Share deal at the GmbH: 3 designs for tax optimization

date | theme

22. September 2018 | Asset Deal at the GmbH purchase: Purchase price tax depreciation

26. October 2018 | Share Deal: Company Purchase & Sale of a GmbH

09. November 2018 | Share Deal at the GmbH: 3 designs for tax optimization (this contribution)

17. May 2019 | Purchase of GmbH: Share Deal and Asset Deal – 3 designs for the buyer

When acquiring GmbH shares (share deal), the purchase price cannot be written off in principle. In addition, the purchase price must be paid from net taxed income. We show the problems in detail and explain three design models, how the borrowing costs can be deducted tax. We also show how the repayment services can be provided without first paying capital gains tax.

Since the acquisition of shares (also: Share Deal) is usually associated with high acquisition costs, the Share Deal is often accompanied by high debt financing loans. The potential buyer naturally wonders to what extent expenses can be claimed in this context in order to achieve a tax reduction of the current profit and to avoid unpleasant surprises.

In the course of this article, some answers will be given to these questions. It should be noted that only reference is made to the tax perspective. Commercial legal views are ignored.

First of all, a comparison of the tax transactions for the acquisition process of shares in persons and corporations will be presented. This explains whether and how the acquisition costs of the purchase price and the debt financing interest can be taxed. Furthermore, reference is made to possible voting rights. It also briefly sets out whether possible tax loss carry-forwards can be carried forward when acquiring company shares.

In the last step, identified problems are to be solved by three design variants.

Basics for the acquisition of shares (share deal)

2.1. Principles for the acquisition of shares in partnerships

A partnership is an association of two or more natural or legal persons pursuing a common purpose.

When acquiring shares in a partnership, it is essential that it is not the acquisition of an independent asset, even if the shares are to be shown in the trade balance. In fact, ‘[...] it is not the partnership shares that are the subject of the acquisition but the individual assets of the partnership’s total assets that are partly attributable to the vendor’.

If a natural or legal person acquires 20% of the shares in the partnership, he receives 20% of the assets of the total assets. In this respect, from a profit tax perspective, the share deal of a partnership can rather be regarded as an asset deal, i.e. as an acquisition of assets. However, under civil law, the assets are not part of the acquisition process, but the shares in the partnership.

The acquisition costs of the shares are presented as a capital account in the tax balance sheet as follows:

If the acquisition cost is higher than the seller’s capital account, the excess amount must be presented in a separate additional balance sheet of the acquirer. This contains the excess capital on the liabilities side. The assets show the assets acquired for income tax purposes. If the assets contain hidden reserves, they are discovered and depreciated with the normal service life, provided that the assets are depreciable.

As gainful objects, not only the already accounted assets come into consideration, but also under certain circumstances the original company value as an intangible asset. This must be written off over 15 years.

‘Since the acquirer has pro rata acquired all the assets of the partnership, the surplus capital is in principle to be distributed equally and objectively among all the tangible and intangible assets of the partnership.’ This applies to both recognised and unrecognised assets. It is questionable, however, in which order or ratio the surplus capital is to be distributed among the respective economic goods. There are three different distribution methods.

The three-stage theory provides for a possible distribution: According to this, the surplus capital is only distributed to the economic goods already accounted for in the tax balance up to market value. If additional capital is then available, this is distributed to non-recognised intangible assets (e.g. patents). Only in the last step is the original company value allocated to the remaining surplus capital.

The modified stage theory, on the other hand, summarizes the first two steps of the three-stage theory. Thus, the surplus capital is first attributed to the hidden reserves of the intangible assets both accounted for and unaccounted for. The remaining surplus capital is then reassigned to the original company value.

A third distribution method provides that all assets accounted for and unaccounted for, including the original goodwill, are equally distributed among the additional capital and written off.

However, for all 3 variants, both depreciable and non-depreciable assets must be accounted for equally. The silent reserves in the circulating capacity, such as e.g. stocks and finished and unfinished products. These are then immediately declared as operating expenses with the assessment of the inventory.

However, the purchase price can also be divided in the tax balance between the capital accounts of the shareholders in their respective shareholding relationship. As a result, the acquirer would have shown a higher capital account in the tax balance sheet, but this would reduce his additional capital in the supplementary balance sheet.

