Purchasing Shares and Partnerships with German Companies and Tax Issues By Dr. Thomas Wülfing Teheran, March 4 th 1
Introduction: About GERMELA I. Legal forms of Doing Business in Germany II. Taxes in Germany: An Overview III. Purchasing Companies: Asset Deal and Share Deal 2
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1. Overview Types of legal entities Non-incorporated entities GbR (civil law partnership) OHG (general partnership) KG (limited partnership) PartG (partnership company) Stille Gesellschaft (silent partnership) Corporate entities GmbH (limited liability company) UG (entrepreneurial company at limited liability) AG and SE (joint-stock company and societas europaea) KGaA (limited joint-stock partnership)... and more... 5
2. General features of partnerships: Association of at least 2 persons who aim a common (business) purpose. No transferability and heredity of shares without consent of other partner(s). Daily management conducted by the partners themselves. Personal liabilty of the partners. Partnership is not fully recognized as a legal entity. 6
3. General features of corporate entities: Characterized by equity participation, not by the shareholders labor or job performance. Free transferabilty of shares. Management conducted by managers or directors who are not necessarily shareholders. Shareholders liability is limited to their share of capital. Shareholders power within decision-making in the company refers to their individual share of capital. 7
4. Partnerships in detail a) Offene Handelsgesellschaft (OHG) = general partnership At least 2 partners who not necessarily have to be individuals, but can also be German or foreign legal entities. Representation of the OHG as a whole individually by all partners, but memorandum of association may enact diffent rules (e.g. representation only by several partners together; exclusion of certain partners from representation). 8
No minimum capital required. Enrollment in the local register of companies required (includes names of partners). Allocation of profit and losses per capita if no other settlement in the memorandum (before allocating an annual profit, each partner gets an advance payment of 4% on his/her equity stake). Full personal liability of all partners for partnership s debt (partners are joint and several debtors). 9
b) Kommanditgesellschaft (KG) = limited partnership Similar to OHG, but certain differences: At least one partner has unlimited liability for the partnership s debt (Komplementär), at least one partner only has liability to the amount of his/her equity stake (Kommanditist = limited partner). The limited partner s equity stake that takes part in the partnership s liability has to be stated in the register of companies. 10
Limited partner is not obliged to take part in the company s daily business, but also doesn t have the right to represent the company. Often found: GmbH (limited liability company) in the role of the Komplementär (= unlimited partner), so a partnership with factual limited liability can be created = GmbH & Co. KG. 11
5. Corporate entities in detail: a) Gesellschaft mit beschränkter Haftung (GmbH) = limited liability company Most simple and mostly found form of a corporate entity in Germany. At least one shareholder who can be an individual or another corporate entity (resident in Germany or foreign). Total capital stock at least EUR 25.000,- (in the moment of enrollment, an amount of at least EUR 12.500,- has to be disposable by the company itself). Contract of association has to be notarized by a public notary; beginning of the legal existence is marked by enrollment in the register of companies; amount of capital stock has to be stated in the register of companies. 12
Representation of the company by its managing director(s) who are appointed and dismissed by the corporation meeting. Directors have to be named in the register of companies. Letters, emails and other correspondence has to contain information about the legal form as GmbH (protection of creditors), its name, location and court of registration, registration number in the register of companies and names of directors. UG as a certain kind of GmbH: entrepreneurial company with a capital stock of at least EUR 1,-. Annual profits have to be added to the capital stock until a stock of EUR 25.000,- is reached (at least ¼ of one business year s surplus). 13
b) Aktiengesellschaft (AG) = joint-stock company Legal form of normally bigger companies with major demand of capital. Minimum capital is EUR 50.000,- which can be devided into par value shares at a minimum value of EUR 1,- each or devided into no-par shares. Representation by management board that conducts daily business. Managers are appointed and controlled by supervisory board. Stockholders meeting is the most powerful decision-making body: appoints supervisory board, decides on changes of articles of association, decides on allocation of profits; every share of a shareholder is one vote. 14
Liability of each shareholder only up to the amount of his/her share capital. Societas Europaea as a special legal form for joint-stock companies in Europe that offers uniform market presence in the countries of the European Union. Affiliated companies under uniform legal standards can be found in these countries. 15
Corporate Taxation Resident companies are taxed on their worldwide income; nonresidents are taxed only on German-source income. Branches are taxed the same way as subsidiaries. Taxable income: business income, passive income (interest), capital gains. Taxation of dividends: Dividends received by a corporation are effectively 95% tax exempt, if at least 10% of shares in the paying company are held by the parent. 16
