Growth in partnerships

BewG | Valuation Act

BGB | Civil Code

ErbStG | Inheritance Tax and Gift Tax Act

EStG | Income Tax Act

GmbH | Company with limited liability

GmbHG | Law concerning limited liability companies

HGB | Commercial Code

UmwG | conversion law

UmwStG | Conversion Tax Act

UStG | VAT Act

An increase in partnerships occurs when the number of shareholders falls. There can be many different reasons for this. In any case, a sole proprietorship can be created by growing a partnership. In addition, an accumulation can cause a GmbH to emerge from a GmbH & Co. KG. Here you can distinguish two variants, the simple and the extended growth. Indeed, the acquisition of partnerships constitutes an alternative to other conversions under the Conversion Act. It even offers the advantage that it can be carried out form-free. However, one must also observe a seven-year blocking period. Otherwise, taxes may be incurred in this process.

1st introduction

In 2019, there were 3,559,197 companies in Germany, of which 402,466 were partnerships. This number of partnerships is much smaller in relation to corporations and sole proprietors, but it is not to be despised. 1

Partnerships play an important role in practice, among other things because they are easy to set up. For the simplest form of partnership, the civil company, the formation can take place solely by coherent behavior of two persons.2 The GmbH & Co. KG belonging to the partnerships is widespread and is a popular form of company. It offers many advantages in terms of company law and tax law. The limitation of liability is particularly important here.3

partnerships must consist of at least two persons and cannot, as in the case of a corporation, comprise only one person. This applies not only to gem. § 705 BGB for the company civil law, but acc. 105 para 1 HGB also for the open commercial company and according to § 161 para. 1 HGB for the limited partnership.4 Now the question arises as to what happens if a partner leaves the partnership or dies. In particular, if the company consists of only two persons and the company cannot be continued as a partnership. In this case, the law sees m. § 738 BGB the so-called “advancement”.

In the following, the growth in partnerships is explained in principle. This includes the process, the accounting and the social and tax aspects. In addition, this seminar work sheds light on the extent to which § 738 BGB can be used to advantage and what design possibilities result from this. Especially in practice, growth is used to transform different societies.5 In particular, the design possibilities of GmbH & Co. KG are in the foreground. How can we take advantage of the growth? Which of the different alternatives makes the most sense from a tax point of view in particular and what might need to be considered?

2nd company law

2.1. Legal basis

In the case of a partnership, the common assets are referred to as total assets. Individual shareholders cannot freely dispose of assets or individual assets. This means that they cannot decide for themselves to sell or transfer individual objects. 6 6

As soon as a shareholder dies or otherwise leaves the company, his former share of the total assets of the other shareholders increases. This means that if the association of persons continues to exist, the growing share will be divided in proportion to the previous shareholding of the shareholders. This increased share then merges with the share held by society before the growth. This is done without any individual transfer, by way of universal succession.7 The basis for this is the universal hand principle. Therefore, an increase can take place exclusively with partnerships.8 However, it should be noted that this is not a change in the legal relationship. The owner of the company assets remains the company itself. Only the share of the remaining shareholders will increase.9

For the retired person, his creation of a shareholder is terminated at the moment when he leaves the company. According to § 738 BGB, the reason for the departure is irrelevant. The shareholder may leave the association on the basis of a shareholder contract, termination, law or exclusion. The paragraph applies to all forms of exit.10

The legislature wanted to equate the growth as much as possible with the situation of a dissolution. The retiring person should have as far as possible no disadvantages.11 This is in § 738 para. 1 sentence 2 BGB stipulates that he shall receive a severance payment, which he would have received in the event of a dispute. In addition, he is relieved of all joint debts, but must, in accordance with § 732 BGB, hand over all assets in his possession, which originate from the total assets, to the company. 12

Exemption from debt relates to liabilities of the company arising up to the time of departure. The former shareholder is still liable personally gem. § 128 BGB analogous. Accordingly, the shareholder is entitled to an indemnity against the company.13 The indemnity also includes the repayment of the collateral which the shareholder previously granted to a creditor of company liabilities on economic goods from his private assets.14

