Tax pitfalls associated with the conversion of a company limited by shares into a partnership, for example as part of a business succession plan
The reasons for changing the legal form from a company limited by shares (e.g. GmbH) to a partnership (e.g. GmbH & Co. KG) can vary. This issue often arises in the context of anticipated succession and the sale of a business.
In the case of a conversion involving a change of legal form, particular attention must be paid to tax-related pitfalls, which can essentially be divided into the following four areas of concern.
1. Notional distribution
In practice, the profits taxed at the level of the GmbH are generally not distributed in full to the shareholder(s), but are (partly) retained. These profits retained in the past are deemed to have been allocated to the shareholders at the time of the conversion and are therefore subject to tax (notional distribution within the meaning of Section 7 of the German Transformation Tax Act (UmwStG)).
2. Limits on the recognition of a loss on acquisition
In addition, a personal capital gain or loss – i.e. one to be determined separately for each shareholder – must be calculated in respect of the shares in the transferring GmbH. This applies in any event to shares held as part of private assets with a shareholding of at least 1% (Shares within the meaning of Section 17 of the Income Tax Act (EStG)) and for shares held as business assets (Section 5(2) and (3) of the Environmental Tax Act (UmwStG)). The acquisition gain is calculated as the difference between the carrying amount of the assets transferred (less the costs of the transfer) and the cost of the shares in the transferring GmbH (Section 4(4) of the Environmental Tax Act (UmwStG)). However, a transfer loss calculated in this way may only be taken into account up to a maximum of 60% of the notional distribution amount (see point 1.) (Section 4(6), fourth sentence, of the German Act on the Taxation of Business Transfers (UmwStG)). Where the shares in the corporation to be converted were acquired for consideration within the five years preceding the tax transfer reference date, the acquisition loss is wholly absorbed (Section 4(6), sixth sentence, of the German Law on the Taxation of Corporate Conversions (UmwStG)).
3. Tax consequences where the carrying amount differs from the book value
The occurrence of a takeover loss can usually be avoided by recognising the assets in the final tax balance sheet at a value above their carrying amount (recognition at an intermediate value or fair value; realisation of hidden reserves; Section 3(1), (2) of the Environmental Tax Act (UmwStG)). Nevertheless, in this case, a capital gain arises at the level of the corporation to be converted, which is subject to both corporation tax and trade tax.
4. No trade tax exemption in the event of a disposal following a conversion
It should also be noted that capital gains arising from the sale or disposal of shares in a partnership are not subject to trade tax, provided that the share is held by a natural person (Section 7, second sentence, of the Trade Tax Act (GewStG)). However, the conversion of a GmbH into a GmbH & Co. KG, for example, cannot be used to sell or dispose of the co-partner’s share immediately after the conversion without incurring trade tax. Rather, the gain on disposal or cessation is subject to trade tax if the shares are sold within five years of the conversion (Section 18(3), first and second sentences, of the German Act on the Taxation of Business Transfers (UmwStG)). Furthermore, a flat-rate deduction of trade tax against income tax within the meaning of. Section 35 of the Income Tax Act (EStG) excluded (Section 18(3), third sentence, of the German Transformation Tax Act (UmwStG)).
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