Converting a sole proprietorship into a GmbH is a common step in Germany. In fact, many large companies started at some point as sole proprietorships before eventually becoming something “bigger”. Bigger does not necessarily have to refer to the number of employees. There are many possible reasons why an entrepreneur might convert their sole proprietorship into a GmbH.
Perhaps the most common reason has to do with the topic of personal security. A GmbH is, as is well known, subject to limited liability. This point alone is worth considering when thoughts about founding a GmbH arise. Another (possible) reason is an expansion at management level. Specifically: you wish to expand your company by adding a business partner who then joins as a shareholder. Last but not least, it is the topic of prestige that causes many sole proprietorships to become GmbHs. As you can see, there are many reasons to convert a sole proprietorship into a GmbH. In this article, we want to examine the topic more closely and look at what options exist for converting a sole proprietorship into a GmbH.
1: What does a conversion mean for business operations?
A change in legal form always has effects on business operations. This also applies when you convert your sole proprietorship into a GmbH. Since the topic of liability is paramount for many entrepreneurs, we would like to begin with that:
a) GmbH and limited liability
As a sole proprietor, you are liable with both your business AND private assets. Should your business get into difficulties, everything you own is “seizable”: company equipment and private property. With a GmbH, things are different. Here, the private assets of the shareholders are “untouchable”. The prerequisite for this is that all shareholders have paid the capital contribution in full and have not later misappropriated it. Further possibilities of liability Beyond this, there are further possibilities of losing the “protection of the GmbH”. This is the case, for example, if the managing director of a GmbH does not report insolvency in time. There are very precise rules for this, which can be found in the Insolvency Code (InsO). The same applies if bookkeeping obligations are not fulfilled. It becomes particularly risky if the annual financial statements were not prepared in time according to the requirements of the Fiscal Code (AO). For the managing directors of a GmbH, there exists a special liability, whilst the shareholders enjoy “relative security”.
b) Converting a sole proprietorship into a GmbH – double-entry bookkeeping
When you convert your sole proprietorship into a GmbH, “extended rules” apply to your bookkeeping, so to speak. This includes, amongst other things, that you must prepare and submit a balance sheet instead of the previous income surplus calculation (EUR).
The annual financial statements
Likewise, the income tax return is replaced by a separate annual financial statement. If you work with a tax adviser, this must be submitted by 31.12. of the following year. The costs for the annual financial statements start at 700 EUR. This also applies if your GmbH is inactive!
What must be included in the annual financial statements?
The annual financial statements must contain the following components:
- Corporate income tax return
- Trade tax return
- E-balance sheet as well as a
- VAT return
Another difference from the sole proprietorship is that the annual financial statements must be deposited in the company register or are published there. The associated website is: www.unternehmensregister.de. This applies to financial years after 01.01.2021. Previously, the deposit or publication took place in the so-called Bundesanzeiger.
c) Different taxation
A GmbH is taxed differently than a sole proprietorship. Until now, you have paid income tax. This is now replaced by so-called corporate income tax. Likewise, the profit no longer lands directly in your “pocket”. Instead, it remains in the GmbH. Strictly speaking, the GmbH has made a profit and not you as an individual. How do you now get to your money? The simplest way consists of paying yourself a monthly salary as managing director. You are then, so to speak, an employee of your company. Alternatively, you make a profit distribution. The interesting thing about the first way (i.e. the payment of a salary) is that you thereby cause personnel costs. Your salary thus reduces the profit of the GmbH. As a consequence, the tax burden decreases. This applies to both corporate income tax and trade tax! The fact that your salary is not the profit of the GmbH does not mean that it would be tax-free. Since you are an employee of the GmbH, income tax is due on it. If you go the route of profit distribution, the so-called withholding tax is due for this. This currently amounts to 25 per cent plus solidarity surcharge. Please also note that a profit must first be determined before distribution. If this is the case, the GmbH must tax it. AFTER THAT you can distribute it to yourself or other shareholders. From this it also emerges that profit distribution is not the optimal way if you require a monthly income.
d) Trade tax
When you convert your sole proprietorship into a GmbH, this does not exempt you from the obligation to pay trade tax. This is due here from the first cent of profit. The exemption amount of 24,500 euros known from sole proprietorships therefore does not (any longer) come into play here.
2) How can I convert my sole proprietorship into a GmbH?
Now that we have examined the differences, it is time to look at how the change can take place in practice. Two options are available to you:
a) Conversion into a GmbH
This is the classic procedure. First, the value of the existing company is determined with the help of a tax adviser and then assessed. Subsequently, you found your GmbH. The special feature of this is that the share capital of the GmbH is contributed as a contribution in kind. What does this contribution consist of? It consists of the previous sole proprietorship! Now this procedure has advantages and disadvantages. The latter include high costs for tax advisers and notaries. The advantages include that existing contracts can simply be transferred to the GmbH (which has “swallowed” the sole proprietorship, after all). You also benefit from this procedure if you later need a bank loan for your GmbH. Banks like to look at the age of the company. If your GmbH is only two years old, but previously existed as a sole proprietorship for 20 years, your company is 22 years old at first glance. From the bank’s perspective, however, a new foundation (of the GmbH) has taken place. Since many banks do not grant loans to companies that are younger than two years (or in that case impose more difficult conditions), the granting of credit is significantly facilitated if you launch your GmbH through a conversion of the sole proprietorship. In that case, the existing financial years of the sole proprietorship would be included in the calculation. Another advantage of the conversion is that you do not have to pay the share capital additionally from your own (already taxed) capital. Instead, it is replaced by the value of the sole proprietorship.
