“Ignorance of tax laws does not exempt from the obligation to pay tax. But often the knowledge.”
Meyer A. Rothschild, Banker (1744–1812)
“The tax law is so complicated and obscure as fog with visibility in 50 m.”
Heinrich List, former President of the BFH (Federal Finance Court, Germany)
Business Seller and Buyer, both parties have an interest to optimize their taxes, because, as former German Chancellor Helmut Schmidt said: “Who has the duty to pay taxes, also has the right to save taxes”
The interests of both parties shape the technic of M&A and its optimization of taxes. For a successful Deal, the M&A Consultants will access the tax situations of seller and buyer and integrate the demands into a satisfactory for both side, viable transaction concept, approved by the tax advisers of both parties. This also means tax advantages and disadvantages in terms of possible step-up volume to be weighed and integrated in an overall price, terms and warranty model.
The following statements about taxes, can only be a first rudimentary information. Legal form, company legal history, share or asset deal, tax figures, the personal interests and the tax situation of the shareholders have among others a significant influence on an optimal transaction structure and tax design which should be checked by a tax expert.
1. Taxes seller side
Depending on the legal form of the selling company and according to the legal form of the Shareholder there are different tax regimes to be observed. On the issue of the treatment of disposal losses should not be dealt with here.
1.1 Sale of a private company or individual company
Private companies and natural persons are to be treated similarly for taxation. Partnerships, as a merger of several natural persons, the income of those Partnerships the is determined in the framework of a separate and uniform profit statement and attributed to the shareholders according to their respective share. Depending on the legal form of the shareholder, differences arise in the tax assessment.
If the entire shares of a shareholder in a company are sold, this is subject to a reduced tax rate. In this case, no commercial tax will arise. Are however only parts of a co-entrepreneur’s share sold, this is regarded as continuous income from trade or business, with the result of the full income and commercial tax.
The reduced rate of taxation can be the 1/5 rule (i.e. the capital gain is distributed factiously over 5 years, the then calculated tax amount is taken by 5, in this way top tax rates should be compensated for). The other possibility is, when the taxable person has passed the age of 55 years or he/she is permanently unable to work, he once in the life has the right to a reduced tax rate of 56% of the average tax rate for capital gains, instead of the 1/5 rule. This applies to capital gains up to € 5 million. Further there is a tax exemption of 45.000,00 € which melts away by the amount that exceeds € 136.000,00 of capital gains.
In case a cooperation (e.g. private-law corporations: GmbH, UG, AG, e.V, cooperative) is shareholder of a Partnership, the gains on disposal is in regards corporate and commercial tax fully taxable. (Currently corporate tax is 15% as well as approximately 14% trade tax at a community multiplier of 400). The commercial tax is applied to Partnership. Tax debtor is in this case the Partnership, not the cooperation.
The capital gain or loss is on corporate income tax level settled with the losses or profits of the corporation, while in respect of the commercial tax this is done on the level the Partnership.
1.2 Sale of a corporation
For capital gains from shares in a corporation it is for taxation decisive whether the shares are held by a corporation or a natural person. In the case, they are held by a natural person, it is necessary to clarify whether the shares belong to the private or business assets. If the shares are held as private assets, the question of the participation level of the last 5 years is of significance.
The participation was directly and indirectly in the last 5 years never 1% of the capital of the company, in this case the gains on disposal are taxed with withholding tax (25%) plus the solidarity surcharge as well as any church tax, if applicable. Deductible on capital gains are however only costs directly linked to the sale of business.
The capital share was greater than or equal to 1% in the last five years, the gains on disposal are subject to taxation of income from trade or business and thus to the partial income system (Teileinkünfteverfahren). They are not subject to commercial tax.
The partial income system (Teileinkünfteverfahren) means that the gains on disposal are reduced by 40%, that means only 60% of capital gains are taxed with personal tax rate of the seller. I.e. based on the maximum tax rate (45%) this results in a load of approx. 27% plus solidarity surcharge and any church tax on the total capital gains. In the reverse case, expenses about the share sale, only 60% are deductible.
In addition, a tax exemption of 9060,00€ for a 100% shareholding, is applied, but this tax exemption melts by the amount the gains on disposal exceed 36.100 Euro.
The § 6b of the Income Tax Act allows individual entrepreneurs and Partnerships to transfer the capital gains from the sale of a corporation to 100% to newly purchased shares of corporations and as far as the gains on disposal are not exempt from taxation per § 3 No 40 sentence 1 in conjunction with § 3c para. 2 of the EStG to newly purchased buildings (not land) and movable assets.
This achieves a quasi-tax-free transfer of the capital gains comparable to the situation of corporations, where capital gains are in accordance with § 8b in principle tax-free (restriction: § 8b para. 3 sentence 1 of the German Corporation Tax Act (KStG).
