The conversion of a company – for example a GmbH – can also be carried out retroactively for up to eight months. This is true even if a company resulting from the conversion did not exist at that retroactive date. If the cut-off date of the conversion falls on the cut-off date of the annual accounts, the separate preparation of a final balance sheet in accordance with the provisions of the UmwG can be waived. As a result, a retroactive conversion avoids drawing up a separate balance sheet at the date of the conversion while respecting the eight-month period. In addition, the retroactive effect also makes potential savings in other aspects, such as corporate tax and business tax.

Converting a business can happen for many reasons, with financial benefits in the foreground in most cases. Equally diverse are the different ways of converting a company. Whether in the case of a change of legal form, a merger, a division or a transfer – they can all be asserted retroactively under certain conditions. The maximum duration for the retroactive effect of a conversion is eight months.

Retroactive effect is regulated by law in both the conversion law and the conversion tax law. The conversion tax law regulates the income tax treatment of conversions. Thus, the retroactive effect of a conversion can affect a number of taxes. This is true even if the retroactive effect takes place during a period in which the company concerned did not yet exist. Lawyers speak of a fiction. This is therefore an assumed state of affairs, which lies in the retroactive effect in the past, and in this way influences, among other things, the taxation of the company.

Since a retroactive effect can occur in all types of conversions, but is subject to certain conditions, we will now show you in detail when this is actually the case. Furthermore, it is certainly of interest that, by skillfully applying the reaction, costs in connection with the conversion can also be saved. This applies in particular to costs arising from the legal requirement for a final balance sheet at the reference date of the conversion.

Advantages of the Reaction of a Conversion

2.1 Use of the current annual balance sheet by retroactive effect

If the conversion date deviates from the annual balance sheet date and one does not make use of the retroactive conversion option, one has to draw up a final balance sheet on the date of conversion in accordance with statutory provisions. This particular balance sheet does not require publication. A profit and loss statement and an appendix are also not necessary. Nevertheless, the re-establishment of a balance sheet during the marketing year entails avoidable costs which increase even further if the obligation to audit the balance sheet exists. Therefore, we recommend exercising the retroactive effect of the conversion to the extent that the current annual balance sheet can be used.

2.2 Use of losses in the retroactive conversion of enterprises

In general, losses carried forward and those from the current financial year can only be retroactively taken into account in the conversion of an entity if this is also due to the receiving entity. Especially for international companies, this may lead to restrictions. However, in the case of a merger of a limited liability company to another limited liability company or partnership, the transfer of corporate and trade tax loss carry-forwards is generally prohibited by law.

2.3. Corporate tax and business tax

Retroactive effect also affects the taxation of a converted limited liability company or the taxable shareholders of a partnership. Of course, this also applies to a sole proprietor concerned. However, this only applies to the application of corporate tax and business tax. Other types of tax, such as property tax, sales tax or gift tax, are excluded.

Next, we would like to show an example of how to save taxes with retroactive effect:

A GmbH decides to change form into a limited partnership. The possibility of retroactive effect by a maximum of eight months is to be used. Thus, the resulting A KG has already existed for eight months, whereas the GmbH must be regarded as non-existent for this period. Consequently, the limited company does not incur corporate tax. And in the case of trade tax, this can also count the allowance that would otherwise be withheld from a corporation.

2.4. Conversion balance sheet approach

Another aspect that is also manifested indirectly with the retroactive effect of a conversion concerns the balance sheet approach of the companies concerned. There is a right to choose whether the balance sheet approaches are adopted with the sub-value or, on request and subject to certain conditions, the book value. A third possibility exists by applying so-called intermediate values. However, this right of choice can only be applied uniformly to all assets affected by the conversion.

2.4.1. Accounting value approach

The advantage of applying the book value is that no hidden reserves are discovered in the course of the conversion and are therefore not taxed. Instead, the hidden reserves are only discovered at a later transfer of the assets and then taxed regularly. However, this also has the disadvantage that the affected assets with the lower book value are written off afterin. If most of the depreciation has already taken place, the book value approach is the most favourable alternative.

2.4.2. Balance sheet approach with sub-value

On the other hand, the partial value approach in the conversion leads to a discovery of the transferred hidden reserves. However, there are grds. a reduced taxation according to § 34 (1) EStG. A further advantage is that this allows higher depreciation than at book values. Therefore, the balance sheet approach with the sub-values is advantageous where the further depreciation of the assets being transferred will take place to a considerable extent.

2.4.3. Subordinated mutual member accounts

The third option with the intermediate values is a mixed form. The intermediate values lie between the book value, as the lowest possible approach, and the sub-value, which represents the highest possible approach. This results in the hidden reserves being taxed in the course of the conversion only up to a part which can be chosen within the said limits. The depreciation of the assets transferred is correspondingly higher.

2.4.4. Advantage of retroactive effect through the appropriate balance sheet approach

For all three balance sheet approaches, the retroactive effect of the conversion may result in lower taxation. Depending on whether the book value approach, the partial approach or the intermediate approach is more favourable for tax purposes, the retroactive effect contributes to the benefit being claimed up to eight months before the date of conversion.