It should be noted that the increased capital accounts trigger a discovery of the hidden reserve in the total assets, so that all shareholders benefit from it. The old shareholders would also have a higher capital account, but without having made a payment. This leads to a negative supplementary balance at the level of the old shareholders. This means that goodwill is recorded on the liabilities side of the supplementary balance sheet and amortised over 15 years. This results in an increase in the tax result, which, however, is compensated by the discovery of the hidden reserves within the total hand assets.

If the purchase price is higher than the existing hidden reserves and the original company value, the excess capital can be claimed immediately as a special operating expense.

All in all, the purchase price for partnership shares contains a high degree of depreciation potential, which can be used regardless of the legal form of the acquirer.

2.1.1 Debt financing expense

An important criterion when buying shares is the financing expense. Depending on the purchase price, high interest rates can occur in connection with the share acquisition. However, in the case of the acquisition of partnership shares, such interest expenses are fully deductible, irrespective of the legal form of the acquirer.

The debt financing expense is to be recorded in the special balance sheet for the individual shareholders and represents special operating expenses.

2.1.2. Loss carry forwards

The loss carry-forward of the business tax is attributed to the partnership itself and can only be claimed by it in later years. A loss transfer is not possible in the case of business tax.

Nevertheless, it should be noted that the loss carry forward is attributed to the shareholders according to their shareholding relationships. Therefore, if a shareholder sells his shares, he leaves the company. This has the consequence that the loss carry forward is linked to the departing shareholder and the shortfall in the loss carry forward is lost proportionally. In this case, the new shareholder does not assume the proportional loss carry-forwards of his predecessor.

A loss carry forward is not possible for income tax according to § 15d EStG.

2.2. Basis for the acquisition of shares in corporations

A corporation is characterized by its own legal capacity as a legal entity. However, their will and actions are carried out by the institution, since the corporation itself is willless.

The acquisition of shares in a corporation is an independent asset under tax law. Although shareholder rights such as voting rights, profit rights and participation in liquidation proceeds are acquired, this is nevertheless assessed as an independent asset.

After the transfer of ownership of the shareholding, the asset must be valued in the tax balance of the shareholder. According to § 8 para 1 KStG in conjunction with § 6 para. 1 No. 2 EStG, a participation in corporations is recognised at the cost or a lower partial value.

Characteristic of shareholdings is that it is an individually valueable and unusable asset. Regardless of the legal form of the acquirer, the acquisition costs have a tax-reducing effect only at the time of the sale.

The depreciation volume of the assets already accounted for is unaffected at book values, since the assets are not acquired by the shareholders for income tax purposes, as is the case with the partnership. The purchase of shares in a corporation is to be separated from the assets in the operating assets knitted.

2.2.1 Debt financing expense in the share deal

As already mentioned in the case of the acquisition of shares in partnerships, the deductibility of the financing interest is also an essential objective of the acquirer in the case of the acquisition of shares in corporations by share deal. However, in the case of shares in limited liability companies, the level of deductibility of the financing interest depends on the legal form of the acquirer.

If the acquirer is himself a limited company, the interest can be claimed in full, although the capital gain and the current profit are exempt at 95 %.

If, on the other hand, a natural person or partnership acquires shares in a corporation for his operating assets, the interest on debt financing can only be claimed up to 60% in accordance with § 3c EstG.

Reason for the limited deductibility is taxation according to the partial income procedure according to § 32d para. 2 No. 3 EStG, which is applicable if there is an indirect or direct participation in the company of at least 25% or an indirect or direct participation of at least 1% and at the same time an activity for the company. Since the partial income procedure results in a tax exemption of 40% of the current as well as the capital gain, according to § 32d Abs. 2 No. 3 EStG in conjunction with § 3 para. 40 EStG only the part of the interest which concerns the taxable part in the amount of 60% can be claimed.

However, a natural person may also hold the shares in the company in his private assets. In this case, from a shareholding amount of more than 1%, there is the right to choose to tax the profits as capital gains (with 25% withholding tax) or with the partial income procedure. However, if the shareholder chooses taxation according to the capital gains, no advertising costs can be claimed in this context since 2009. There is now only a lump sum of 801€ (for co-investment 1,602€).

2.2.2. Loss carry forward in the share deal

According to the previous legal situation, the loss carry forwards were assigned to the legal person and could be taken over without restriction in the event of a change of share, since the acquisition of the share did not change the legal person itself.

