Please note that this text refers to German tax regulations.
Already at the time of founding the company, it is possible to create the corporate law structure in such a way that tax law privileges for proceeds from the sale of shares or profit distributions can be used in the future.
The planned use of exit proceeds or profit distributions lays the foundation for the decision between different structuring options.
- A holding structure is particularly suitable if future exit proceeds are to be further invested since a tax exemption of 95% is granted in the case of an exit.
- The application of the partial income method can be advantageous if exit proceeds are to be distributed into the private assets of the shareholders, as only 60% of the distribution amount is taxed at the personal tax rate.
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The holding structure creates tax optimized reinvestment opportunities
A holding company - also called parent company - is a corporation (e.g. GmbH, UG, AG) that holds a share in another corporation.
When shares in the subsidiary are sold, 95% of the proceeds are exempt from taxation in accordance with Section 8b (6) KStG in conjunction with (1). In effect, only 5% of non-deductible business expenses are taxed at the standard rate of trade tax and corporate income tax (approximately 30%). The tax privilege results in an effective taxation of approximately 1.5% at the level of the parent company (see figure 1).
The full tax benefit is granted from a parent's participation in the subsidiary of 15%.
It is important to note that the legislator has provided a lock-up period of 7 years. The taxable amount of the proceeds is reduced by 1/7 for each year since the foundation of the holding company.
According to section 8b (1) KStG in conjunction with (5), the tax benefits of the sales proceeds also apply to income distribution (e.g. dividend payments) by the subsidiary to the parent company.
The partial income method favors taxation at shareholder level
If shares in the company are not held in a holding company but as private assets, the partial income method from section 32d (2) EStG may be applicable.
When applying the partial income method, only 60% of the proceeds from dividends and sales of company shares are taxed with income tax, 40% of the proceeds are income tax free. The personal tax rate (plus solidarity surcharge) is used for the taxable amount of the proceeds. For example, a personal income tax rate of 45% at shareholder level results in an effective tax rate of approximately 27% (see figure 2). If the partial income method is applied, income-related expenses are deductible.
The partial income method can only be applied to profit distributions from the corporation to the private assets of shareholders if they hold at least a 25% stake in the company (see section 32d (2) 3a EStG).
Alternatively, a participation of at least 1% is sufficient if the parties involved simultaneously "exert a significant entrepreneurial influence on [the] economic activity [of the corporation] through a professional activity [...]" (section 32d (2) 3b EStG). This is the case, for example, if the shareholder to whom the distribution is to be made is also a managing director.
In a comparison at shareholder level, both arrangements lead to almost identical tax rates
Comparing the models with an exemplary exit proceed of € 1.000, the application of the holding principle within a holding structure and the partial income method leads to an almost equal tax burden at shareholder level (see figure 3).
The establishment of a holding structure offers founders the opportunity to use exit proceeds from share sales for reinvestment in a tax-effective manner.
For founders who do not plan any further investments with the exit proceeds, the partial income method, which is less complex to implement, can be more advantageous.
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