of § 20 Abs. 1 S. 1 UmwStG is only available if all essential operating principles of the individual company are transferred to the GmbH. [14] Essential operating bases are all the assets necessary for the continuation of operations. The assets of the sole proprietorship can, on request and under the conditions of § 20 para. 2 No. 1 to 4 UmwStG at book value or a higher value and transferred. First of all, it must be ensured that the acquiring corporation is subject to corporate tax. Furthermore, the liabilities, excluding equity, must not exceed the assets. In addition, as already provided in the original version of the Act, the taxation right of the Federal Republic of Germany for the capital gains of the transferred operating assets at the GmbH may not be excluded or limited. As a last criterion, § 20 para. 2 UmwStG stipulates that the common value of the other consideration granted in addition to the new shares of the company may not be more than 25 percent of the book value of the sole proprietorship or EUR 500,000. If these criteria from Nos. 1 to 4 are complied with and the application was submitted to the competent tax office at the latest upon submission of the first final balance sheet of the acquiring company, the submission is tax-neutral. It is controversial whether the application has already been submitted in the declaration in conjunction with the recognition of book or intermediate values or must be submitted separately to the tax office. In order to inhibit the risk, in practice the application for security is regularly submitted separately to the tax office. In the judgment of the BFH of 19.12.2018, the latter made it clear that the application can also be made implicitly by applying the book values in the tax return, since the law does not require a specific form of application. [15] All assets and assets should be transferred with the respective book value from the sole proprietorship to the GmbH in order not to detect hidden reserves at the level of the sole proprietorship. If essential operating bases are retained at the time of the transfer, all assets shall be valued at the partial value and the hidden reserves shall be fully uncovered. The relevant time for assessing whether an asset constitutes an essential operating base of the transferred business is the version of the conversion decision or the conclusion of the transfer contract. [16] If at the time of the transfer non-essential operating bases are retained which do not hinder the continuation of the operation, these are to be treated regularly as taken from the operating assets at the time of the transfer and the hidden reserves are to be discovered and taxed.[17] As a general rule, the transfer takes place at the time when the ownership of the transferred assets is transferred to the acquiring company. In cases of individual succession, the transfer of beneficial ownership shall take place at the time provided for in the transfer agreement. In the case of universal succession, the transition shall take place at the latest at the time of registration of the conversion into the commercial register. [18] Upon request, according to § 20 Abs. 6 pp. 1 and 2 UmwStG the tax transfer date retroactively to the date of the final balance sheet of the sole proprietorship in accordance with § 17 para. 2 UmwG, insofar as this is not more than eight months before the conclusion of the transfer agreement and not more than eight months before the date of transfer of the transferred assets. [19] In this case, according to § 20 Abs. 5 UmwStG to determine the income and assets of the sole proprietorship and the GmbH as if the transferred assets had been transferred to the GmbH at the end of the tax transfer date. [20] If the request for a back relationship is not made, the conversion date shall be set at the time of the transfer of economic ownership or the date of the conclusion of the transfer contract, but at the latest upon entry in the commercial register. [21] In order to ensure a sustainable tax-neutral contribution of the individual company, the seven-year blocking period of § 22 Abs should be mandatory. 1 UmwStG are respected. If the shares received on the transfer are sold within seven years after the tax transfer date or a so-called substitute realisation status as defined in § 22 para. 6 Nos. 1 to 6 UmwStG, there is a retroactive taxation of the hidden reserves contained in the transferred assets at the transfer date.[22] However, there is no full taxation of the capital gain, as this would presumably be contrary to European law.[23] The remedy is to be provided by the new interpretation of the SEStEG, according to which the amount to be taxed is reduced linearly by one seventh annually, since the presumption of abuse is in accordance with Art. 11 para. 1a FusionsRL decreases with increasing distance from the time of introduction. [24] In addition, according to § 22 Abs. 3 UmwStG in the seven years following the transfer date at the latest by 31. to provide evidence to whom the shares received at the time of the contribution are attributable. If the proof is omitted, the shares apply within the meaning of § 22 Abs. 1 UmwStG as sold and the hidden reserves are also retroactively subject to taxation.

