Why it makes sense to convert a sole proprietorship into a GmbH with a view to selling the company at a later date

Why it makes sense to convert a sole proprietorship into a GmbH with a view to selling the company at a later date

Many entrepreneurs work hard for years to build a sustainable business model. The vision is often clear: at some point, the company should be sold - be it as part of the Company succession, through a strategic sale or as a classic exit. However, while many plan for the long term when it comes to products, processes and personnel, the legal form is often only considered from the perspective of the start-up - quick, cheap and uncomplicated. This is why many opt for the sole proprietorship. Yet it is precisely the legal form that determines how easily and tax-efficiently a company can be sold later on.

Legal differences in the sale of a company: sole proprietorship vs. limited liability company

Anyone operating as a sole trader faces several challenges when selling their business. Firstly, the sole proprietorship is legally closely linked to the person of the owner - contracts, rights, obligations and authorisations are linked to the person of the owner.

This means that a buyer cannot simply take over the company „as a whole“, but must acquire each individual asset and contract separately. This often requires the consent of third parties, such as landlords, customers or licensors. This not only complicates the transaction, but also generally reduces the attractiveness of the company in the sales process.

The situation is completely different for a GmbH. It is a separate legal entity and therefore legally independent of the shareholder. Anyone who sells all of their shares in a GmbH is not just selling individual assets, but the company as a whole.

For the buyer, this creates a clearly delineated and structured property that - ideally - is ready for immediate takeover. Contractual relationships remain in place, employees stay on board and customer relationships remain intact. Banks and investors also generally favour the purchase of corporations, as the legal framework is clear and stable.

Comparison of the tax burden when selling a company: how the capital gain is taxed

There is also the tax component: When a sole proprietorship is sold, the entire capital gain - i.e. the difference between the book value and the actual purchase price - is immediately and fully subject to income tax.

Even if certain tax concessions apply, in practice a tax burden of 30 to 35 per cent often remains - sometimes even more if there is no personal age concession.

In contrast, the sale of GmbH shares can be structured in a much more tax-efficient manner.

If the GmbH is held directly by the entrepreneur (i.e. as private assets), taxation is based on the partial income method. This means that only 60 per cent of the capital gain is taxable and subject to the personal income tax rate - often resulting in a tax burden of between 25 and 28 per cent.

It is even more attractive from a tax perspective if the entrepreneur does not hold the shares himself but via a holding company (see below). In this case, only 5 per cent of the capital gain is subject to taxation at the level of the holding company. 95 per cent of the gain is tax-exempt.

The difference is therefore considerable - depending on the structuring, the difference can be more than 30 percentage points. Particularly in the case of higher company values, this can mean the difference between long-term secured assets or considerable liquidity outflows.

The holding structure as a strategic tax-saving model

The sale of a GmbH is particularly attractive from a tax perspective if it takes place via a so-called holding structure. In this case, the operating GmbH is not held directly by the entrepreneur, but by an intermediary holding GmbH.

If the operating GmbH is sold at a later date, 95 per cent of the capital gain remains tax-free at the level of the holding company. The basis for this is § Section 8b (2) KStG, according to which capital gains from shares in corporations are generally tax-free.

However § Section 8b (3) KStG stipulates that five per cent of the capital gain is deemed to be non-deductible business expenses - regardless of whether expenses were actually incurred. This flat-rate five per cent is therefore taxable. In practice, this results in an effective tax burden of approx. 1.5 to 2 per cent - depending on the trade tax rate at the holding company's registered office.

Strictly speaking, this „5 per cent correction“ does not result in five per cent of the profit being taxed at a tax rate of five per cent, but rather in five per cent of the tax-exempt profit being added to the corporate income and taxed accordingly. The remaining 95 per cent remains tax-free.

The tax burden on the sales proceeds can therefore be drastically reduced through a holding structure. A subsequent reinvestment within the holding company is also possible. Fiscally advantageous possible.