Capital gains resulting from the sale of a domestic or foreign corporate subsidiary are tax exempt at an extent of 95%. Losses: Loss carry back for one year, carry forward indefinitely. A change in ownership of at least 25% leads in a partial loss of a carry forward, a change of at least 50% results in a total loss of a carry forward. Tax rate: Corporate tax rate is 15%. Additionally, municipal trade tax is levied on business establishments in Germany, rate ranges between 14% and 17% (depending on the city). Including solidarity surcharge, an effective tax rate of 30% to 33% is given. 17
Certain anti-avoidance rules: Thin capitalization: Prevents extensive interest deduction especially for loans between shareholders and their company. Controlled foreign companies rules: Passive income of subsidiaries in low-tax-countries is attributed to a German shareholder who effectively controlls the foreign comapany. Transfer pricing rules: Prevent profit shifting to subsidiaries in low-tax-countries by arranging non market-compliant prices on goods or services floating between parent company and subsidiary. 18
Compliance rules for corporations: Tax year is 12 months, accounting period does not have to be a calendar year. Deadline for filing returns is 31th of May, but extended to 31th of December of the following year if a tax advisor is involved. Penalties for late filing: up to 10% of the payable tax, maximum EUR 25.000,- per tax return. Penalties for late payment: 1% per month on assessed taxes, 0,5% per month on tax due, but not assessed yet. 19
Each company has to file a separate tax return. Tax consolidation is possible for purposes of corporate tax and municipal tax: Parent has to hold the majority of shares in the subsidiary and a profit and loss transfer agreement has to be concluded and conducted for a period of at least 5 years. In this case parent and subsidiary are seen as a fiscal unit (Organschaft). For VAT purposes, a fiscal unit leads to the fact that only one common tax return has to be filed for the whole group. 20
2. Withholding taxes Dividends: Statutory rate of 25% applies, but 40% refund for foreign corporations upon application (effective rate: 15,825% incl. solidarity surcharge). Rate can be reduced according to tax treaty, but in the case of Iran no further reduction. Iran based individuals are taxed at a rate of 20%. Interest: In general no withholding tax (exception: securities in German real estate). Royalties: Tax rate is 15,825%, but in the case of a recipient in Iran the rate is reduced to 10% by tax treaty. 21
Other taxes on companies / social security: VAT on the sale of goods and the provision of services at a regular rate of 19%. Tax on real estate transfers: 3,5% to 6,5% of the sales price, rate depends on the federal state where the real estate is located. Real property tax: Annual tax on the value of property, rate: 0,35% of the tax value. Social security: Employer bears half of the wage-related contributions to social security (health, nursing care, unemployment and pension insurance), currently ~ 21% of the employee s gross income. 22
3. Taxation of individuals: German residents are taxed on their worldwide income, nonresidents on German-source income. German residence is given if a person has permanent accomodation or spends at least 6 months per year in Germany. Taxable income: employment, trade or business income, selfemployment, agriculture, capital, rental income and certain other income (e.g. capital gains). Personal allowances are available for certain personal needs, e.g. contributions to social security and other insurances, health expenses, child and spouse support etc. 23
Tax rate: Progressive rate up to 45% plus solidarity surcharge of 5,5% on the amount of tax. Examples for a single person: Annual income: Average tax rate: EUR 20.000,- ~ 14% EUR 50.000,- ~ 27% EUR 100.000,- ~ 36% EUR 200.000,- ~ 40% EUR 300.000,- ~ 42% EUR 500.000,- ~ 44% These rates apply for example on the business profit of a nonresident member in a German partnership. 24
Taxation of capital income: flat tax of 25% plus solidary surcharge on interest and dividends. For nonresidents reductions according to tax treaty apply (see above). Capital gains from shares: 25% on the profit from selling shares. If the seller held at least 1% of the shares of a corporation for at least 5 years, the regular income tax rate applies, but 40% of the capital gain is tax exempt. Capital gains from real estate: Regular income tax rate, but total tax excemption after a holding period of 10 years. 25
Other taxes on individuals: Real estate transfer tax: 3,5% to 6,5% on the sales price. Real property tax: 0,35% p.a. on the tax value. Inheritance tax: On inheritances and gifts, rates range between 7% and 50% depending on degree of relationship and on the amount of the inheritance. Major tax exemptions for family: spouse: EUR 500.000,- tax exempt kids: EUR 400.000,- tax exempt Nonredsidents are subject to German inheritance tax if property or assets based in Germany are transferred, e.g. German real estate, business property. 26
1. Introduction and overview Two general ways to purchase a company: Asset Deal: Single assets are sold to the buyer, legal relationships are transferred individually to the buyer. These assets can build a new company or part of a company on the buyer s side. Share Deal: Shares in partnerships or corporations are sold without changing the business entity. = purchase of rights. 27