3.1.2.2 Sales tax

If assets are transferred to a corporation against the granting of shares, this represents a sales tax exchange of services.[25] The contribution consists in the transfer of assets of the sole proprietorship to the corporation, with the granting of new shares in return. This applies irrespective of whether the transfer is made as part of a new creation or a capital increase and irrespective of whether the transfer is made in individual or universal succession. [26] As far as a business sale is in accordance with § 1 para. 1 a S. 1 UStG, the introduction process cannot be controlled.[27] A business sale in the sense of VAT law is gem. § 1 Abs. 1 a S. 2 UStG, if a company or a part of a business is brought into a company for payment or free of charge. The decisive factor, as in income tax law, is that all assets necessary for the continuation of the business are brought in and the business brought in is continued. [28] If a sole proprietorship is transferred to a corporation, a non-taxable business sale in the whole is usually in accordance with § 1 para. 1 a UStG. The acquiring GmbH enters i.S.v. § 1 Abs. 1 a S. 3 UStG at the time of transfer to the VAT status of the transferred sole proprietorship.[29] The taxation period of the sole proprietor ends if the business is brought in during the year acc. § 16 Abs. 3 UStG at the time when the assets are transferred and the sole proprietor’s operations cease. [30] In this case, a sales tax return must be submitted for the year of submission both for the sole proprietorship and for the GmbH. If the contributions are made at the end of the calendar year, the taxation period ends as usual at the end of the calendar year, so that no double VAT return is required.

3.1.2.3 Property transfer tax

If the sole proprietor’s assets to be contributed also include real estate as defined in § 2 GrEStG, the transfer of ownership constitutes a taxable acquisition process as defined in § 1 para. 1 No. 3 S. 1 GrEStG. A legal act is subject to § 1 Abs. 1 No. 3 S. 1 GrEStG the real estate transfer tax, if a domestic property without a legal transaction, which creates a right to transfer ownership, passes to another owner. The tax exemption provision of § 6 a S. 1 GrEStG provides for a taxable acquisition process according to § 1 Abs. 1 no. 3 GrEStG does not trigger any tax, insofar as the legal act on a conversion within the meaning of § 1 para. 1 no. 1 to 3 UmwStG, a transfer or other acquisition operation is based on a social contractual basis. Accordingly, the transfer of a sole proprietorship to a GmbH constitutes a taxable acquisition process, but this is exempt from real estate acquisition tax according to § 6 a GrEStG.

The contribution of the newly created GmbH, which will continue the sole proprietorship, will be introduced in the second step of the conversion into a newly founded GmbH, so that a holding structure is created. There are several ways to contribute shares in one GmbH to another GmbH. Since the transfer of a sole proprietorship to a holding structure is in most cases a 100 % shareholding, only the qualified share exchange pursuant to § 21 UmwStG will be discussed below. If shares in a corporation are transferred to another corporation against the granting of shares in the acquiring company (share exchange), the transferred shares are in accordance with § 21 para. 1 S. 1 UmwStG in principle with the common value in the acquiring company. In order not to have to tax any capital gain, can on request according to § 21 Abs. 1 S. 2 UmwStG the transferred shares are recognised at the book value or a higher value if the requirements of § 21 para. 1 S. 2 No. 1 and 2 UmwStG are fulfilled. After the transfer, the acquiring company must have a majority of the voting rights in the acquired company by virtue of its participation, including the shares received in the course of the transfer. [32] In addition, as in the case of the contribution of the sole proprietorship, the common value of the other consideration may not exceed 25 per cent of the book value of the shares transferred or EUR 500,000 at most the book value. Accordingly, in addition to the new shares in the holding company, the shareholder can obtain a claim against the same company that does not exceed EUR 500,000, but may not exceed the book value (equity) or 25 percent of the book value of the transferred company. If the conditions have been met and the application for the shares to be recognised at book values has been submitted to the competent tax office, the shares transferred may be recognised at book value if the right of taxation of the Federal Republic of Germany for the shares acquired continues to exist. [33] As already explained in connection with the contribution of the sole proprietorship, the application can also be made in conjunction with the recognition of the book values in the corporate tax return. However, it is recommended, as in the case of book value continuation, to submit the application separately to the competent tax office in order to ensure a smooth process. The value recognised at the holding company applies to the transferor as the selling price of the shares transferred and as the cost of the shares received.[34] If the shares are recognised at the holding GmbH with the book values, the exchange of shares is tax-neutral if at least 1 new share in the holding company was granted. There is also a seven-year blocking period for the tax-neutral transfer of operative GmbH to Holding GmbH. The blocking period explained in the previous section, which arose when the sole proprietorship was transferred, remains unaffected and continues in parallel with the new blocking period for the sale of the shares in the holding company.[35] Consequently, the transfer of the sole proprietorship to the holding structure is tax-free only if both the holding company and the operative GmbH are not sold within seven years of the respective transfer. Unlike the transfer of the sole proprietorship to the GmbH, there is no tax return of eight months when the operative GmbH is transferred to the Holding GmbH. Accordingly, in the case of an under-year contribution to a holding structure, it must be noted that the conditions for the tax exemption of profit distributions in the year of the share exchange are not met, since at the beginning of the year the participation must be at least 10 percent for corporate tax and 15 percent for business tax. The share exchange is to be regarded as unproblematic from the point of view of sales tax and real estate transfer tax and represents a problem only in individual cases.[37]