Withdrawal strategies from the holding company: capital gains tax vs. income tax

If the entrepreneur ultimately wishes to use the capital gain privately, the question arises as to the most tax-efficient withdrawal strategy.

If a distribution is made from the holding GmbH to the shareholder, capital gains tax of 25 per cent plus solidarity surcharge is generally payable. This tax is levied at a flat rate on investment income such as dividends and is calculated independently of the personal income tax rate.

In contrast, the profit from the sale of a sole proprietorship or a directly held GmbH (in the partial income method) is subject to income tax. In this case, the amount of tax payable depends on the personal tax rate - which can be up to 45 per cent for high incomes.

Example: Sale via holding company vs. sole proprietorship

An entrepreneur sells his operating GmbH via his holding company and realises a capital gain of EUR 1 million.

At holding company level, corporation tax is only payable on 5 per cent of the profit - this corresponds to a tax burden of around EUR 15,000. The remaining 985,000 euros are freely available to the holding company. If an immediate distribution is now made to the shareholder, capital gains tax is due: around 26.375 per cent (including solidarity surcharge), i.e. around EUR 260,000. The entrepreneur is left with a net amount of approx. 725,000 euros.

By way of comparison, if a sole proprietorship is sold directly, the entire capital gain is subject to income tax. Even with allowances and a reduced tax rate, the effective tax burden is often around 32.5 per cent, i.e. around 325,000 euros. The net proceeds are therefore around 675,000 euros.

When a GmbH is sold as private assets, the partial income method (§ 3 No. 40 EStG): 60 per cent of the profit is taxable, and with a personal tax rate of 42 per cent, this results in a tax burden of around 252,000 euros. This leaves the entrepreneur with around 748,000 euros net.

Overview: Tax burden and net proceeds in comparison

This overview clearly shows that even if a holding company distribution is made, the overall tax burden is lower than for a sole proprietorship.

Although the private limited company is slightly ahead in terms of net income, it does not offer the same strategic flexibility for reinvestment or gradual asset accumulation as the holding structure.

Flexibility of the holding company: reinvestment instead of distribution

Another advantage of the holding structure is its flexibility in terms of timing: as long as no distribution is made, the profit remains „unutilised“ for tax purposes within the holding company. It can be used there for reinvestment, participations, private capital investments or strategic asset accumulation (e.g. property acquisition) - without an immediate tax burden at shareholder level. Capital gains tax is only triggered upon actual distribution.

The holding company thus acts like a tax-privileged store of assets from which distributions can be made at a suitable time - tax-plannable and economically flexible.

Blocking period after contribution: tax exemption not immediate

But be careful: if you want to transfer your sole proprietorship to a GmbH in a tax-neutral manner - i.e. without immediate taxation of hidden reserves - you have to make use of the so-called Blocking period in accordance with § 22 UmwStG pay attention. This is seven years. If shares are sold within this period, the contribution gain is taxed on a pro rata basis. For each year that has passed since the conversion, the taxable portion is reduced by one seventh - a so-called meltdown model. Only after the seven years have elapsed does the subsequent taxation cease completely.

For entrepreneurs, this means that anyone considering selling their company - whether in five, seven or ten years' time - should act early.

This is because the lock-up period will only expire on time if the conversion is carried out in good time and the tax structuring options be fully utilised in the sale.

Conclusion: Create structure early on - benefit from tax later on

The Conversion into a limited liability company is therefore more than just a legal change of legal form. It sets the course for entrepreneurial flexibility and tax planning leeway - especially if the medium-term goal is company succession or a sale.

If you think strategically, you plan the right legal form not just shortly before the exit, but many years in advance.

Read more about the conversion of a sole proprietorship into a GmbH:
From sole proprietorship to limited liability company: paths, opportunities & pitfalls

Are you planning to sell your company or would you like to set yourself up well for the next steps in terms of structure and tax?
Please feel free to contact us. We support you with the conversion and accompany you from tax optimisation to a legally compliant structure for the future.