Foreign hybrid companies offer the advantage that you as a shareholder can decide for yourself whether the taxation should take place as a partnership or a corporation. A typical example of this is the LLC popular in the USA. But also the German GmbH & Co. KG can fall into this category from the point of view of foreign financial authorities. At least in the case of German taxation of hybrid companies from abroad, this can lead to ambiguities. Because it is then also due to the opinion of the tax office, in which way it considers the taxation of a hybrid company in Germany as legally compliant. In doing so, it makes a legal type comparison of the hybrid company, with several criteria being important. These relate to the question of management, limitation of liability, transferability of shares, profit allocation and distribution, provision of capital, duration of the company and approval of the incorporation of the company by official bodies.

In our contribution today we would like to inform about the German taxation of hybrid companies abroad. Admittedly, the topic may sound complex and seem abstract. However, since hybrid companies enjoy great popularity abroad – especially in the Anglo-Saxon-speaking region – and are therefore also of interest to German investors, we attach considerable relevance to the topic.

Now the question arises as to why hybrid companies contain such enormous potential that entrepreneurs also accept the complexity associated with them. Well, the answer to that is: flexibility. To understand this blanket statement, we need to take a closer look at what this actually implies. After all, this is also the key to understanding why Germany is very differentiated when it comes to taxing hybrid companies abroad.

Although we basically do not need to start a global search for an example of a hybrid company, because we have basically developed our own hybrid company in Germany with GmbH & Co. KG. However, an LLC founded in the US offers a far greater understanding of the scope of freedoms possible in designing a hybrid society. Especially since the taxation of hybrid companies in Germany is already linked to the requirements of the Federal Ministry of Finance, which explicitly include the regulation in connection with a US LLC. For this reason, the regulation presented here based on the US-LLC is also considered the most widely recognized model for the German taxation of hybrid companies worldwide.

An essential feature of the LLC, both in the US and in general, is that it does not constitute a corporation in the narrower sense. However, it has its own legal personality. This applies irrespective of all other characteristics that fall to it both in the applicable company law and under contract law.

This also means that the establishment of the US LLC requires approval by the respective state. An existence by virtue of a social contract or by virtue of activity is thus excluded. This distinguishes them significantly from individual companies and partnerships.

When a U.S. LLC is formed, one or at least two shareholders may be required, depending on the applicable company law of the state in which it is to be formed. In this context, corporations may also be considered as shareholders.

No minimum capital is required when starting a US LLC. In addition, there are no specifications as to the type of contribution that the shareholders may contribute to this. Thus, both cash deposits and deposits in kind, including future provision of services, are possible. However, a foundation can also take place without any contribution. However, the amount of the contributions of the individual shareholders sometimes influences the subsequent profit distribution.

Since the LLC has its own legal personality, it usually also bears liability for liabilities and other obligations. Thus, their shareholders are largely excluded from liability. As a result, their private assets are protected from third-party claims in most cases. Due to this, however, there are also restrictions regarding the purpose that an LLC may have. For example, the establishment of a credit institution or insurance in the legal form of an LLC is excluded.

In the management of the LLC, there is far-reaching freedom, which either takes shape by a company contract or is due to all shareholders under company law. Management can be regulated by all, individual or none of the partners. In the latter case, external managers in the employment relationship must then take on this task.

In principle, company law determines the distribution of profits according to the amount of the shareholders’ contributions. However, there is the possibility that company law, as with other company law requirements, may also give way to contract law regulations. The design for profit distribution is therefore all doors open.

In the United States, there is a sometimes rather idiosyncratic separation of rights in a single thing. For example, it is possible to transfer a property without the right to the mineral resources also having to be affected.

The same applies to the transfer of shares in an LLC. This is because a distinction is made between the property rights and the membership rights of a shareholder. Thus, purely hypothetically, the transfer of the rights to the deposit as well as to a profit share is possible without including the membership rights to the management or the voting rights. Therefore, it is often a matter of the articles of association to regulate the transfer of company shares. Often this depends on the approval of the other shareholders. Incidentally, this also applies in particular to a transfer by inheritance.

Company law does not provide for the duration of the existence of an LLC. This leads to two consequences.

On the one hand, the departure of a shareholder by self-determined action, exclusion or death as well as by insolvency of the LLC leads to the termination of the company. Also, an end of the company decided by all shareholders ends the existence of the LLC. Furthermore, the company can end if the regular, often annual reports to the federal states required for continuation are not taken into account. Because this leads then by law to the end of the LLC.

On the other hand, the shareholders have every possibility when drawing up the social contract to determine most conditions for the termination of the LLC themselves. Only the provisions of the respective state for the notification of the existence of the LLC are understandably excluded from this.

So how to approach the taxation of hybrid companies abroad in Germany? As a partnership? Or rather a blanket company than a corporation? The tax administration had to find an answer to this question in order to be able to carry out taxation in Germany. Although the double taxation agreement concluded with the USA requires that the companies established in the partner state are recognised. As a rule, this also applies to all other double taxation agreements that Germany concluded. However, this does not mean that we have to follow the taxation rules there.