As defined in the introduction, the objective of this seminar paper is to explain how a holding structure can be created from a sole proprietorship and in particular the tax specifics should be addressed.

The steadily increasing popularity of holding structures is due, among other things, to the tax advantages, such as the 95 percent tax exemption from profit distributions and capital gains. This design model also offers a positive side effect in the limitation of liability. Thus, the holding company acts as a kind of “buying pig” in which all assets are held and, if necessary, reinvested. In the operating company, only the current business is conducted and due to the limitation of liability there is no access for creditors to the assets of the holding company.

In most cases, a holding structure consists of two limited liability companies. In this construct, the holding company holds 100 percent of the shares of the other company. In order to be able to integrate an existing sole proprietorship into such a structure, the sole proprietorship must be converted into a GmbH in the first step, in order to finally transfer the GmbH to the newly founded Holding GmbH by means of a share exchange in the second step. These two operations are only possible tax-free if the assets or the shares transferred can be recognised at the book value.

In both cases, an approach to book values requires an application from the acquiring company to the competent tax office. The extent to which the application is made in conjunction with the recognition of the book values in the tax return of the assuming party is not agreed. For safety reasons, a separate application should be submitted when it is introduced. In addition, some prerequisites for the respective conversion processes must be checked and fulfilled in order for this to be carried out at book values. Furthermore, the seven-year blocking periods at the time of submission should be urgently observed. If, within a period of seven years, either the shares in the holding company or in the other company are sold, the hidden reserves existing at the time of the transfer are subject to retroactive taxation. However, the tax liability payable is reduced by one-seventh each year, as it is assumed that the presumption of abuse decreases with increasing distance from the time of submission. In addition to the holding period, within the seven years following the date of the transfer, no later than 31. a proof of who the shares received at the time of the contribution are attributable to at the reference date. The transfer of the individual company to the GmbH can be carried out retroactively (max. 8 months), while the transfer of the shares to the holding company is not retroactively possible from a tax point of view. This poses some problems in the taxation of the holding company in the year of the transfer if the shares are transferred during the year. Thus, the tax exemption in the year of the transfer does not apply if the shares were not already owned by the holding company at the beginning of the year, so that the profit distributions in the year of the conversion must be subject to full taxation in the holding company.

