If you want to convert your sole proprietorship into a holding company, you should consider some aspects. First, transformation is a two-stage process. First, the individual company is converted into a GmbH. In a second step, another GmbH is founded as a holding company. The previously converted company is then added to this Holding GmbH by exchange of shares. However, there is a blocking period of seven years for both conversion and transfer. Otherwise, the sale of one or both companies will trigger a retroactive taxation of the hidden reserves. The same applies if the transfer to Holding GmbH involves a shareholding of 50 % or less. Taxation is also to be expected in this case.

In a number of contributions, we have already pointed out the different tax advantages of a holding company. However, since we know that you as an interested entrepreneur would like to know how you can also enjoy these advantages with your individual company, we have bundled the most important facts in this article. After all, the transformation of a sole proprietorship into a holding company is not an everyday undertaking. In addition, special features must also be considered after the successful transformation of the company. Otherwise, failure to comply with certain conditions will lead to retroactive taxation. Before we get to the details, however, we would like to draw a framework around the initial situation and address some more information.

SEGMENT002 1.1. What is in the Beginning

In the following, we develop the process to convert a sole proprietorship into a holding company. It is irrelevant for the starting point whether the sole proprietorship is of a commercial nature or whether it is rooted in a freelance activity. In both cases, the procedure and the associated goal are identical: the creation of a holding company.

1.2. Converting sole proprietorship into holding company: the result

For good reason, most holding companies in Germany exist in the legal form of the GmbH. Because the tax advantages of a GmbH can be considerable. In certain cases, up to 95% of profits can be tax-free. Even the exemption from business tax may be possible. In addition, limitation of liability is an important element that deserves special attention when starting a company. Of course, other forms of company are also possible here, both partnerships and corporations being possible. However, the GmbH offers the greatest flexibility in tax terms as well as in the design of the company structure, to name just one of the many pluses. Therefore, we limit ourselves here to a GmbH, but at the same time admit that it can also be read as a representative for other forms of company.

Converting a sole proprietorship into a holding company in 2 steps

In order to convert a sole proprietorship into a holding company, a two-step process must be followed. After all, a single company should produce a construct consisting of at least two companies.

By the way, it should be noted that this particular model of conversion among professionals is also known as chain input.

2.1. Step 1: Establishment of a GmbH to start a sole proprietorship

As the first measure on the way from a sole proprietorship to a holding company, a GmbH is to be founded. Except for the start-up capital, this GmbH is initially empty. But when the individual company is brought into the GmbH, it is filled with the desired economic vitality. We have thus created an operating company from the sole proprietorship, which as a corporation is now waiting to become part of a larger holding company.

2.2. Step 2: Establishment of a Holding GmbH and contribution by share exchange

Here, too, the foundation of a GmbH is the first stage at the beginning of our arrangements, with which we convert a sole proprietorship into a holding company. Since this second GmbH as a newly created company is also initially quite empty, it should participate in operative GmbH. This is done by a so-called share exchange according to § 21 UmwStG between you and the shareholder(s) of operative GmbH. Only through this acquisition is the holding company created, from which you can then profit taxably. Holding GmbH is now entrusted with the holding and management of the participation in the operating company, which initially existed as a sole proprietorship.

Converting sole proprietorship into holding company: 2 important characteristics

When converting individual companies into holding companies, however, two aspects must be considered. One aspect concerns two blocking periods in connection with the contribution or exchange of shares. The second aspect is related to the amount of the shareholders’ contribution.

3.1. Closure periods for the sale of companies

Whether it is the initial transfer of the sole proprietorship to operative GmbH or the exchange of shares to create the holding company, any hidden reserves are subject to direct taxation in both cases. Because the law basically specifies the approach with the common value in the transfer. However, this can be circumvented by applying for conversion instead by recognizing the assets at the book value. In this way, one can avoid the hidden reserves being revealed.

However, the sale of one of the two companies can also lead to retroactive taxation of the hidden reserves. However, this only applies during a blocking period of seven years after the respective conversion process. One-seventh of the taxable amount is exempted for each elapsed year. For example, for a sale in the sixth year after the conversion, only two sevenths of the hidden reserves are tax relevant. Moreover, retroactive taxation determines the value of the hidden reserves as it was to be calculated at the time of conversion.

After the expiry of this blocking period, the general provisions on the taxation of capital gains apply. A retroactive taxation with the values at the time of conversion is then excluded.

3.2 Minimum amount of participation in the share exchange

The second important aspect, which is relevant in the transformation of individual companies into a holding company, concerns the amount of the shareholding of the acquiring Holding GmbH in the operating company. He, too, is again associated with the desire to carry out the conversion as neutrally as possible for tax purposes. Because only if the shareholding is more than 50%, the share exchange of the contributor in relation to the hidden reserves is without direct tax consequences. However, the prerequisite here is that the value approach is made with the book value during the entire conversion process.

Therefore, the conversion is very simple for a sole owner of the sole proprietorship. Because with a share of 100%, the share exchange is above the minimum of 51%. However, with two equal partners, each of whom wants to bring their own individual company into a joint holding company, neither of them can claim the privilege for themselves to have the share exchange tax neutral. Holding-GmbH now acquires only 50 % of the shares in the operating company. This leads to a taxation of the hidden reserves within the framework of the so-called transfer profit II.