a) Asset Deal: Pros: Detailed information on the buyers side required about the goods and rights he buys. Buyer can pick assets that he wants or that he does not want to buy. Cons: Principle of clarity and definiteness: All the assets that should be bought have to be transferred seperately, which can be complicated, longlasting and expensive. Regarding the transfer of legal relationships, the contractor on the other side has to agree to the transfer in some cases. Transfer of certain assets may cause requirement of consent of authority of merger control. 28
b) Share Deal: Pros: Object of purchase is very clear. Fast process of selling, less transaction costs may arise. Legal relationships in the target company remain untouched. The whole company is sold; seller does not keep an empty corporation. Cons: Taking over of all debts and risks in the target company, also hidden ones. Former decisions of decisionmaking bodies remain valid. Consent of authority of merger controll can be necessary. Corporations listed on the stock exchange: If 30% or more of shares are acquired by the buyer, an offer of acquisition of shares has to be made to all other shareholders. 29
2. Requirements for effectiveness: a) Asset Deal: o Transfer of single contracts (e.g. rental agreements concerning business property): Consent of the other party of each contract. o Partnerships: Consent of all partners if the whole company or a major part of the assets is to be sold. o Joint-stock company: Consent of stockholders meeting if all property of the company is to be sold (change of the purpose of the enterprise) or if one single asset shall be sold whose value amounts to > 80% of the sum of all assets. 30
b) Share Deal: o Partnerships: Consent of all partners is necessary, but no further formal requirements. o GmbH (limited liability company): Contract of acquisition of shares requires the form of notarization. o Joint-stock company: Usually free transferability of shares. Exeption e.g.: tied and registered shares ( vinkulierte Namensaktien ). 31
3.) Requirements in labor law: a) Asset deal o Employees can veto a change of their contract of employment, hence the contract with the seller would remain unchanged. o Collective labor agreements (Tarifverträge) keep their validity if the buyer does not have a system of collective labor agreements. o Certain elements of employee participation via decisions of the workers council (Betriebsrat). b) Share deal o No special requirements, contracts of employment stay untouched. 32
4.) Liability a) Seller s view: o Share deal: By transferring all shares to the buyer, risks arising out of the company s past are passed to the buyer. o Asset deal: Seller keeps an empty company that may bear financial risks (company s debts, tax liabilities, warranty claims etc.) b) Buyer s view: o Share deal: liabilities stay alive. This can be a higher risk especially in the case of buying a partnership because partners are personally liable for their company s debt even if it arose in a time before they became partners. o Asset deal: Liability only for adopted and new debts that arise after the purchase. 33
c) Due diligence: Especially when conducting a share deal, it is the buyer s interest to achieve knowledge about risks that could be hidden in the target company. To get this knowledge, the process of a due diligence is carried out regularly. This contains amongst others the following: o Financial due diligence: Collection and checking of financial o data (loans, contracts with permanent liabilities, cash flow etc.) Commercial due diligence: Analysis of markets and business models, marketing strategies etc. o Legal due diligence: search for legal risks, e.g. possible claims for compensation, law suits. o Tax due diligence: Analysis of fiscal risks, e.g. from future auditing of past fiscal years. 34
c) Due diligence: Especially when conducting a share deal, it is the buyer s interest to achieve knowledge about risks that could be hidden in the target company. To get this knowledge, the process of a due diligence is carried out regularly. This contains amongst others the following: o Financial due diligence: Collection and checking of financial o data (loans, contracts with permanent liabilities, cash flow etc.) Commercial due diligence: Analysis of markets and business models, marketing strategies etc. o Legal due diligence: search for legal risks, e.g. possible claims for compensation, law suits. o Tax due diligence: Analysis of fiscal risks, e.g. from future auditing of past fiscal years. 35
5.) Tax Issues from the buyer s view a) Asset Deal o Economically, the seller and the buyer reach an agreement on the price of the total package of assets that shall be transferred. It is the buyer s interest to allocate the purchasing price to assets that lead to tax depreciation / deduction. Hence, the purchasing price should as far as possible not be allocated to assets that are not depreciable such as real estate property, shares in companies and certain intangible assets. o Refinancing costs are deductible by the buyer. 36
b) Share Deal o No allocation of the purchasing price to depreciable assets possible. The value of the share itself is not depreciable. o Book values of assets stay unchanged. o To achieve compensation of refinancing costs and future profits of the target company, the target should not be bought directly by a foreign investor, but by another corporation that is founded for the purpose of buying the target company. In this case, the purchasing company and the target company can form a fiscal unit so that refinancing costs and profits can be compensated in Germany. 37
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