Relocation to Germany when a foreign based company is involved
von Peter Scheller
When shareholders of foreign based companies relocate to Germany, the tax implications can be severe. This is especially the case if the shareholder is the only manager of a small or medium-sized company. In this case the place of effective management of the company is also transferred to Germany with major tax consequences for the company and the shareholder alike. This article describes the basic tax issues but particularly the valuation of the company’s assets at the moment that is becomes a tax resident entity in Germany.
Tax residence of a company in Germany
A company is tax resident in Germany if it has its statutory seat or its place of effective management (POEM) in Germany. Since the statutory seat of a foreign company always remains abroad, then the question to answer is where does the company have its POEM?
The term place of effective management refers to a place where the management takes decisions and undertakes activities of major importance in regard to legal, organizational and economic transactions of the enterprise. This means the place where the management carries out its day-to-day management activities. The term fixed place does not require an actual premises for the enterprise. For example, the place of management can be in the private home of the managing director.
In general a sole shareholder/partner and manager of a company who relocates to Germany carries out thereafter his/her management activities in Germany. This applies for corporations and partnerships alike. To prove that he or she still carries out management activities abroad is a very difficult task and would only be the case if the following applies:
- The manager travels abroad to perform management duties on a regular basis (the majority of his or her working time)
- He or she must prove this by travelling reports and receipts, minutes of meetings abroad with employees, customers, other business partners etc.
- There must be economic substance abroad (e.g. employees, an office or workplace, telecommunication evidence etc.).
If the foreign business entity has other managers who are not tax resident in Germany the POEM might remain abroad. This is especially the case if the day-to-day decisions are carried out abroad. The following measures may indicate that this is the case:
- The manager who relocates to Germany is not a manager or managing partner of the business entity at all. This is the safest way to prove that the POEM has not been transferred to Germany. However, in small business entities often this is impossible due to practical reasons.
- The existence of a shareholders’ or partners’ resolution stating that the manager who relocates to Germany is not entitled to carry out any management duties of importance as long as he or she is physically staying in Germany. The manager who relocates to Germany should be restricted to auxiliary services for as long as he or she is physically present in Germany. Management activities can be allowed if the manager is performing them outside of Germany.
- Meetings of the Board of Directors or of the managers are held outside of Germany.
- Most of the managers are situated abroad and the manager who relocates to Germany is not the manager with the biggest influence on day-to-day decisions.
- There are other indications that the POEM is abroad (e.g. the management is carried out by an independent management service company).
- In most cases sole shareholders/partners of corporations or partnerships are not able to prove that the POEM has not been transferred to Germany when they relocate to Germany. If this is the case the foreign company becomes for tax purposes a “German entity” and has to fulfil all tax obligations in a same way as a German company.
- There is another issue to be considered which is not tax relevant but has an effect on the legal status of the company in Germany. Germany’s corporate law follows the “corporate domicile theory”. This means that a company with a statutory seat abroad which transfers its POEM to Germany loses its legal status as a corporation. By German law the entity qualifies as a partnership which results in the unpleasant consequence that all shareholders have unlimited liability for all debts of the company. This does not apply for companies from the European Union, the European Economic Area or from countries that have entered into a special agreement with Germany (such as the USA). However, for a company that transfers its POEM from other country to Germany great care is needed. Such companies should avoid carrying out any business transactions in Germany if limited liability is an issue for its shareholders.
For more information see here https://scheller-international.com/blog-beitraege/the-unwanted-permanent-establishment-in-germany.html.
Tax consequences in Germany
If a foreign company transfers its POEM to Germany it becomes tax resident in Germany. A corporation will be subject to German corporation tax and trade and business tax. If the foreign business entity is a partnership the profits will be taxed at the level of the partners. The partnership will be subject to trade and business tax only. If the foreign entity carries out any taxable transactions in Germany (supplies of goods or services) it will also be liable to VAT. For more information see here https://scheller-international.com/blog-beitraege/id-10-tax-issues-to-be-considered-if-doing-business-in-germany.html
In addition to the taxation of business transactions there are also special scenarios which could trigger major tax consequences in Germany, such as:
- Selling of shares: If a shareholder/partner sells their shares or partnership interests, this transaction results in a capital gain taxation at the level of the shareholder or partner.
- Corporate restructuring: Sometimes a corporate restructuring is required in order to transfer shares to investors such as venture capital companies, business angels, competitors or other investors. The restructuring may result in a gain from a conversion or merger which may be subject to taxation at the level of the company and the shareholders.
- Exit taxation: It also may be that shareholders or partners leave Germany after a few years. In general the POEM will also be transferred out of Germany and this will result in an exit taxation.
In the before mentioned cases the taxable gain will be calculated as follows:
- Take the selling price or fair market value of the business entity or the shares
- minus the selling or restructuring costs
- minus the book value of the equity capital or acquisition costs of the shares
The book value of the equity capital is the value of the business entity’s assets minus the liabilities.
Valuation of assets at the moment of transferring the POEM to Germany
The business entity’s assets will be re-valued at the moment the POEM is transferred to Germany. The assets have to be valued at a fair market value (Step-up). In general the most valuable assets of small and medium-sized companies are intangible assets. This is for example computer software in the form of online-platforms, applications or other individual software products. The same applies for technical developments, procedures and products, patents, domain-names, trademarks and other intellectual property. In general intangible assets which are developed or generated by the company are not shown in its books. If the POEM of the company is transferred to Germany all assets have to enter the opening balance sheet at their fair market value. The step-up of assets has various positive tax effects:
Most intangible assets (as well as tangible assets) can be depreciated. The entry of assets at fair market value in the opening balance sheet results often in a significant increase of depreciations. This reduces the current earnings in following years.
The step-up also increases the book value of the equity capital of the company. This may in the future reduce gains from selling shares, restructuring or exit from Germany.
The technical ways to value intangible assets are income, market or cost based.
If the value of the company as a whole is bigger than the sum of all assets minus liabilities, then a goodwill value has to be shown in the opening balance. There are various methods to determine the value of a business entity, e.g. the discounted cash flow-method. A goodwill can be depreciated for tax purposes over a period of 15 years.
If a foreign company transfers it POEM to Germany the step-up of assets (especially intangible assets) is of major importance in order to reduce tax liabilities in periods following the transfer. However, there is one drawback. German tax authorities will require conclusive proof of the asset’s values, and therefore professional surveys are required. This obviously results in cost but in general this is justified by the tax advantages that follow.
Peter Scheller, Steuerberater, Master of International Advisers, Fachberater für Zölle und Verbrauchsteuern
Alexander Wangerowski, Steuerberater, https://aw-stb.de/