date | theme

16. February 2022 | No profit distribution to a holding company in the year of its establishment!

9 March 2022 | Combine holding with foundation: 3 tax advantages secure!

12. April 2022 | Foundation holding as an alternative to GmbH holding

August 5, 2022 | Sell IP tax-optimized: a design model with Holding & Foundation

17. July 2023 | Holding in comparison to individual companies and GmbH (this contribution)

There are similarities and differences between a sole proprietorship, a GmbH and a holding company. So we look at a holding company in comparison to individual companies and GmbH and find that the differences are particularly in the area of liability risks and taxation. But there are also significant differences in the choice of ways to reinvest profits. In addition, you can design a lot more taxable with holding structures. However, there are framework conditions that influence when which of the three structures is more advantageous.

A holding company is usually a purely asset management company. Unlike operating companies, value creation is at best an exception. In a holding company, neither a production nor a service takes place compared to operating companies. Although the rental of real estate may be an activity that holding companies like to operate, this also falls strictly speaking into the area of asset management.

Now our readership may note at this point that this is already a very good comparison between a holding company and other forms of company. However, we answer that this comparison is only superficial. He should show you what the essence of a holding company is. The aim of this essay, on the other hand, is to show you how a holding company may serve as a supplement to the large group of operating companies. Where and when is it beneficial? When do other corporate structures make more sense? We want to establish all this by looking at the holding company in comparison to other forms of company.

This brings us first to the in-depth exploration of the alternatives to the holding company. In principle, either individual companies, partnerships or corporations come into consideration here. Since there are only minor differences between individual companies and partnerships that would be relevant when comparing with a holding company, in our article we consider the individual company as representative of all partnerships. On the other hand, one can argue that the importance of the GmbH for German entrepreneurship is significantly greater than the Aktiengesellschaft or the SE and other corporations. Therefore, and because there are hardly any significant differences between the individual corporations for our considerations, the GmbH should be the prime example in our comparison with the holding company.

A sole proprietorship is either a business or an enterprise engaged in a professional activity. It is essential that the profits are attributable to a single person, namely a sole proprietor. It bears the full entrepreneurial risk for the individual enterprise. The risk actually extends beyond the company’s assets. This is because the private assets of individual entrepreneurs are also subject to liability in the event of damage or other debt obligations. A shielding of private assets is therefore excluded in principle for individual entrepreneurs.

But there is more that we should pay attention to when comparing with a holding company. In addition to the liability aspects, we also have to deal with the taxation of individual companies. This applies that the profits of the sole proprietorship are directly subject to the personal tax rate of the sole proprietors. For an exemplary profit of about EUR 55,000 annually, according to the tax calculator of the Federal Ministry of Finance, an income tax of about EUR 14,000 is incurred. If you have a taxable income of about EUR 58,500, you enter the tax area where the top tax rate applies. In this area, EUR 0.42 of income tax applies to every euro profit. Often a trade tax overhang and other taxes can be added. So you can then assume that only half of the profit remains.

As a corporation, the shareholders invest money in a GmbH. This in turn uses the capital paid to them to generate profits through business activities. However, this principle has a significant advantage over a sole proprietorship. This is because the private assets of the shareholders are shielded. Finally, because the GmbH is a legal entity, it has independent rights and obligations (§ 13 (1) GmbHG). This minimizes the liability risk of its shareholders to their contribution. The company itself is liable with all its assets.

Now we come to taxation. Here too, we must consider the GmbH as an independent person. It pays its own taxes, namely corporation tax and business tax. In total, about 30% of taxes come together. This is already somewhat lower than in the case of taxation of sole proprietors, if they have to count on the top tax rate.

However, it must be remembered that the GmbH shareholders have not yet received a dividend. So we must also include taxation on the distribution of profits to shareholders. This is a flat-rate capital gains tax of 25 %. If we tax the remaining 70% of the profit at 25% after corporate taxation, only about 50% of the profit will flow to their shareholders.

So what is the advantage of the GmbH over individual companies? On the one hand, the limitation of liability. On the other hand, GmbH-Shareholder-Managing Directors can also have a Managing Director salary paid for their work. On the part of the GmbH, this represents operating expenses that it can deduct from tax. This saves you at GmbH level already taxes. If you also cleverly design the managing director's salary, then managing directors pay less than the top tax rate in income tax. But as we have already shown, this is only possible to a certain extent, but it may still be enough for a comfortable life of a managing director.