Freudenberg, Tobias, Heinze, Stefan (NJW, 2020): New Legal Weekly: NJW, 2020 Issue 52, Munich: Beck, 2020

Hasselbach, Kai, Nawroth, Christoph, Rödding, Adalbert (Holding Handbook, 2020): Beck’sches Holding Handbook, 3rd edition 2020, Munich: Beck, 2020

Heckschen, Heribert, Herrler, Sebastian, Münch, Christof (Notary Manual, 2019): Beck’sches Notary Manual, 7th edition 2019, Munich: Beck, 2019

Menner, Stefan, Bilitewski, Andrea (Conversion Tax Act, 2019): Conversion Tax Act, 5th edition 2019, Munich: Beck, 2019

Ott, Hans (Corporate taxes and balance sheet, 2022): Corporate taxes and balance sheet, No. 16 of 26.08.2022, Herne: NWB, 2022

Schmitt, Joachim, Hörtnagl, Robert (Conversion Law, 2020): Conversion Law, Conversion Tax Law, 9th edition 2020, Munich: Beck 2020

Sindelfingen, Anton Gordon (BwNotz, 2020): Zeitschrift für das Notariat in Baden-Württemberg: BwNotz, Issue 2, Stuttgart: Württembergischer Notarverein e.V., 2020

Wassermeyer, Franz, Piltz, Detlev Jürgen, Lüdicke, Jürgen, Schön, Wolfgang (International Tax Law, 2009): International Tax Law: IStR, 2009 Issue 1, Munich: Beck, 2009

Wollny, Paul, Hallerbach, Dorothee, Dönmez, Hülya, Liebert, Melanie, Wepler, Axel, (Practical transmissions, 2022): Business and practice transmissions, 10th edition 2022, Herne: NWB, 2022

[1] Corporate taxes and balance sheet, 2022, p.613

[2]Corporate taxes and balance sheet, 2022, p.613

[3]Cf. Corporate taxes and balance sheet, 2022, p.613

[4]Cf. Holding Handbook, 2020, paragraph 25

[5]Cf. Holding Handbook, 2020, paragraph 24

[6]Cf. Notary Manual, 2019, paragraph 177

[7]Cf. transfers of practice, 2022, paragraph 1762

[8]Cf. Notary Manual, 2019, paragraph 177

[9]Cf. Notary Manual, 2019 paragraph 177 b

[10]Cf. NJW, 2020, p. 3768

[11]Cf. BMF, letter of 11.11.2011, IV C2, paragraph E 20.10 BStBl I (2011), p. 1314.

[12]Cf. BwNot, 2020, paragraph 98

[13]Cf. BwNot, 2020, paragraph 98

[14]Cf. RNotZ, 2022, paragraph 313

[15]Cf. BFH, judgment of 19.12.2018, I R 1/17 BStBl II (2019), p. 709.

[16]Cf. Conversion Act, 2020, paragraph 75

[17]Cf. BMF, letter of 11.11.2011, IV C2, paragraph 20.08 BStBl I (2011), p. 1314;

Conversion Act, 2020, paragraph 73

[18]Cf. BMF, letter of 11.11.2011, IV C2, paragraph 20.13 BStBl I (2011), p. 1314.

[19]Cf. RNotZ, 2022, paragraph 314

[20]Cf. § 20 para. 7 S. 1 UmwStG

[21]Cf. Conversion Act, 2020 paragraph 258

[22]Cf. RNotZ, 2022, paragraph 314

[23]Cf. Conversion Tax Act, 2019, paragraph 83

[24]Cf. Conversion Tax Act, 2019, paragraph 83

[25]Cf. Conversion Act, 2020, paragraph 22

[26]Cf. Conversion Act, 2020, paragraph 22

[27]Cf. RNotZ, 2022, paragraph 315

[28]Cf. RNotZ, 2022, paragraph 315

[29]Cf. RNotZ, 2022, paragraph 315

[30]Cf. Conversion Act, 2020, paragraph 30

[31]Cf. RNotZ, 2022, paragraph 314

[32]Cf. International Tax Law, 2009, paragraph 6

[33]Cf. International Tax Law, 2009, paragraph 6

[34]Cf. Corporate taxes and balance sheet, 2022, p. 615

[35]Cf. Converting Tax Act, 2019, paragraph 88

[36]Cf. Corporate taxes and balance sheet, 2022, p. 615

[37]Cf. International Tax Law, 2009, paragraph 5