date | theme

21. August 2020 | Converting individual companies: GmbH versus GmbH & Co. KG (this contribution)

24. August 2020 | Transformation of a sole proprietorship: objectives and procedures

26. August 2020 | Other consideration for transfer to GmbH: valuation of assets

Who wants to convert his individual company, usually has the two Alternative GmbH and GmbH & Co. KG in mind. Both types of companies have the advantage over banks that they generally enjoy a higher reputation. However, there are clear differences in tax treatment. In this case, the partnership is advantageous in particular for low income, because then a low personal income tax rate has a positive influence on the amount of the tax. In addition, in the case of sole proprietorships and partnerships, unlike corporations, trade tax can be partly counted against income tax. For profits of more than EUR 60,000 (for individual investments) and equity up to EUR 500,000, however, the GmbH can represent a more worthwhile goal for conversion. Because then you can demand the capital injection in return for the contribution of the individual company during the conversion. Subsequently, the GmbH shareholder can use this claim to obtain profits from the GmbH indirectly and without taxes.

In the video we explain the tax advantages & disadvantages of converting a sole proprietorship into a GmbH or a GmbH & Co. KG.

Why you should convert a sole proprietorship

Whoever runs a sole proprietorship bears full financial responsibility for his company. For many, this may seem superficially obvious, but only a few people are fully informed about the extent of the private consequences that result in an emergency. Because the liability is comprehensive here. In other words, the sole proprietor is liable with his entire assets including cars, securities, home, holiday home, rented real estate or what else he may call his own assets.

Another point that results indirectly from the above is that individual companies often enjoy a higher reputation in credit institutions compared to partnerships or corporations. It is the aura of professional business operations that is primarily in the foreground here. However, the risk that a potential creditor with a sole proprietor has no information about the actual financial situation of his business partner is also minimized in the case of a company registered in the commercial register. In addition, the GmbH is obliged to publish its balance sheets annually. Being able to obtain information about a potential business contact is also a clear advantage over a sole proprietorship.

In addition to these points, there may be the question of whether you can also save taxes if you should convert your sole proprietorship. This question in particular is of particular interest to many individual entrepreneurs.

2nd individual company convert to GmbH or GmbH & Co. KG

If an entrepreneur wants to convert his sole proprietorship, then the two company forms GmbH and GmbH & Co. KG are particularly shortlisted. To this end, we will first address the differences that have no tax reference.

On the other hand, if you are also interested in the subtleties of the conversion law and the conversion tax law, we refer you to our article specifically aimed at this topic.

2.1. Company law aspects of the GmbH

2.2.1. Nature of the GmbH

The GmbH is a corporation and as such also an independent legal entity. This means that she needs a director to exercise her rights and obligations. In the case of a sole proprietorship, this is usually the entrepreneur himself, but in the case of a GmbH, the shareholders determine who should be responsible for the management.

Furthermore, an outstanding aspect that the GmbH embodies is hidden in the abbreviation of its name. Because the liability of a GmbH is limited to its own assets. In other words, the shareholders of the GmbH are protected against further claims of third parties. This applies in particular to their private assets. Only their contribution to the share capital of the GmbH is directly affected in the event of liability. In contrast, a sole proprietor bears the full entrepreneurial risk himself.

That is why the GmbH is an interesting option for many entrepreneurs, into which they can convert their individual company.

2.2.2. Foundation of the GmbH

Some special features are important for the establishment of a GmbH. The minimum amount of the share capital – EUR 25,000 – is the most important. Although you can found a GmbH with material funds instead of money, but this is only possible after a close examination of the values of the material funds. In addition, the GmbH must be provided with a value of at least EUR 12,500 at the time of foundation, which corresponds to half of the minimum share capital of a GmbH. And of course you also have to appoint a managing director, whereby this must be a natural person. In most cases, this is also one of the shareholders or, more likely, even the only GmbH shareholder. He must fulfil certain legal requirements in order to hold this post. For example, convicting an aspirant for certain crimes is an exclusion criterion. And in order to effect the registration of the company in the commercial register at all, a notary must notarize the social contract.

Furthermore, an existing UG limited liability can result in a GmbH. This UG is converted here. However, since both companies have the legal form of a corporation, one speaks of a change of name.