In fact, adopting the taxation right of a foreign state would significantly restrict German tax sovereignty. Therefore, this was certainly not an option. As a result, only German law could be used as a benchmark for the taxation of hybrid companies abroad. So one had to decide on the basis of German criteria in individual cases whether a foreign hybrid company should be regarded as a partnership or a capital company.

This is followed when assessing certain criteria based on social forms recognized in Germany. This assessment is therefore also called legal type comparison. A total of nine criteria are considered, five of which are considered to be particularly meaningful. Therefore, one also speaks of the five hard and four soft features in the legal type comparison. However, ultimately decides the overall picture that the legal type comparison provides.

If all shareholders are involved in the management, this speaks for a taxation of hybrid companies as a partnership. However, if only some shareholders are responsible for the management, so that other shareholders are therefore excluded from it, this is to be regarded as an indication of a limited company.

Since the LLC is always an independent legal entity, the shareholders are generally excluded from unlimited liability. This criterion therefore points towards a taxation of hybrid companies as a capital company.

The third criterion we need to examine for the taxation of hybrid companies. is related to variance in the transfer of shares. If the transfer of shares of a shareholder to other persons outside the company depends on the consent of the other shareholders, this feature indicates a partnership. In the case of a corporation, on the other hand, participations are freely transferable.

If a distribution of profits to the shareholders depends on a shareholder resolution, this speaks for a taxation of hybrid companies as capital companies. In contrast, shareholders of a partnership are always entitled to a profit allocation in principle. This also applies if the availability of the allocated profit is subject to a separate decision by the shareholders.

The criterion concerning the nature and extent of the capital raising in the establishment of a foreign hybrid company is by no means as clear as one would like. Although you can compare to the legal requirements that you use in Germany for the establishment of a capital company. Because there is a money deposit, but at least a contribution in kind, in which services are excluded, is fixed. However, the possibility offered in § 5a GmbHG of setting up a limited company without having to invest significant capital relativizes this criterion.

In any case, the waiver of a contribution under the social contract or the sole provision of services is to be understood as an indication that a taxation of hybrid companies as a partnership is warranted.

The taxation of hybrid companies also determines the duration for which the company should exist. If a social contract or civil law restriction of the life of the company applies, this can be equated with the existence of a partnership. In particular, this also counts if the articles of association stipulate a termination of the company due to a voluntary or involuntary departure of a shareholder. In addition to the death of a shareholder, this also includes insolvency on his part or his exit.

But here too we are dealing with a situation that can only be derived to a limited extent from German civil law. A German partnership can also be entitled to continue under the conditions mentioned.

However, if the company is not subject to company law norms or social contractual clauses that provide for termination, this can generally be seen as an argument for taxing hybrid companies as a corporation.

If the profit distribution takes place on the basis of conditions that indicate that the shareholder receives the profit solely on the basis of his capital provision, this supports the taxation of hybrid companies as a capital company. However, if features of an entrepreneurial initiative are also recognizable in the shareholder, then one should rather advocate taxation than a partnership. This also applies if a profit distribution takes place by head.

This criterion can therefore look different for two shareholders of the same hybrid company. For this reason too, individual case examination is quite justified.

Since the legal type comparison is always based on German law, an assessment of formal foundation requirements must also be included. For example, German law only considers a corporation to be established if it fulfils the registration in the commercial register as a condition. However, in other countries there is often no correspondence to the German commercial register; for example, also in the USA. Therefore, the absence of this criterion alone cannot under any circumstances justify the taxation of hybrid companies as personnel companies. However, if the criterion is actually met, then it must be recognized as an indication per corporation.

If you are looking for further criteria for one or the other taxation of hybrid companies, then you may find something. For example, experts have raised the number of shareholders as a characteristic. However, there are no binding jurisdictions for criteria other than those already mentioned. Other criteria should therefore be treated with a certain degree of restraint in this respect.

Now that an examination of all criteria has taken place, it is time to draw a conclusion. However, we must proceed in two stages. First of all, it is necessary to weight certain criteria which are considered to be particularly meaningful. These are the first five criteria mentioned: centralised management, limitation of liability, free transferability of shares, profit allocation and capital raising. On the other hand, the decision on the taxation of hybrid companies is excluded solely on the basis of the existence of a single characteristic.

So it depends above all on these criteria whether a taxation of hybrid companies takes place in one way or another. However, if this analysis does not give a clear picture, then the other criteria are also included in the consideration.

Ultimately, a decision on the taxation of hybrid companies can lead to differences of opinion between the tax authorities and taxable shareholders. If you think that you have passed your opinion on this before the tax court and are looking for professional support, then we are happy to support you as a competent partner with outstanding expertise in international tax law.

However, it is even better to align the design of a hybrid company abroad even before it is founded with later taxation in Germany. In this way, you avoid any dispute or even unforeseen surprises by income tax notice. Here, too, we are happy to provide you with our experienced expertise. You simply call us and we will be happy to help you realize the optimum from your participation in a hybrid company abroad.