Business Sale: What Taxes Are Incurred?

The sale of a business is a complex process that involves not only negotiating the sale price but also addressing tax aspects. An early understanding of tax rules can help avoid financial surprises and optimize the tax burden. This article highlights the key tax issues in business sales and provides valuable tips for tax optimization.

What Taxes Are Incurred in a Business Sale?

1. Income Tax on Capital Gains

One of the most important tax aspects when selling a business or business shares is the income tax on the capital gains achieved. The capital gain is calculated by deducting the acquisition costs and other deductible expenses from the sale price.

For individuals, such as sole proprietors or partners in a partnership, this gain is subject to their personal income tax rate. Depending on the amount of taxable income, the tax rate can be as high as 45% (as of 2023). Additionally, there is a solidarity surcharge of 5.5% on the income tax.

However, there are also ways to reduce the tax burden. Under certain conditions, tax benefits such as the allowance under § 16 EStG or the one-fifth rule can be claimed.

The allowance under § 16 EStG allows entrepreneurs who have reached the age of 55 or are permanently incapacitated to receive a capital gain of up to €45,000 tax-free.

The one-fifth rule, on the other hand, allows the capital gain to be spread evenly over five years. This can achieve a reduction in progression and lower the effective tax rate.

Example: An entrepreneur sells his sole proprietorship for €1 million. The acquisition costs were €400,000. The capital gain of €600,000 is subject to his personal tax rate of 42%, resulting in a tax burden of €252,000. By applying the one-fifth rule, the tax burden could be reduced to approximately €220,000.

It is evident that income tax can have a significant impact on the net proceeds from a business sale. Careful tax planning in advance, ideally with the support of an experienced tax advisor, can help optimize the tax burden and maximize net proceeds.

Source: IHK Hamburg: Capital Gains

2. Trade Tax

Another important aspect is trade tax. Entrepreneurs who sell their sole proprietorship or shares in a partnership may also have to subject the capital gain to trade tax.

Trade tax is a municipal tax, the amount of which depends on the so-called assessment rate of the respective municipality. The assessment rate varies from municipality to municipality but is usually between 200% and 500%. With an assessment rate of 400%, the trade tax would effectively amount to about 14% of the profit.

However, there are also ways to avoid or reduce trade tax. A complete exemption from trade tax is possible if the business is properly closed. Certain conditions must be met, such as the cessation of business activities and the sale or withdrawal of all essential business assets.

Example: A partnership sells its business operation. The capital gain amounts to €500,000. With a trade tax assessment rate of 400%, approximately €70,000 in trade tax would be due in addition to income tax. However, through proper business closure, trade tax could be completely avoided.

It is important to note that corporations such as GmbHs or AGs are not subject to trade tax on the capital gain. Instead, corporate tax applies, which is discussed in more detail in the next section.

Trade tax can thus represent a significant additional tax burden for sole proprietors and partnerships. An early examination of the possibilities to avoid or reduce trade tax, such as through proper business closure, can significantly increase the net proceeds from the business sale.

Source: Sattler und Partner: Taxes in Business Sales

3. Corporate Tax for Corporations

When selling a business operated as a corporation (e.g., GmbH or AG), different tax regulations apply than for partnerships. Here, the remaining profit in the company is subject to corporate tax.

The corporate tax rate is currently 15% on the taxable profit. Additionally, there is a solidarity surcharge of 5.5%, resulting in an effective tax burden of approximately 15.825%.

It should be noted, however, that profits distributed by the corporation to its shareholders are subject to taxation again at the shareholder level. Here, the so-called withholding tax of 25% plus solidarity surcharge applies, resulting in a total tax burden of approximately 48.5%.

Example: A GmbH is sold for €5 million. After deducting the book values, a profit of €3 million remains. At the GmbH level, approximately €474,750 in corporate tax, including solidarity surcharge, is due. If the remaining €2,525,250 is distributed to the shareholders, approximately €631,313 in withholding tax is due, leaving the shareholders with approximately €1,893,937.

This effect of double taxation - first at the company level and then at the shareholder level - is also referred to as the "double-edged sword" of corporate taxation and can significantly increase the effective tax burden.

However, there are also structuring options to optimize the tax burden. For example, it may be advisable to structure the sale through a holding company or to spread the sales process over several years to mitigate progression effects.

The taxation of corporations in business sales is therefore complex and requires careful planning. Through skillful structuring and the use of structuring options, the tax burden can often be significantly reduced.