2.2. GmbH & Co KG

2.2.1. Nature of the GmbH & Co. KG

Unlike the GmbH, the GmbH & Co. KG is a partnership. To be precise, it is a limited partnership. A limited partnership, on the other hand, distinguishes the fact that, on the one hand, at least one shareholder is fully liable for liabilities of the company towards third parties. In this respect, it is like a sole proprietor. Such a full-fledged at the KG is also called a complementary. Furthermore, at least one other shareholder is involved in a limited partnership whose liability, unlike the general partner, is limited to his contribution. This is called either partisan or limited partner.

And now to the specific case of GmbH & Co. KG: A GmbH is involved in the KG as a general partner. Although it may seem absurd for a limited liability company to act as an unlimited general partner, this is easy to explain. The limitation of liability to which the name GmbH refers is related to its shareholders. As a full owner of a limited partnership, the liability of the GmbH is of course unlimited, i.e. with all its assets. Overall, however, this has the great advantage that liability with the private assets of all directly or indirectly participating shareholders who are natural persons is excluded. For the same reason as at the GmbH, for many entrepreneurs the GmbH & Co. KG is another alternative into which they can convert their individual company.

2.2.2. Foundation of GmbH & Co. KG

If an entrepreneur now wants to convert his sole proprietorship and decides for GmbH & Co. KG, then this usually results in the following corporate structure: First, the establishment of a GmbH is necessary, which then joins the KG as a general partner. Here, the sole entrepreneur is often also the sole GmbH shareholder. In addition, he is the only limited partner at the founding of GmbH & Co. KG. This has enabled the sole proprietor to convert his sole proprietorship without having to rely on the participation of other persons. The participation ratio is freely selectable. Thus even a 100% participation of the limited partner in the limited partnership is possible. Nevertheless, Komplementär-GmbH assumes unlimited liability.

If you now convert your sole proprietorship so that it results in a GmbH & Co. KG, then this basically has no fundamental tax consequences. Because a sole proprietor and a partner of a partnership tax their income through the assessment for income tax. However, a GmbH is also involved in the KG. As a rule, the former sole proprietor appears both as a shareholder of Komplementär-GmbH and as a limited partner of the limited partnership. Thus, a distinction is made between the taxation of the general partner company as a corporation tax and the income tax of the limited partner. Since we basically only include Komplementär-GmbH in the limited partnership for this function, their participation is usually 0%. Consequently, 100 % of the profits are taxed at the limited partnership.

3.1. The trade tax of GmbH & Co. KG

As a commercial company, GmbH & Co. KG is a commercial enterprise. Thus, a business tax is also to be paid on their profits. The amount of the tax depends to a large extent on the rate charged by the municipality or city in which the company is established. Although business tax is a business tax, it is excluded as an operating expense in this respect. Thus, in this case, it is the limited partner who, through his participation in the limited partnership, bears 100 % of the business tax. More on that in a moment.

3.2. Income tax of the limited partner after conversion

At the limited partner of the GmbH, the remaining profit is now taxable. Depending on the amount of the profit, the applicable personal tax rate is also cancelled. From a taxable income of about EUR 60,000, one expects the top tax rate of 42 % for an individual assessment.

No matter how high the income tax is, it is fortunately still subject to a reduction. In fact, the shareholder can set the trade tax borne by him almost completely. In other words, the limited partnership of GmbH & Co. KG only bears a negligible share in the order of 1% of the trade tax.

4. Individual companies convert to GmbH

Now we come to the tax treatment of the GmbH, which results from the conversion of the individual company. The following aspect is important for our further design. Because the amount of the capital account of the sole proprietorship at the time of conversion should amount to a maximum of EUR 500,000. But first we consider the taxation of the profit, which the now GmbH and its shareholder tax.

4.1. Corporate tax of the GmbH

As a corporation, the GmbH is subject to corporate tax assessment. Corporate income tax is the equivalent of income tax for natural persons. A uniform rate of 15 % applies.

4.2. Trade tax of the GmbH

Unlike a partnership in which the shareholder bears trade tax, the GmbH pays its trade tax itself. However, an accounting for the income tax of the GmbH shareholder is excluded.

