You want to launch a start-up and have heard that you can save taxes thanks to a holding company? Right now, you are probably wondering whether this is just a rumour or whether you can really save taxes through a holding company. And if so, why is that the case? We want to have a look at these questions to help you decide whether incorporating a holding company really is an attractive option for you.
In order to understand the advantages and disadvantages of a holding company from a tax perspective, we will take a look at what taxes your private limited liability company (GmbH) and you as a founder have to pay in the first place.
Kickoff: The Taxes We Pay
First of all, it is important to distinguish between you as a private person and your GmbH. You are two different taxable persons and your respective income is worked out and assessed separately. In addition, the GmbH as a legal entity (corporation) is subject to different taxes than you are as a natural person.
1. GmbH Level
If your GmbH has chargeable gains, these gains are subject to corporation tax (Körperschaftsteuer) and trade tax (Gewerbesteuer) at the level of the GmbH.
- Corporation Tax
The corporation tax rate for company profits is 15%. A further 5.5% solidarity surcharge is levied on top of this (for corporations nothing has changed with regard to the solidarity surcharge). There is no tax-free allowance for the chargeable gains of the GmbH.
- Trade Tax
Trade tax has two components: the standard rate and the variable assessment rate. The standard rate is 3.5%. The assessment rate is determined by the municipality in which your GmbH has its administrative office. Its’ range usually varies between 380% and 490%. The trade income of the GmbH is multiplied by the tax rate of 3.5% and the assessment rate (in our example the assessment rate amounts to 490%):
Trade Income x 3,5% x Assessment Rate of e.g. 490%.
In our example, the trade tax results in a tax burden of 17.15%. In the case of corporations, such as the GmbH, there is no tax-free allowance for trade income. Just like corporation tax, it is due from the first euro onwards.
2. Personal Level
You as a founder will only have taxable income when your GmbH distributes profits (dividends). Your GmbH has already paid corporation tax and trade tax on its profits. The profits remaining after tax deduction can now be distributed to the shareholders of the GmbH. The standard withholding tax is in turn levied on the dividends distributed to the shareholder (i.e. you as a founder). The standard withholding tax is 25%. In addition, the 5.5% solidarity surcharge is levied on top of this and, if applicable, church tax.
3. Managing Director’s Salary
The managing director's salary must be strictly separated from the dividend distributions. You may be founding shareholder and managing director of your GmbH at the same time. Ideally, you have concluded a managing director service agreement with the GmbH in which your remuneration is determined. The remuneration you receive as managing director will probably be treated as money you earn from employment. For the GmbH, the remuneration is an operating expense; it reduces the GmbH's chargeable gains. When determining the amount of your remuneration, you must ensure that it is at arm’s length. I.e. the GmbH would pay the same amount to an externally hired managing director. Any remuneration that is not at arm's length is considered a hidden profit distribution.
Teaser: The Benefits of the Holding Company
The holding company is usually a small limited liability company (UG (haftungsbeschränkt)). It can be incorporated quickly and with little capital. You as the founder will be the sole shareholder and managing director of your holding company. The holding company now founds a subsidiary, the operating GmbH (together with the other founders). The holding company is the shareholder of the subsidiary GmbH and you are the shareholder of the holding company. Thus, we have at least three taxable persons in a holding structure: the subsidiary GmbH, the holding company and you as a natural person.
1. GmbH Level
The holding structure has no consequences on the level of the GmbH. The GmbH must pay corporation tax and trade tax on its chargeable gains. However, dividend distributions of the GmbH first flow to the holding company, because the holding company is the shareholder of the GmbH.
2. Holding Company Level
At the level of the holding company, things get exciting. First, we note that in our example the holding company is a UG (haftungsbeschränkt), i.e. a corporation. Just like the GmbH, its chargeable gains are subject to corporation tax and trade tax. However, precisely because the holding company is a corporation, it benefits from a holding company bonus. This means that the holding company has a tax-free allowance of 95% on its capital gains, i.e. 95% of the dividends distributed by the GmbH to the holding company are free of tax. Corporation tax and trade tax are only levied on the remaining 5% of the distributed profits. This results in a tax burden of approx. 1.5% at the level of the holding company. Provided, however, that the holding company holds a participation of at least 10% in the GmbH. And the holding company must be a corporation; partnerships do not benefit from the holding company bonus. In our example, both of these apply.
The profits that are now available at the level of the holding company can be reinvested through your holding company. E.g., in another company that you want to build up or a company in which you want to acquire a participation.
Therefore, the holding company is attractive for all those who want to reinvest their profits promptly. In that respect, the holding structure creates a significant reinvestment effect.
Entrée: Downsides of the Holding Company
On the other hand, in case you actually want to distribute the profits from your GmbH to yourself as a private person, the holding structure suddenly becomes quite unattractive. If the holding company distributes the profits to you as a private person, these profit distributions will be subject to the standard withholding tax of 25% plus solidarity surcharge and, if applicable, church tax.
And thus, we have just discovered the crux of the holding structure. If the profits from the GmbH are supposed to end up in your private bank account, the holding structure offers no advantages and causes additional costs. Firstly, there is an additional 1.5% tax burden at the level of the holding company. And secondly, the holding company entails additional administrative costs (e.g. the fee for the chamber of commerce and industry (IHK)).
Therefore, the establishment of a holding company is not a recipe for more money in your private bank account. If you do not plan to reinvest the profits from the GmbH promptly, the holding structure will be rather disadvantageous for you.
Dessert: The Fancy Aspects of the Holding Company
As we pointed out, the holding structure benefits from a reinvestment effect because the tax burden at the level of the holding company only amounts to 1.5%. If you pursue an exit strategy, you can fully exploit this reinvestment effect. You have successfully built up your company, you have reached a high valuation, you can’t wait to tackle your next project and you now decide to embark on a share sale.
However, it’s not you as a private person who sells the shares in the GmbH, but your holding company sells its shares in the GmbH. And the same bonus that applied to dividend distributions from the GmbH to the holding company, will now apply to the purchase price for the share sale, i.e. 95% of the purchase price are tax-free at the level of your holding company. In consequence, there is only a tax burden of round about 1.5% on the proceeds of the share sale. And the seed capital for your next project is already available at the level of your holding company.
Digestif: Drawbacks of the Holding Company
You should, however, be cautious, if the holding company grants a shareholder loan to its subsidiary. If the GmbH defaults and cannot repay the loan, the downside of the tax exemption becomes obvious: the holding company cannot deduct the default on the loan for tax purposes when working out its chargeable gains.