b) Sale of the sole proprietorship to the GmbH
Here, the GmbH is founded first. Alternatively, you can also buy a shelf GmbH. The share capital is paid as a cash contribution. After the GmbH foundation, you determine the value of the sole proprietorship, which in this case still exists. Subsequently, you sell your previous company to the GmbH and have the purchase price paid out by the GmbH. The method mentioned has its very own advantages and disadvantages. In order to have a basis for decision-making, you should know these. Let us begin with the sale to the GmbH: As a sole proprietor, you are a natural person for tax purposes, i.e. a human being of flesh and blood. The sole proprietorship is your private property. When you sell it to your GmbH, you have earned money privately and must also tax it privately. Conversely, the GmbH must wait 15 years until it can write off the costs for the purchase. Another peculiarity of this procedure is that existing contracts of the sole proprietorship are not automatically taken over. Whether this is an advantage or disadvantage depends on the individual case. Depending on what kind of existing contracts are involved, it can also be a blessing. From a banking perspective, your GmbH is a new company. If you need money, you consequently cannot argue that you have “been successfully in business for 20 years”. You are running a “fresh company”. From the banks’ perspective, this is associated with risks. DSGVO (General Data Protection Regulation) also comes into play. In practice, this means that you cannot pass on your customer data from the sole proprietorship to the GmbH without the active consent of the customers. Legally speaking, they are two different companies, and the regulation on data protection intervenes here.
Advantages:
Now the “second way” also has advantages. It is significantly more cost-effective and simpler. In fact, the foundation of a GmbH can be processed much more quickly with it. The reasons for this are:
- no expert opinion from the tax adviser necessary
- lower notary costs if only one shareholder is present and the standard protocol is used
- the process is accelerated by the elimination of the expert opinion
- since the notary has to check less, the appointment with him can take place more quickly
- less examination work by the register court
| Criterion | Conversion into a GmbH | Sale of the sole proprietorship to the GmbH |
|---|---|---|
| Share capital | As contribution in kind (value of the sole proprietorship) | As cash contribution |
| Costs | Higher (valuation report, higher notary fees) | Lower (no valuation report, lower notary fees) |
| Speed | Slower | Faster |
| Existing contracts | Transferred automatically | Not transferred automatically |
| Company age (bank perspective) | Business years of the sole proprietorship are taken into account | GmbH is treated as a new incorporation |
| Taxation upon sale | Must checked individually | Sale proceeds must be taxed privately |
| Depreciation of acquisition costs | — | It takes 15 years |
| Customer data (GDPR) | Transfer is mostly possible without any problems | Transfer only possible with active customer consent |
Conclusion:
As this article shows, “there are several roads to Rome” when converting your sole proprietorship to a GmbH. None of these ways is perfect in itself. Rather, each has its very own advantages and disadvantages. Which way should you choose? As is evident from the text, this question cannot be answered universally. Companies (and people) are far too different for that. In the end, it will be criteria such as individual circumstances, the respective business model and personal financial situation that tip the scales. Your future plans should also be included. Last but not least, personal taste plays a role. There are sole proprietors who were successfully in business for years, but understood the switch to a GmbH as a new start. In that case, they wanted to get rid of “old baggage”. Others were very proud to continue their company as a GmbH. In the end, it will always be about continuing what you have already done before in a different way.
We recommend obtaining comprehensive advice before this major step. This also includes involving your tax adviser. We hope to have helped you with this article and wish you much success, health and always good business!
FAQ
As a sole proprietor, you are liable with your entire business and private assets. After conversion into a GmbH, the private assets of the shareholders are generally protected. Provided the capital contribution has been paid in full and not misused. However, liability protection can lapse if, for example, insolvency is not reported in time or bookkeeping obligations are not fulfilled.
There are two ways: In the classic conversion, the value of the sole proprietorship is determined by expert opinion and contributed as a contribution in kind to the newly founded GmbH. When selling the sole proprietorship to the GmbH, the GmbH is first founded with a cash contribution and the sole proprietorship is subsequently sold to it. Both methods have individual tax, legal and financial advantages and disadvantages.
Instead of income tax, a GmbH pays corporate income tax on its profits, which initially remain in the company. Managing directors can pay themselves a monthly salary, which reduces the GmbH’s profit as an operating expense. Alternatively, a profit distribution is possible, which is however subject to withholding tax of 25% plus solidarity surcharge. Furthermore, the trade tax exemption of 24,500 euros that applies to sole proprietorships no longer applies.
The annual financial statements of a GmbH must include corporate income tax return, trade tax return, e-balance sheet and VAT return. When working with a tax adviser, it must be submitted by 31 December of the following year and published in the company register. The costs start at 700 euros, even if the GmbH was inactive in the year concerned.
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