Transition from UG to GmbH Before Sale

Transition from UG to GmbH Before Company Sale: Navigating Tax Pitfalls

For many start-ups and founders, the limited liability entrepreneurial company (Unternehmergesellschaft, UG) is the ideal legal form to start a business with minimal capital. However, once the company becomes successful and is to be sold, the question arises as to the right timing for the transition to the "classic" GmbH. The transition to a GmbH can enhance sales prospects and offer tax advantages—but it also involves certain pitfalls that must be considered.

UG or GmbH: Advantages and Disadvantages for the Sale

From a corporate law perspective, the UG is essentially a "small GmbH" with a minimum share capital of one euro. For tax purposes, it is largely treated like a GmbH, meaning it is subject to corporate income tax and trade tax. Nevertheless, there are some differences that can impact the sales process and tax consequences.

A significant disadvantage of the UG is the mandatory reserve formation. 25% of the annual surplus must be allocated to a statutory reserve until the share capital reaches €25,000 (§ 5a para. 3 GmbHG). This restricts distribution possibilities and can reduce the company’s value from the perspective of potential buyers.

Moreover, the UG’s liability is limited solely to its share capital, which often initially amounts to only one euro (minimum share capital). This can deter prospective buyers due to the increased liability risk. In contrast, the GmbH requires a minimum share capital of €25,000, which conveys greater seriousness and security.

Additionally, the designation "UG (limited liability)" can be a disadvantage, as it is often associated with a "budget image" and lower creditworthiness. Renaming to a GmbH can create a trust advantage and facilitate sales negotiations.

Tax Aspects of the Conversion

When converting a UG into a GmbH, this can be structured either as a change of legal form (§§ 190 et seq. UmwG) or as a contribution in kind (§§ 20, 36 UmwG). Both options have different tax implications.

Change of Legal Form According to §§ 190 et seq. UmwG

In a change of legal form, the company’s identity remains intact; only the legal form and possibly the share capital change. For tax purposes, the change of legal form is considered a transfer of the UG’s assets to a (fictitious) new GmbH. For the company itself, the change of legal form is generally tax-neutral under § 25 KStG, meaning hidden reserves are neither realized nor taxed.

However, a so-called "contribution gain II" can arise if the shareholders’ capital accounts are negative (e.g., due to losses or withdrawals). This gain is subject to corporate income tax and trade tax and can increase the tax burden at the time of conversion.

For shareholders, a change of legal form is tax-neutral under § 20 para. 8 UmwStG if the UG shares have been held for at least seven years. Otherwise, a taxable capital gain may arise, which is subject to 60% income tax under the partial-income procedure (§ 17 EStG).

Contribution in Kind According to §§ 20, 36 UmwG

In a contribution in kind, the UG’s assets are transferred to a newly founded GmbH. Unlike the change of legal form, this is a consideration-based transaction where the UG shareholders receive shares in the new GmbH.

For tax purposes, the contribution in kind is treated as a sale of the UG’s assets. This means that hidden reserves at the company level are realized and taxed (corporate income tax, trade tax). For shareholders, the contribution in kind results in a capital gain subject to 60% taxation under the partial-income procedure (§ 17 EStG).

A contribution in kind can therefore lead to a significant tax burden. However, it may also offer advantages, for example, if loss carryforwards of the UG are to be utilized or hidden liabilities (e.g., pension provisions) are to be reduced.

Structuring Tips and Practical Advice

• Timing of the Conversion: The conversion should ideally take place well before the planned sale to minimize tax risks and facilitate sales negotiations. If the conversion is only carried out as part of the sale (so-called "signing-closing structure"), disputes with the tax authorities over possible circumvention of § 20 UmwStG may arise.

• Increase of Share Capital: Transitioning to a GmbH requires increasing the share capital to at least €25,000. The capital increase can be made through cash or contributions in kind by the shareholders, by converting reserves, or through a combination of these measures. Careful documentation and valuation of contributions are essential to avoid tax risks.

• Choice of Legal Form: Besides the "classic" GmbH, conversion into a GmbH & Co. KG may also be advisable. This legal form offers more flexibility in profit distribution and can optimize the shareholders’ tax burden. However, complex tax and corporate law issues must be considered, making individual advice indispensable.

• Dividend Policy: To increase attractiveness for investors, the dividend policy should be reviewed and adjusted if necessary before the sale. Tax consequences (capital gains tax, partial-income procedure) and effects on company value must be taken into account.

• Due Diligence and Data Protection: During the conversion, all relevant documents (articles of association, commercial register entries, annual financial statements, etc.) should be checked for completeness and consistency. Data protection aspects (contracts, IT systems) must also be considered to minimize liability risks.

Practical Example: Conversion of a UG into a GmbH

The ABC UG (limited liability) was founded five years ago by shareholders A and B. The share capital amounts to €1,000, equally held by A and B. The company has developed positively and is now to be sold to an investor. To increase sales prospects, the UG is to be converted into a GmbH beforehand.

Option 1: Change of Legal Form

A and B decide to convert the UG into a GmbH by change of legal form. The share capital is increased to €25,000 through cash contributions by the shareholders. Since the UG shares have been held for more than seven years, the change of legal form is tax-neutral for A and B (§ 20 para. 8 UmwStG).

At the company level, the change of legal form does not trigger realization of hidden reserves (§ 25 KStG). However, a contribution gain II of €5,000 arises because shareholder A’s capital account has a negative balance due to withdrawals. This gain is subject to corporate income tax (15% plus solidarity surcharge) and trade tax.

Option 2: Contribution in Kind

A and B opt for a contribution in kind. They establish a new GmbH (ABC GmbH) into which they contribute the UG’s assets. In return, they receive shares in ABC GmbH.

At the UG level, hidden reserves of €100,000 are realized and taxed at approximately 30% (corporate income tax, solidarity surcharge, and trade tax). For A and B, the contribution in kind results in a capital gain of €50,000 each, which is subject to 60% income tax under the partial-income procedure.

Although the contribution in kind leads to a higher tax burden than the change of legal form in this case, it may be advantageous under certain circumstances—such as when the UG has significant loss carryforwards that would otherwise expire. Also, transferring individual assets (e.g., real estate) to shareholders can be more tax-efficient within a contribution in kind.

Conclusion

The transition from a UG to a GmbH before a company sale is a complex issue with many tax pitfalls. Whether a change of legal form or a contribution in kind is appropriate depends on the specific circumstances of each case. In any event, the earlier the conversion is planned and prepared, the greater the chances of minimizing tax risks and optimizing the sale proceeds.

Thorough due diligence, forward-looking drafting of the articles of association, and a smart dividend policy are as important as choosing the right conversion path. Given the complexity of the matter, involving experienced tax advisors and attorneys is indispensable—it usually pays off quickly. Only those who understand and optimally adjust the tax levers can truly reap the rewards of their hard work when selling their business.