Source: Rose Partner: Taxation in Business Sales

4. Value Added Tax

An often overlooked aspect of business sales is value-added tax (VAT). In principle, the sale of a business is VAT-exempt if it involves the transfer of an entire business or a separable part of a business.

The VAT exemption is derived from § 1 Abs. 1a UStG and is intended to ensure that the buyer can seamlessly enter the seller's VAT position. However, the prerequisite is that the buyer continues the business and does not merely acquire individual assets.

However, if individual assets such as real estate, machinery, or inventories are sold separately, VAT may be due on them. The regular VAT rate is currently 19%, reduced to 7%.

Example: In the context of an asset deal of a bakery, the business building is sold separately for €500,000. Since it is real estate, VAT is due on it, in this case, €95,000. The buyer must therefore spend a total of €595,000 but can possibly claim the VAT as input tax.

It is therefore important to carefully examine which assets are transferred in a business sale and whether they are sold individually or as part of an entire business. A clean delineation and documentation can help avoid unexpected VAT payments.

In addition, the VAT consequences should be considered when determining the purchase price. If the purchase price is agreed upon plus VAT, the buyer bears the VAT. If it is agreed as a gross amount including VAT, the VAT reduces the seller's net proceeds.

The VAT treatment of business sales is therefore complex and requires careful analysis. Through careful structuring and documentation, however, risks can be minimized and net proceeds optimized.

Source: Tax Tips: Business Sale

Tips for Tax Optimization in Business Sales

As the previous sections have shown, the tax burden in a business sale can be significant and significantly reduce net proceeds. However, there are a number of ways to optimize the tax burden and maximize net proceeds.

Early Tax Planning with Advisors: The most important tip is to address the tax aspects of the business sale early and involve professional advisors such as tax advisors, auditors, or lawyers. They can help analyze the individual tax situation, identify structuring options, and minimize the tax burden.
Holding Structure: One possible option is to contribute the business to be sold into a holding company. This allows the capital gain to be reinvested at the holding level and the taxation to be optimized. In addition, a holding structure allows for more flexible structuring of the sales process.
Allocation of the Purchase Price: The purchase price should not be treated as a single amount but should be allocated to various components such as goodwill, real estate, machinery, or inventories. This allows different depreciation options and tax rates to be optimally utilized.
Use of Allowances: As already mentioned, there are a number of allowances and tax benefits that can be used in a business sale. These include, in particular, the allowance under § 16 EStG and the one-fifth rule. Through skillful structuring, these allowances can often be optimally utilized.
Loss Offsetting: If there are still tax loss carryforwards on the part of the seller or the company, it should be examined whether these can be offset against the capital gain. This can significantly reduce the effective tax burden.
Timing: By timing the sales process, e.g., over several fiscal years or by agreeing on a performance-based purchase price component (earn-out), progression effects can be mitigated and the tax burden optimized.
International Aspects: In cross-border transactions, international tax aspects must also be considered. Here, double taxation agreements or structuring through foreign companies can offer opportunities for tax optimization.

It is clear that there are a variety of ways to optimize the tax burden in a business sale. Which options are sensible in each case depends on the individual circumstances and should be analyzed as part of comprehensive tax planning.

By involving experts early and carefully structuring the sales process, significant tax advantages can often be realized and net proceeds maximized. An investment in tax planning can therefore be worthwhile.

Conclusion

The tax aspects of a business sale are complex and can significantly influence the success of the transaction. As our explanations have shown, there are a variety of taxes that can be incurred in a business sale, from income tax to trade tax and corporate tax to VAT.

Each of these taxes follows its own rules and can significantly reduce the tax burden and thus the net proceeds. Especially in larger transactions, tax payments in the six- or seven-figure range can quickly arise, which can jeopardize the success of the sale.

It is therefore essential to address the tax aspects of the business sale early and seek professional support. Tax advisors, auditors, and lawyers can help analyze the individual tax situation, identify structuring options, and minimize the tax burden.

There are a number of ways to optimize the tax burden, from using allowances and tax benefits to structuring the transaction to timing the sales process. Which options are sensible in each case depends on the individual circumstances and should be analyzed as part of comprehensive tax planning.

One thing is clear: early planning and preparation is the key to success. Those who only consider the tax aspects at the last moment risk unpleasant surprises and significantly lower net proceeds.

Our advice to all entrepreneurs planning to sell their business is therefore: address the tax issues early, bring professional support on board, and take the time for careful tax planning. Investing in a sound tax strategy can quickly pay off and secure the success of your transaction.

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