One of the central rights of the retired person is acc. § 738 BGB of the already mentioned severance payment claim. This arises immediately upon departure from the company.15 As in the case of debt relief, the company is the debtor of the claim.16 A stratification balance sheet is necessary for the determination of the claim. The special balance sheet is prepared using a company valuation. This is usually done with the income value method, §§ 199 ff. BewG, i.e. Estimation of the future achievable annual yield. According to § 810 BGB, the retired shareholder can check the accuracy of the prepared balance sheet on the basis of the business books and existing documents. Instead of a severance payment claim, a payment obligation of the former shareholder towards the partnership may also arise. This is the case if the severance payments balance drawn up in accordance with the income-value method shows a loss.17

The severance payment entitlement can, however, be regulated by a company contract in deviation from the law. According to Bergmann, this also makes sense, since the value determination of the claim can be simplified.18

The severance payment can be limited or even completely excluded. The nature of a company is decisive here. In an ideal society, the limitation can go from a change in the severance pay entitlement to complete exclusion. In the case of an economically active company, however, a complete exclusion of the right to severance pay is ineffective. This would already be immoral at half the book value of the shareholding. The legal regulations would again be decisive. There must also be no gross disproportion between the severance payment and the actual value; this would also be immoral and thus inadmissible.19 However, it is not objectionable if a certain value is regulated as severance payments in the company from the beginning and the company increases significantly in value in the meantime. However, this impairment must be adjusted according to the circumstances, should an excessive disproportion arise.20

On the other hand, installment agreements and later due dates are permitted, especially since a severance payment can be a significant burden for society. However, it would be objectionable if the severance payment period were longer than 10 years. This is legally inadmissible, since a later payment also represents a restriction for the former shareholder. This disadvantage would have to be compensated with appropriate interest rates.21

2.2. Accounting under commercial law

After an increase, commercial law precludes the transferring partnership from drawing up a final balance sheet and financial statements. According to company law, the company no longer exists after the growth and therefore no management bodies exist. As a result, society can no longer keep books. Also a possible discovery of the hidden reserves is no longer possible in the accounting. However, it is possible to carry out an interim financial statement shortly before the completion of the growth, so that a determination of the previous development and value of the assets can be carried out for tax purposes.22

For the accounting of the receiving legal entity, the first decisive factor is whether the entity was previously subject to accounting. If this is not the case, the sole proprietorship must first prepare an opening balance sheet. If the operation has already been subject to accounting, this is not necessary. Then the acquisition is an ongoing business transaction.23

Accordingly, the difference between the former book values of the assets and the value recognised in the profit and loss account shall be shown in the new company/sole proprietor. According to Sagasser, Bula and Abele, due to the analogy of the merger and § 24 UmwG, it is possible to select the value to be used in the balance sheet of the new legal entity. This can be decided between the book value, intermediate value or common value of the assets. Thus, in the balance of trade, a loss or gain in growth can be avoided by using only the book values.24 If the growth process has been completed in return for payment, the share of hidden reserves according to Sagasser, Bula and Abele in the respective assets are to be capitalised in the ratio of the severance payment attributable to the outgoing shareholders. Accounting for intangible assets created by the company is also permitted.25

2.3 Design possibilities

2.3.1. General

For design practice, the accumulation in the following constellation is interesting: a company consists of only two persons and one of the two is excluded.26 In contrast to corporations, such as a GmbH, a partnership cannot consist of only one person. The law stipulates that partnerships must consist of at least two participants. The company dissolves accordingly upon the departure of the penultimate shareholder and the total assets are transferred completely to the remaining shareholder.27 This takes place without liquidation, which means a considerable reduction in costs and expenses.28