With § 8c KStG and § 10a GewStG, the legislature put a stop to this regulation for the loss carry-forward of corporate and business tax.

Since the change in the legal situation in 2008, the loss carry forwards of a corporation on acquisition of 25% to 50% of the shares are now to be reduced proportionally. In the case of a harmful takeover of shareholdings of 50%, the loss carry forward is even completely eliminated. This reduction in loss carry-forward cannot be ignored with more share transfers. If several share transfers take place within five consecutive years, they are added together.

Now there is only a prospect of taking on a loss carry forward if the entrepreneur can prove that the company has hidden reserves at the time of acquisition. If this is the case, the loss carry forward in the amount of the hidden reserves can be taken over by the acquirer and offset against future profits.

3rd property transfer tax

For real estate transfer tax reasons, it is necessary that the acquisition of shares in persons or corporations is subject to special consideration if the company has identified real estate in the business assets. Because in a partnership according to § 1 Abs. 2a GrEStG acquires at least 95% of the partnership shares within five years, this constitutes a transaction subject to property advertisement tax.

In the case of a corporation, according to § 1 para. 3 GrEStG the acquisition of 95% of the shares by share deal also constitutes a real estate acquisition taxable transaction.

For a long time, the tax administration was of the opinion that the real estate transfer tax triggered by this transaction must be allocated as acquisition costs to the building or the non-depreciable land and depreciated over the period of use. The background is that the real estate advertisement tax is triggered causally by the real estate and this must be allocated as in an asset deal.

This view was contradicted by the Federal Court of Justice. In the BFH judgment of 02.09.2014 IX R 50/13, the Bundesfinanzhof clarified that “acquisition costs of an economic good can only be those costs that are actually attributable to its procurement according to economic aspects”. When acquiring the partnership shares, however, the focus is on acquiring the company, not on purchasing the land. In civil law, the legal entity has thus not changed. This is still the partnership. Only the shareholder shares have changed, which according to § 1 Abs. 2a GrEStG is only a fiction of the transfer of the land to a new partnership. This lacked “a substantive connection between the acquisition of the partnership shares and the real estate transfer tax going beyond the mere causality”.

The real estate transfer tax can thus be claimed in full as operating expenses and does not have to be allocated to the acquisition costs of the land.

4th design variants

It was explained in the course of the article that an acquisition of shares in a corporation of a natural person is only possible for a deduction of financing interest of 60%, provided that the partial income procedure applies.

The goal of an entrepreneur, however, will be to find a way to claim the perfect interest and at the same time maintain the tax exemption of the part income procedure in the case of a sale.

Since the limited extraction capacity exists due to the part income process, a way has to be found to circumvent it. After considering the prerequisite for the part income procedure, it was found that the involvement of the natural person is the disturbing part. If the acquirer were a limited company, the financing interest could be claimed in full.

This problem can be solved with the help of a holding structure.

For the implementation of the design variants, the creation of a holding structure is the starting point. Before purchasing the planned share capital shares, the acquirer (of course person) must set up a holding company in which he has a 100% interest. Holding-GmbH in turn establishes a new capital company, which only acts as an acquisition vehicle. This acquisition company will then carry out the purchase of the target capital company and take up all necessary loan agreements for the share purchase.

At this point it was achieved that the debt financing interest is not attributed to the natural person but to the acquisition company (corporation). Thus, although the interest expense at the acquisition company can be claimed 100% as operating expense, the expenses are not offset by any income that could be offset. The resulting loss carry forward is taken over for the following years.

The offsetting of debt financing interest with operating income can be solved by various design variants.

4.1. Variant 1: Organism

A design variant for offsetting interest expenses with operating income is possible with the creation of an income tax organization within the holding structure explained in point 3.1.1.

If an income tax organization is now created around the target capital company and the acquisition company, a profit and loss transfer agreement is concluded between the two companies. This has the effect that the operating result of Ziel GmbH is transferred to the acquisition company. It should also be noted that the profit and loss transfer agreement must exist for 5 years.

The operating result of the target corporation can then be offset against the interest expenses of the acquisition company and is taxed at the level of the acquisition company with corporation tax and business tax.