4.3. Income tax of the GmbH shareholder

Since the GmbH is an independent person, it can decide for itself how it wants to deal with its profit. On the one hand, it is free to use the profit for future investments. On the other hand, the annual shareholders’ meeting may decide to distribute the profit as a dividend to the participating shareholders. In this case, the GmbH is obliged to withhold a withholding tax on the distributed amount and to pay it to the financial administration. This is because the dividend represents income from capital assets at the receiving partner. A flat-rate tax rate of 25 % is to be used, whereby a flat-rate allowance of EUR 801 is deducted from the taxable dividend in the case of individual investments.

In addition, we assume that the shareholder also acts as Managing Director of the GmbH. Of course, he also receives a managing director salary. This is deductible from the profit in the balance sheet of the GmbH as operating expense. Thus, the managing director’s salary also indirectly reduces taxes. For this, the salary must be taken into account in the income tax of the managing director. Here again, the personal tax rate of the taxpayer plays a major role.

Conversion of individual companies: when is a GmbH & Co. KG advantageous?

In the upcoming analysis, the focus is on GmbH & Co. KG. It can shine with the advantage that the business tax is deductible to a large extent from the income tax of the limited partnership. In addition, especially for companies that earn a profit of less than EUR 60,000 per year (for joint investments up to EUR 120,000), the cheaper personal tax rate is particularly attractive. However, if the top tax rate determines the level of the shareholder's income tax, then taxation of approximately 50% is to be expected.

Converting sole proprietorships: Steuervorteil GmbH?

6.1. Analysis of the tax advantages of the GmbH

If all tax levies incurred in connection with a GmbH are added up, they are also in the order of 50%. Because the 15 % of the corporation tax and the trade tax in Germany, which is usually about 15 %, show that the dividend accounts for 70 % of the profit. A further 25 % of the capital gains tax is due.

6.2 Influence of the Managing Director’s salary on taxation at a GmbH

As a rule, the effects of a possible managing director salary are also relevant. On the one hand, this reduces the taxable profit of the GmbH, on the other hand, this leads to regular taxation in the context of the assessment to the income tax of the shareholder-managing director. So, on the one hand, we compare the effect of saving corporation tax and business tax and capital gains tax with an income tax at the personal tax rate of the shareholder. As a result, the tax savings due to the managing director’s salary are only due to a personal tax rate of more than 52,5 %. However, since this is practically excluded, the managing director’s salary always represents a tax advantage in favour of the GmbH. However, this is variable, wherein care must also be taken that a hidden profit distribution can exist, which influences the size of the advantage.

6.3. Convert sole proprietorships: other consideration when transferred to GmbH

Another advantage can be considered in the context of the conversion. If the sole proprietorship has equity up to an amount of EUR 500,000 at the time of conversion, then one can work towards the conversion that the GmbH grants its shareholder a claim in return for the contribution of his sole proprietorship. This requirement is also known under the technical term "other consideration for transfer to a GmbH".

If the equity remains within this amount, only the share capital of the GmbH to be recognised for conversion reduces the claim. Because most entrepreneurs in such cases convert their sole proprietorship by providing the GmbH with the legally required minimum share capital of EUR 25,000, this can create the largest possible claim without restrictions of EUR 475,000 for the new GmbH shareholder.

What, however, has to be taken into account in the case of higher equity and how exactly the eligible counterclaim of the contributing shareholder has a tax effect, we have prepared for you in a further article.

6.4. Tax use of the claim by the GmbH shareholder

But what is the purpose of the shareholder’s claim against his GmbH built up in this way? For this purpose, we assume that the company actually generates ongoing profits that the shareholder would like to receive. Since this should be done without tax if possible, the GmbH can, instead of the distribution of a dividend, the reimbursement of the claim. In this way, the claim can be used to achieve the indirect distribution of the profit tax-free.

6.5. No obligation to pay a dividend

The GmbH also has the freedom to decide whether it distributes the profit to the shareholder or prefers to save it. Because the capital gains tax only applies if a distribution actually takes place.

In the case of a partnership, this is so far only possible under special rules, but the alternative taxation of a partnership under the rules of the Corporate Tax Act has so far not been accepted by entrepreneurs. Therefore, it is questionable whether the planned changes in the framework of the economic support to deal with the corona-related economic effects will make a decisive difference.