One advantage of the growth in design practice is that a change of legal form can occur.29 The company is continued in the legal form of the remaining shareholder. This can accordingly be a sole proprietorship or another form of company. The growth represents an alternative to the conversions of the UmwG. In addition, there are more design possibilities. Thus, a conversion can also be carried out with a receiving legal entity, which is otherwise excluded by the UmwG. Mergers of different partnerships by a growth are also conceivable. This is possible by transferring all shares to a receiving legal entity at the same time in both companies.30 The acquisition also facilitates transfers of land. No notarization and resignation is required. Only the land register must be cleaned up.31

Overall, it can be said that the conversion by means of agglomeration is not only time-saving and cost-efficient, but also causes less effort. Neither special formalities are to be fulfilled nor any conversion dates are to be adhered to, nor the consent of creditors or contracting parties is necessary.32

For the aforementioned design possibilities, however, a so-called takeover agreement is required. This means that it is or has been agreed that the total assets will be transferred to the last shareholder and this will not be regulated by way of liquidation. It is irrelevant here whether the agreement already exists from the beginning in the articles of association, or was only adopted at a later date by all shareholders. With an effective takeover agreement, §§ 738 ff. BGB apply analogously and thus the design possibilities already mentioned.33

2.3.2. Special features at GmbH & Co. KG

Especially at a GmbH & Co. KG, a conversion by means of the growth method is popular in practice.34 A departure of the limited partner causes the assets of Komplementär-GmbH to grow. A change in the legal form of the company is thus carried out. Here, however, a distinction must be made between the simple and the expanded growth model.35

In the simple model, all limited partners, as already described above, leave society. The GmbH is the last remaining shareholder. All assets do not have to be transferred individually to the GmbH. This brings with it the advantages of accumulation already described.36 However, the simple accumulation model has a decisive disadvantage: the hidden reserves must be taxed.37 The tax consequences will be discussed in the next section of the seminar paper.

In the expanded growth model, the GmbH increases its capital in the course of the conversion. This is done by the limited partners their co-entrepreneur shares by means of an open contribution in kind according to §§ 56a, 7 para. 3 GmbHG to the GmbH. In return, the former shareholders receive shares in the receiving GmbH.38 Thus, the transfer falls under §§ 20 ff. UmwStG As a result, the hidden reserves are not to be discovered and taxed.39 The exact explanation of tax neutrality is described below.

3. tax law

3.1. Simple growth model

For income tax treatment, a distinction must be made as to whether the shareholder retires free of charge or against a severance payment. If a cash compensation is paid, the taxation according to m. § 16 Abs. 1 p. 1 no. 2 EStG. There is a capital gain.40

It also depends on the amount of the severance payment. If a so-called book value clause has been agreed, i.e. a severance payment in the amount of the nominal amount of the shareholder's share of capital, neither a profit nor a loss arises from the sale of the co-entrepreneur's share. A book value compensation is only permissible in the case of accumulation if the book value is not a great disproportion to the market value.41

If the cash compensation exceeds the capital account of the departing shareholder, the proceeds of the sale are generated. After deduction of the disposal costs and the book value of the assets, this represents a capital gain within the meaning of § 16 EStG.42 The book value to be recognised by the acquiring company is determined by drawing up a separate deposition balance sheet. Since the shareholder or the shareholders resign from the partnership and their company assets increase by law to the last shareholder, the retiring persons cannot withdraw total assets from the company assets. Therefore, no common value has to be added to the proceeds of the sale (the severance payment), as may be possible in a normal sale of business. The time of payment is irrelevant for taxation under § 16 EStG. The transfer of economic ownership is decisive. Only the reduction of the severance payment or the occurrence of a suspensive condition leads to a change in the proceeds of the sale.43

A loss on disposal occurs when the cash settlement is below the carrying amount. For the reasons already described, such a severance payment can only be granted under certain conditions so that it is not immoral. The loss is also calculated according to the scheme already described: the severance payment as proceeds, reduced by the costs of disposal and the book value.44