In this case, the gains on disposal belong to the ongoing commercial income and are subject to the partial income system (Teileinkünfteverfahren), i.e. 60% of the capital gains less 60% of expenses are taxed. On commercial tax level also 60% of capital gains less 60% of the expenses. However, there is no addition of tax-free income in accordance with § 8 No. 5 GewStG. In the case of capital gains a tax exemption of € 24.50 0.00 is available. In the case that after this exemption there is still a commercial tax, this commercial tax will be settled with personal income tax (§35 EStG). As long as the community multiplier don‘t exceeds 380% this will result to a full discharge of commercial tax, multipliers beyond 380% will result in a commercial tax burden.
1.2.3 The seller is a corporation
The income from the sale of a corporation is in the divesting corporation to 95% tax free. I.e. 5% of the gains on disposal will be considered non-deductible operating expenses and treated with 15% corporation tax plus solidarity surcharge tax. The same applies in the case of the commercial tax. This does not apply to credit and financial services institutions.
1.2.4 Seller is a partnership
In this case the legal form of the shareholders of the partnership rules the taxation, since the partnership is transparent and only in regards to the commercial tax a tax subject. In so far the statements in regards to natural persons and corporations apply accordingly.
In regards to the commercial tax the partnership is tax subject. Is the shareholder of the selling partnership a corporation, 5% (nondeductible operating expenses) of the capital gains are subject to the commercial taxes. Is the shareholders of the selling partnership a natural person, 60 % of the disposal gain is subject to commercial taxes. If the shareholders are natural persons and corporation’s taxation is determined by the respective shareholdings.
This only briefly marked tax topics, on the seller’s side, which can be, depending on the personal as well as operating situation, as complex as you wish, are consequently opposed by the interests of a potential acquirer.
2. Tax assessment acquirer
For a successful deal, always both sides are to be observed. In most cases the acquirer has an interest to transform the purchase price as completely as possible in tax-reducing depreciation potential. Essentially the interests of the acquirer summarize as follows:
- Tax optimized distribution of the purchase price to the acquired assets, including goodwill
- Tax effective detection of hidden reserves by restructuring measures after closing
- Tax optimal financing of the purchase price
- Avoidance of additional burdens caused by transaction taxes and property acquisition tax
- As far as possible use of acquired loss carryforwards
The possibility to transform the purchase price into tax optimizing depreciation potential, exist for a share deal only for the purchase of partnership shares, while this possibility is largely not possible for the purchase of shares of corporation. An Asset Deal, which transforms the purchase price in depreciation potential, is strongly depending on the status of the company and may but also may not make sense. Especially the impact on the seller side needs to be considered.
Currently, only with an Asset Deal the purchase price for a corporation can be unproblematically transformed into depreciation potential. The various models to transform the purchase price of corporation into depreciation potential, like downstream merger, combination model, transformation model, partner model, have been ruled out by legislator during the last years. Insofar these models are not subject of this article.
The intercompany grouping model creates, in a share deal still limited depreciation potential.
2.1 Intercompany grouping model
The shares of the target company are acquired by a subsidiary company founded by the acquirer in the legal form of a GmbH & Co KG (with one or more natural persons as limited partners and without capital participation of the general partner). Between the GmbH & Co KG as the controlling company and the target company as a subsidiary company a fiscal union for corporate and commercial tax purposes is established. Afterwards the assets with hidden reserves of the target company are sold in an internal asset deal to the GmbH & Co KG. The resulting capital gain is neutralized by a current value depreciation. The limited partner’s share and the share in the general partner GmbH is afterwards sold to the acquirer. This procedure is limited since § 3c para 3 sentence 2 EStG limits impairments of the shares of a controlling company to 60%. Therefore, also the intercompany grouping model is substantially impaired.
2.2 Seller conversion model.
A further possibility to create depreciation potential is the seller conversion model. The target company is transformed by the seller prior to closing in a partnership, quite often a GmbH & Co KG. Afterwards the shares are sold to the acquirer. The purchaser receives in this way, on a secure legal basis, the desired tax-reducing depreciation potential. This model results in a tax burden for the seller and only makes sense if the shares are shares issuedin return for a contribution in kind below fair market valuepursuant to §§ 20, 23 UmwStG and are still within the blocking period, which were fully taxable. To note, there are still possibly adverse tax consequences in the case of a possible return of conversion into a corporation.
2.3 Sales Tax (VAT)
The acquisition of company shares is not subject to the sales tax (VAT). The sales tax legal concept of the business unit is similar to the income tax concept of partial operation.
2.4 Real Estate transfer tax
Real Estate transfer tax arises if within the assets of the acquired corporation are properties and in the control of acquirer are 95% of the shares, directly or indirectly. In the case of partnerships with property assets, the real estate transfer tax is also triggered if within 5 years at least 95% of the shares in the hands of the acquirer. Also for property there are various tax optimization models. Since those models may influence the income tax sector they need be closely monitored and coordinated.
From the above-mentioned statements, which refer only to transactions in Germany. It becomes obvious that the subject of taxation has an significant influence on transaction design. The experienced M&A Consultants, depending on the situation, the personal preferences of the client and the market needs and opportunities will develop a transaction model, coordinated with the respective tax advisers, which will result in an optimum result for both parties.
This contribution has been created with care. Any liability (for the correctness of the information) is excluded. (as of Dec. 2016)