This means that you can refrain from an annual profit distribution, so that there is no capital gains tax. Rather, this accumulated profit reserve enables the GmbH to make further investments. This, too, is certainly an advantage that the GmbH can demonstrate over a sole proprietorship. The investment that a GmbH can make from its retained earnings was subject to taxation of only about 30 %, whereas the investment that a sole proprietor can make was previously subject to taxation at the top tax rate plus other taxes of about 50 %. As a result, the amount that a GmbH can invest from a profit of EUR 60,000 is higher than that which remains for individual entrepreneurs.

But if the accumulated profits simply remain in the GmbH and continue to grow over time, then this gradually develops into a liability risk. Should a loss occur later, which is accompanied by high claims against the GmbH, then the GmbH might be able to compensate at least part of the claims. This would mean that the money saved in the GmbH would still be lost.

What liability risks does a holding company have? In short, almost none. Remember: a holding company only manages assets. Entrepreneurial decisions, as they are everyday in an operating subsidiary, are the exception for a holding company.

However, taxation also plays a major role in a holding company. Depending on the legal form in which a holding company is established, there is either transparent taxation at the level of the shareholders or direct taxation at the level of the holding company. In the former case, we would have set up a partnership as a holding company, in the latter a corporation. In fact, a holding company is preferred in the vast majority of cases to a GmbH. However, because of the so-called box privilege, a special feature of the Corporate Income Tax Act, Holding-GmbH usually pays only 1,5 % tax on the profit distribution it receives from its subsidiary.

5.3.1. Minimizing the liability risk of subsidiaries

The main advantage of the holding compared to the GmbH is not taxable. Finally, there is a tax of 1,5 %, albeit a small one, which a GmbH could save itself by saving its profits. Rather, the advantage of the holding company in relation to the GmbH is to be seen in the fact that the profits managed by the holding company are excluded from their liability in the event of an event subject to damages at the level of the operating subsidiary. Because the assets are now in the holding company.

If the subsidiary were to face a threat of insolvency in such an event, the holding company could negotiate an alternative solution with the creditors. In exchange for a write-off of the subsidiary’s liabilities, which in any case does not have a chance of being paid in full, the holding company would take over part of those liabilities. For creditors, this is often both the easier and the less financially lossy way to get out of the situation. In return, the holding saves its subsidiary from insolvency. However, this is accompanied by a taxation of the waived liability.

5.3.2 Option to redeem profits from the sale of subsidiaries

A further advantage of the holding compared to a shareholding in private or operating assets is that the box privilege also applies to a company sale. More specifically, a holding company pays only 1.5% tax on the sale of a subsidiary. This means that a large part of the profit from the company sale is then available for reinvestment. We remember: If a sale from taxed private assets would remain at most half for this.

5.3.3. Greater freedom in tax design

Another point that can be made when considering a holding compared to sole proprietorship and GmbH is that you can design a holding much more tax-wise. Be it the indirect distribution of profits through the repayment of loans to its shareholders, the avoidance of the exit tax or many other possibilities, the holding company is the ideal tool for tax structuring.

Which brings us to the disadvantages of the holding company. A fundamental disadvantage of the holding company compared to operating companies is that it only becomes an advantage because it serves to compensate for disadvantages of operating companies. This may seem paradoxical, because this is actually a positive point that speaks for a holding company. However, this also means that the holding company does not generate any advantages in comparison to operating companies. With some exceptions, there is no significant profit at holding level; This arises primarily at the level of the operating subsidiaries. In other words, this disadvantage of the holding company can be seen in the fact that it serves only as a tool for avoiding disadvantages of operating companies.

But there is more. Finally, you have to regularly prepare balance sheets and submit tax returns at a holding company, especially in the legal form of a GmbH. This often requires professional support – and that costs.

Let’s summarize here. There are situations in which the holding company is a useful complement to other forms of company. On its own, the holding company can at best generate profits in asset management. In this respect, the holding company is much less effective compared to individual companies and GmbH. Nevertheless, a strict separation between the functions of a holding company and its operating subsidiaries makes sense in certain situations. In this way, a holding company helps to minimize liability risks in its subsidiaries by taking on risky assets. The advantage here is that a holding company has comparatively low liability risks because it does not itself carry out current business on the scale of operating companies.

However, the framework conditions must first be in place so that a holding company can develop its advantages compared to other corporate structures. With an annual company profit of less than about EUR 60,000, apart from the existing private liability, the sole proprietorship can be at least tax-advantageous compared to a GmbH with or without a holding company. With a higher profit margin up to about EUR 200,000 per year, a simple GmbH is probably enough to establish an optimal structure. In addition, a holding company is definitely worth considering.