In contrast, there is a task gain according to § 16 Abs. 3 EStG, should the former shareholder receive no consideration. According to the prevailing opinion, this is a concealed contribution by the limited partner to the general partner-GmbH.45 46 47 Even if it is in principle a concealed contribution by the shareholder, the BFH decided in the judgment of 11.02.2009 that the provisions of § 6 para. 3 EStG and thus a continuation to book values and the associated tax neutrality, is not applicable. The hidden deposit is necessarily preceded by the task, which is why § 16 Abs. 3 EStG is relevant.48 This judgment is widely accepted in the literature. § 6 Abs. 3 EStG presupposes that the transaction is granted free of charge for private reasons. The argument against a private process is that in practice it can be assumed that the severance payment entitlement is only waived, since in general the limited partners are also involved in the Complementary GmbH. Accordingly, they continue to participate indirectly in the assets of the company. In addition, it is the operational and not the private goal to convert the GmbH & Co. KG into a pure GmbH.49

For tax purposes, the operating task according to § 16 para. 3 EStG equivalent to the sale of business. The legal consequences are the same. The proceeds of the sale represent the common value of the co-entrepreneur share/asset.50 Normally, however, there are special features in the calculation and determination of the task profit. But in the growth, the entire share of the co-entrepreneur goes over in a uniform process. Since, as already explained, the share is taken from the operating assets before it is transferred with the concealed contribution, the task proceeds are calculated according to § 16 para. 3 sentence 7 EStG with the common value. Recognition of the subvalue is excluded.51 The further calculation of the task profit is carried out according to the usual schemes.52 For each shareholder, a separate profit determination must be drawn up. The respective special assets are attributable to the owners. The combined total hand assets are distributed according to the profit distribution key among the persons involved.53

according to § 16 para. 4 EStG there is a tax exemption, should the vendor be over 55 years old, or be disabled under social security law. The amount of €45,000 is reduced if the capital gain is greater than €136,000. The share exceeding the amount of € 136,000 reduces the maximum amount (§ 16 para 4 EStG). The allowance is personal. Accordingly, any shareholder of the dissolved partnership can claim the allowance.54 In addition, the capital gains according to § 34 para. 2 no. 1 EStG be divided over five years. This equalizes the control load. The profits realised by the sale or abandonment increase the progression of the income tax rate and thus the tax to be fixed. § 34 EStG is intended to counteract this tax burden.55 The profit on sale or relinquishment shall be established by the determining office within the framework of the separate and uniform profit determination. Whether the conditions for the allowance are available, the tax office of the shareholders has to decide.56

Overall, book value continuation is excluded in the simple growth model and the hidden reserves must be uncovered and taxed accordingly for income tax. This was also confirmed and confirmed by several BFH judgments. There is no possibility in this constellation to apply § 20 UmwStG.57 A further disadvantage of the simple growth model is that an undesirable shift of the assets can occur. If the retiring shareholders in the limited partnership do not have the same shareholding in the GmbH, there will be a change in the shareholding in the company assets.58

According to § 7 S. 2 GewStG, the profit from the sale or assignment is usually not subject to trade tax, since in most cases the limited partners are natural persons who are directly involved.

A disadvantage of the conversion to a GmbH, however, is that the trade tax loss carry-forward possibly generated is lost. For this it is necessary that the corporate identity and the entrepreneurial identity is preserved. Even if a partnership now has partial legal capacity, the holders of the right to the loss deduction are the individual co-entrepreneurs themselves.59 60 Since the general shareholder GmbH is not involved in the assets of the company, the former loss carry forward cannot be used.61

With regard to inheritance tax and sales tax, it can be said that the increase does not lead to any tax liability. The accumulation is in close legal connection with the joint purpose of the company and is therefore not taxable as a gift, since it lacks the necessary generosity (§ 7 para. 62 For VAT purposes, there is no controllable exchange of services, as the GmbH typically continues the company. Thus, there is a business sale in its entirety, cf. § 1 para. 1a UStG63

If there was a property in the company’s assets, the addition actually triggers real estate transfer tax, see § 1 para. 3 No. 2 GrEStG. However, it should be noted here that the tax is only fixed in the amount in which the GmbH is not involved in the partnership. However, since the general shareholder GmbH is not regularly involved in the assets, 100 % real estate acquisition tax is incurred.64

