With the Growth Opportunities Act of 27 March 2024, the legislator introduced a number of tax changes. Among other things, it made a total of four adjustments to the option for corporate taxation of partnerships in accordance with Section 1a KStG, which came into force retroactive-ly for the 2024 assessment period (“VZ”).
It cannot be denied that Section 1a KStG has so far led a shadowy existence despite its funda-mentally positive effect for taxpayers. The number of corresponding applications since the standard was introduced in 2021 is still estimated to be in the three-digit range. The legislator is now attempting to increase the attractiveness of Section 1a KStG by making it easier (see German Parliament Printed Paper (“BT-D”) 20/8628, p. 2 (in German)).
This raises the question of whether the legislator has succeeded in making the option under Section 1a KStG more attractive in future. This question will be examined in this article.
Section 1a KStG was introduced with effect from 1 July 2021. According to the explanatory memorandum (BT-D 19/28656, p. 21), the aim was to give taxpayers more tax structuring options and to make German tax law more international.
Previously, corporations had a significantly lower tax rate compared to partnerships when retaining profits due to their tax burden of around 30%. Due to the transparent taxation of partnerships, a tax burden of up to 47.48% (plus corporation tax where applicable) was possible at shareholder level if the shareholder was a natural person. The retention tax relief introduced in 2008 within the meaning of Section 34a of the German Income Tax Act (EStG) was intended to provide relief, but the standard is difficult to manage. A further obstacle was that the tax liability of 28.25% resulting from the reinvestment previously had to be paid from non-favoured funds. This was changed by the Growth Opportunities Act.
Furthermore, the German transparent taxation of partnerships does not exist in many jurisdictions and therefore sometimes leads to undesirable qualification conflicts.
Note: However, according to the statutory regulations, Section 1a KStG does not change the civil law nature of the respective company. In this regard, the provisions of the German Civil Code (“BGB”) / German Commercial Code (“HGB”) / partnership company (“PartG”) and the deviating rules in the articles of association are still decisive.
So-called registered civil law associations (“eGbRs”) are now also included in the group of persons entitled to apply (Section 1a (1) sentences 1 - 4 KStG new version). These are all GbRs that are entered in the company register (see Section 707a (2) BGB). Registration is generally voluntary, even if it is required for some legal transactions (in particular for transfers of real estate pursuant to Section 47 (2) Land Registry Act (“GBO”). However, this means that the law falls short of the original draft of the Growth Opportunities Act to give all GbRs, and not just those registered, the option to register.
In the following, we would like to look at some examples of constellations for which an option can now be considered:
According to the new Section 1a (1) sentence 7 KStG, the application can now be submitted in cases of new formation up to one month after the conclusion of the partnership agreement with (back ) effect for the current financial year. The same applies to the change of legal form from a corporation to a partnership, whereby the one-month period begins with the registration of the change of legal form with the relevant register of the corporation or partnership.
According to the explanatory memorandum, it should therefore be possible in these cases to ensure consistent treatment as a corporation tax subject (see BT-D 20/8628, p. 191). This is to be welcomed, as the old legal situation was extremely unsatisfactory in this respect.
A new second half-sentence has been added to Section 1a (2) sentence 2 KStG, according to which the retention of the share in the general partner GmbH held as special business assets II is not detrimental to the book or interim value application within the scope of Sections 20 (2), 25 UmwStG under the new legal situation. This means that the previously required notarised transfer of the GmbH shares to the KG (resulting in the creation of a single KG) will no longer be necessary in future.
The background to the amendment is that no hidden reserves are to be retained in the event of a tax-neutral transfer in accordance with Sections 20 (2) and (25) UmwStG. In the case of a GmbH & Co. KG, the general partner's interest in the KG is typically 0%. The only income of the general partner GmbH is a small liability fee. Even if the shareholding is to be allocated to the necessary special business assets II (see H 4.2 (2) "Shares in corporations" Income Tax Manuel (“EStH”)), there is therefore usually no retention of hidden reserves, as these do not usually exist in practice.
Most recently, Section 1a (3) sentence 5 KStG was shortened so that only the actual withdrawal at shareholder level leads to a deemed dividend within the meaning of Section 20 (1) no. 1 EStG. In future, a notional dividend will no longer be triggered if only the payment can be demanded. The legislator clarifies in the explanatory memorandum (see BT-D 20/8628, p. 192) that a withdrawal is any process as a result of which the profits no longer represent equity of the opting company and are no longer available for offsetting against losses of the company. For example, posting to a debt capital account or offsetting against a claim against the shareholder is sufficient for this. On the other hand, company law does not provide for a separate distribution resolution for partnerships - in contrast to corporations. This fundamental difference could justify different treatment in some respects.
The deletion of the previous addition ("or their payment can be demanded") and the sole focus on the actual withdrawal date brings advantages that should not be underestimated. The old version of the standard has so far meant that – unless the partnership agreement provided otherwise – a claim for payment could generally be demanded at the end of the calendar year or deviating financial year and this was subject to taxation without an inflow of liquidity to the shareholder. Until now, this almost mandatory consequence could only be avoided de facto through a distribution block regulated in the articles of association.
The issue of so-called disproportional (also known as incongruent) distributions has not yet been publicly discussed in this context. In the case of partnerships, each partner can in principle determine under civil law at what point in time they withdraw their profit shares (Section 122 HGB). The profit distribution key under commercial law is not necessarily affected by this. Unlike in the case of a corporation, no (uniform) resolution on the appropriation of profits is required. As the differences under company law continue to exist despite the exercise of the option, a different actual withdrawal in accordance with Section 1a (3) sentence 5 KStG should not result in a disproportionate distribution by the opting company.
If the option under Section 1a KStG is exercised, care should be taken to ensure that withdraw-able profits and shareholder loans are recognised separately. The method of accounting should also be reflected in the articles of association. After all, the question of when a payout can be demanded will no longer play a role in future.
Anyone who now has the impression that the problems with an option in accordance with Section 1a KStG have been eliminated should realise that the standard still has weaknesses that should be addressed by the legislator. In addition, there are a number of peculiarities that depend on the individual case, meaning that it is almost impossible to implement a structure by using Section 1a KStG without expert help. The following are examples of some of the weaknesses and peculiarities:
It remains to be seen whether the standard will now make it out of the niche of tax structuring practice. The pitfalls that still exist, which do not make practical implementation easy, are likely to continue to deter many.
Especially in loss-making start-up phases, the choice of a partnership can be advantageous from a tax perspective. This applies in particular to start-ups (for a comprehensive description, see Kleen, magazine Finanzrundschau, 2022, 1115). If the question arises at a later date as to whether the change from the income tax system to the corporation tax system should be completed after the loss-making phase by changing the legal form from a partnership to a corporation, an option in accordance with Section 1a KStG should at least be considered in future.
The eGbR in particular, which is now included in the regulation, now offers a lean alternative to the existing corporations and other opting partnerships with its simple formation, low formation costs and the flexibility in contract design.
Due to the complexity, we believe that the decision in favour of an opting partnership should only be made after forward planning.
This overview is for initial information purposes only and expressly does not constitute legal or tax advice.