Since corporations, in particular GmbHs, are more often affected by conversions than partnerships or sole proprietors, we focus on these corporate forms as representatives in the following.

3.1. Change of legal form of a corporation into a partnership

In the event of a change of legal form of a corporation into a partnership, a retroactive conversion according to § 9 UmwStG by eight months is possible. First, the limited liability company must draw up a final balance sheet on the date of the transfer. This conversion balance sheet shall be consistent with the opening balance sheet of the partnership. Furthermore, the retroactive effect from the date of the register entry of the mould change is to be set.

An example:

B GmbH is aiming for a change of form for 2019. The result of the conversion is to be a GmbH & Co. KG. It is planned that the conversion should take place by 31.08.2019. Due to the legal possibility of retroactive effect for up to eight months, the corporation selects 31.12.2018 as the conversion date. This results in three advantages for the company: On the one hand, the GmbH can also use its annual balance sheet for 2018 as a final balance sheet for the conversion without having to create a new balance sheet specifically for this purpose. This saves the GmbH the costs of separate accounting. On the other hand, the newly founded GmbH & Co. KG can also claim the tax benefits resulting from the conversion for the period January to August 2019. These advantages are the avoidance of corporate tax and the use of the business tax allowance.

3.2. Mergers of corporations

When two corporations are merged into one, they each have to draw up a final balance sheet at the date of the conversion. Here again, the conversion can be retroactively applied for eight months, with the date of registration of the merger of the undertakings serving as the relevant date. Of course, the limited liability company resulting from the merger then takes over the balance sheet approaches from the merged companies.

An example:

The two corporations C GmbH and D GmbH are seeking a merger into CD AG. The timetable for the merger provides for this as of 31.08.2019. Of course, the option for retroactive conversion to 31.12.2018 is also selected in this case in order to use the associated advantage by avoiding the creation of a separate final balance sheet.

The division of enterprises includes three variants, the division, the separation and the spin-off. Therefore, a separate consideration is necessary.

3.3.1. Splitting

An entity in which a split is made is dissolved in such a way that the result of the conversion produces two or more entities that take over the split shares. In return, the former shareholders of the split company will receive shares in the acquiring companies. The shares correspond to the equivalent value of the transferred assets.

In fact, a split of up to eight months from the date of registration can be carried out retroactively. Thus, the companies to which the assets of the split company are transferred have the benefit of retroactively claiming the tax consequences of the conversion for eight months. An example for explanation:

E GmbH operates the commercial rental of warehouses. As of 31 August 2019, it is to be split retroactively into two follow-up companies to be founded. In this case, F GmbH is only to receive the land for administrative purposes, while G GmbH is to take over the lease of the assets contained in the land. In this way, F GmbH as a pure real estate company receives the advantage of the extended property reduction in trade tax – retroactively by eight months. While the original E GmbH would normally have to pay trade tax in full for January to August 2019, the split leads to a reduction in the trade tax incurred on it.

3.3.2. Separation

The separation involves a transfer of assets from a separating entity to a receiving entity. In return, the shareholders of the divestiture will receive equity in the host entity.

A retroactive effect in the case of separations is also permitted by law. Again, a period of no more than eight months shall apply, with the date of registration as the reference date.

3.3.3. Derivation and transfer

The spin-off is a conversion in which assets are transferred from one spin-off to another. In doing so, the divestiture entity remains in existence but receives shares in the receiving entity for the transfer of the assets. Thus, unlike the separation, the shareholders of the divestiture are only indirectly affected by the new shareholdings resulting from the conversion. Therefore, on the part of the host entity, the transfer is also considered a contribution.

And here too, the retroactive effect of the spin-off and contribution of up to eight months is possible. However, the exact legal regulations for this differ from those of the other types of conversion. On the one hand, instead of the date of registration, the date on which the transfer contract is concluded applies here. On the other hand, the law distinguishes between a transfer to a corporation and a transfer to a partnership. Thus, the transfer to a partnership can only be carried out retroactively if this takes place within the framework of a universal succession. The transfer by universal succession is in turn only given if this takes place within the framework of a hive-off. A transfer in another way, on the other hand, constitutes an individual rights succession and is thus excluded from retroactive effect.

3.3.4. Examples of submission

So here are some examples to explain individual succession and universal succession:

The transfer of one or more individual companies to an OHG or KG constitutes a transfer within the framework of individual legal succession. A retroactive effect is thus excluded.

The transfer of parts of an enterprise as a result of a spin-off is to be regarded as universal succession. It is irrelevant whether the divestiture undertaking is a sole proprietorship, a corporation or a partnership. Consequently, the retroactive effect is also applicable to this form of contribution. If, for example, a GmbH or a limited company decides to spin off a part of the business to another subsidiary, either already existing or newly founded, then a retroactive effect of the contribution can be used. The same also applies if a registered merchant wishes to transfer parts of his business to an existing GmbH or a newly founded GmbH. This introduction also constitutes a conversion by universal succession in which retroactive effect is permitted.

A final note on submission: The merger of undertakings also leads to a transfer by universal succession to the host undertaking.