3.2. Advanced growth model

As already mentioned, § 20 UmwStG is applicable in the expanded growth model, since the outgoing co-entrepreneurs receive shares in the general partner GmbH in return.65 This means that the hidden reserves of all assets are not uncovered, since the book values can be continued. According to § 20 UmwStG, however, this is only possible if all essential operating principles of the company are transferred to the GmbH. Essential operating principles are all economic goods that the company needs functionally and quantitatively. Thus, all assets, so that the operation can be continued, or economic goods which have high hidden reserves.66

However, the GmbH does not necessarily have to set the book values. It also has the possibility to set the transferred operating assets at the intermediate value or the common value. However, the continuation of the book value has the advantage described above that the hidden reserves do not have to be taxed and no capital gain arises.67

However, there is also a disadvantage with this model. In order to maintain tax neutrality, the outgoing shareholders may not sell their shares in the GmbH within seven years. The shares are subject to a so-called blocking period. Retroactively, a capital gain could arise.68

The value of the operating assets at the GmbH is regarded as acquisition costs for the shareholders for their new shares, but also as the sale price of the old shares in the limited partnership, see § 20 para. 3 UmwStG. Therefore, only the continuation of the book value leads to tax neutrality, otherwise § 16 para. 1 EStG.69

pursuant to § 22 para. 1 UmwStG, at the time of the sale of the co-entrepreneur shares of the shareholders, a sale is retroactively feigned within seven years. The capital gain or the so-called transfer profit I is here the common value of the transferred operating assets at the time of the contribution above the registered value of the GmbH (acquisition costs of the shareholders’ participation).70 The fictitious capital gain is reduced by one-seventh within the seven-year blocking period, see § 22 para. 1 S. 3 UmwStG.

pursuant to § 22 para. 2 UmwStG the same legal consequence applies if the GmbH sells the transferred assets within seven years. The taxation of the so-called transfer profit II is borne by the shareholders themselves, even if they may have had no influence on the sale. In practice, therefore, it is often provided in the transfer agreement that the GmbH must reimburse all tax disadvantages to the co-entrepreneurs.71

In addition, the statutory regulation according to § 22 para. 7 UmwStG. If the assets transferred are recognised below the common value in the balance sheet, the hidden reserves are transferred to the company assets. This increases accordingly and the values of the co-entrepreneur shares increase correspondingly in their value. Paragraph 7 thus stipulates that the sale fiction described above also applies if another co-entrepreneur sells his shares within seven years. Even if he was not involved in the growth.72

4th Conclusion

In my opinion, the growth is a good and practical alternative to the various conversion possibilities according to the UmwG. However, there is the problem that the accumulation can be used only to a limited extent as a design possibility.

The main limitation is that the acquisition is only applicable to partnerships. As already stated in the introduction, most companies are not partnerships, but sole proprietorships or corporations. Nevertheless, GmbH & Co. KG is a widely used form of company. It is also popular in practice, as it offers many advantages.

If a GmbH & Co. KG is available and you want to convert it, the various growth methods are worth considering. Not only the cost factor, but also the effort reduction cannot be ignored. A liquidation or conversion according to the UmwG is subject to many formalities and regulations. These must all be respected. Conversely, a conversion by means of agglomeration is shape-free.

Of the two methods of augmentation presented, the simple and the expanded, only the expanded makes sense.

The simple growth method also brings the advantages in terms of costs and effort as opposed to a liquidation or liquidation. to a conversion according to the UmwG, but these are made none by the taxation of the hidden reserves. If there are no hidden reserves in the total hand power, the simple growth method makes the most sense. However, this constellation is usually not given, especially if, for example, an operating property is available. Under normal circumstances, it is likely that a profit under § 16 EStG will arise.

The expanded growth model combines virtually all the above-mentioned advantages, costs and effort, and the hidden reserves do not have to be taxed. However, this only works if you adhere to all the framework conditions described above. In particular, the 7-year blocking period must be observed.

Overall, it can be said that the growth creates many design possibilities and too little attention is paid in practice.