Avoiding Tax Pitfalls when setting up a German GmbH
Many founders start their business activities even before they establish a legal entity, such as a limited liability company (GmbH), for their business. The question of which new legal form is most suitable arises at the latest when the founders are sure that the business idea is sustainable, when they want to take on additional partners (e.g. co-founders or employees), or when they need financing from investors to bring the business to the next level. The challenge from a tax point of view is how to transfer the activities performed by the founders up to this point to a company (in particular a GmbH) without any tax burdens. In many cases this can be quite tricky.
Tax-neutral contribution of business into a GmbH
From a tax perspective it is crucial that the founders comply with certain formalities when they establish a GmbH and transfer their early-stage business activities to it. To avoid income tax (which can be triggered by the disclosure and taxation of hidden reserves), the entire business – not just parts of it – must be transferred to the GmbH as a contribution in kind. The GmbH can therefore be formed by a non-cash capital contribution, (Sachkapitalgründung). Alternatively, it is first established by a cash contribution and then the business is transferred in a capital increase against a contribution in kind. In this case the contributing founders receive additional shares in the new GmbH.To avoid taxation it is critical that all assets that are part of the business and that the tax authorities consider to be an “essential basis of the business” (wesentliche Betriebsgrundlage) are in fact transferred to the GmbH. The “essential basis of the business” can include internet domains, trademarks and other intellectual property rights (such as existing source code that can be protected by copyright). The founders must not withhold any of these assets as this could trigger a significant tax burden.