4.2.Variant 2: Debt-financed distribution

The acquisition company has taken out a loan for the acquisition of the target capital company. As a first step, the target capital company now takes out a loan that is little higher than the loan that the acquisition company had to take out for the acquisition. This loan is then distributed by the target capital company to the acquisition company.

At this point it is explained why the loan of the target corporation must be higher than the loan of the acquisition company. The distribution of a corporation to another corporation with a shareholding of at least 10% is tax exempt according to § 8b para. 1 KStG, but according to § 8b Abs. 5 KStG 5% of the distribution amount is added to profit as non-deductible expenses. Thus, only 95% of the distribution is effectively tax exempted.

The 5% of the distribution must be taxed at 15% corporate tax. The same applies to trade tax, as there is also a tax exemption from a shareholding of 15%.

However, it is important for the levels of participation to exist at the beginning of the calendar year[8]. If this is not the case, the exemption for both corporation tax and business tax cannot be used. Therefore, it is recommended to acquire the target corporation only shortly before the end of the year, so that the acquisition company’s investments in the target corporation exist at the beginning of the calendar year.

With the acquired distribution amount, the acquisition company can fully repay the previously taken out loan. She is then debt-free.

The financing expenses are at the target corporation, which can offset the interest expenses with its own operating income. It therefore finances itself.

It should be noted, however, that a distribution of profits can only take place if a correspondingly high balance sheet profit is shown.

4.3.Variant 3: Merger

Another design variant is the downward or upward merger of the acquisition company with the target capital company.

The complete merger of a corporation with another corporation is in accordance with § 11 para. 1 S. 1 UmwStG to the common value, book value or an intermediate value possible.

As a result of the merger, the assets of the target corporation and the financing loan of the acquisition company are now in the acquiring company. The transferring company then goes under. This allows the interest on debt financing to be offset against operating income.

If the target capital company is now merged with the acquisition company, it goes under, the assets are then in the acquisition company. For the valuation of the assets there is now a right to vote according to § 11 Abs. 1 S. 1 UmwStG. Often the choice to take over the book values is the most favorable, since no hidden reserves are revealed and therefore no transitional profit has to be taxed. However, since the transitional profit of the merger results from the difference between the book value of the shares of the transferring entity and the value at which the transferred assets are to be taken over, the assets can also be taken over at the common value without any transitional profit being taxable. Because the target capital company was bought by the acquisition company at the common value. Accounting for a merger to the common value is thus possible without taxing the transition gain. In this respect, the acquisition company can uncover the hidden reserves and at the same time benefit from the depreciation for the depreciable assets.

If the target corporation holds land as assets on its balance sheet, it must be noted in an upward merger that ownership of the land changes ownership. This fact is a real estate transfer taxable transaction, which according to § 1 Abs. 3 GrEStG property transfer tax triggers. In the event of an upward merger, the assets and debts are transferred entirely to the acquisition company. The target corporation goes under as a result. The acquisition company will become the new owner of all assets.

In the case of a merger pursuant to § 6a S. 1 GrEStG in conjunction with § 1 Abs. 1 No. 1 UmwStG, but the controlling company (acquisition company) must have a direct or indirect and uninterrupted participation in the target company for five years both before and after the transaction.

5th summary

Tax optimization to circumvent unwanted effects is sufficient in tax law. However, it is also important to consider which goals the taxpayer strives for in order to be able to work out a suitable design. It is important to determine the various factual requirements in order to eliminate the corresponding harmful ones in order to arrive at the desired result. Often it is enough just to change a prerequisite in order to achieve the goal. However, this often leads to new problems that need to be solved instead. Depending on the complexity of the situation, under certain circumstances no suitable solution can be found.

In the course of the work, the problem area for optimizing debt financing expenses in relation to the parts income procedure was discussed in particular. All three design variants solve the present problem, but each of the variants also contains possible disadvantages, which can in turn be an exclusion criterion for the taxpayer.

The income tax organization is bound to this structure for the first profit and loss transfer agreement for 5 years. Restructuring is therefore not possible. For the leveraged distribution of profits, the company to be acquired requires a very high balance sheet profit, which possibly increases the purchase price of the company. The merger in turn contains a blocking period of 7 years, during which the company may not be sold without further sale. Depending on the goal of the shareholders, it is therefore necessary to work out and apply the correct design.