Can an LLC Inc.

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StB Dr. Michael Best, partner at Pöllath & Partners, Munich

In American legal dealings, the legal form of a Limited Liability Company ("LLC") is increasingly being used, a form of company that has the peculiarity that it is a limited liability company under American civil law, but is regularly treated as a partnership under American tax law. In this case, it combines the corporate law advantage of the capitalist limitation of liability with the tax advantages of a partnership (tax transparency).

Such a “hybrid” is not regulated in German law. For the German tax treatment of the company or its shareholders, an assessment must therefore be made on a case-by-case basis, i.e. whether the company is to be regarded as a corporation or a partnership.

This can have significant (negative) tax implications. If an LLC z. If, for example, it is treated as a corporation in Germany, the payments to German shareholders are subject to taxation as dividends. Since at the same time the LLC is treated as a partnership in the USA, the shareholders there are also subject to taxation with the income of the LLC. This can lead to double taxation. Another case with significant effects are foreign (American) partnerships in which the LLC is a general partner and thus the question of commercial character depends on the qualification of the LLC as a partnership or corporation.

For German shareholders of an LLC or of structures that have an LLC, it is therefore of considerable importance to check the German tax classification of the LLC in advance or, if necessary, to influence the legal structure of the LLC in order to avoid German tax disadvantages .

A special form of LLC is the "one-person LLC", which therefore only has one partner. In American tax law, if there is no option to be treated as a corporation, it is treated as a so-called "disregarded entity", i. H. the income is allocated directly to the shareholder. The treatment under German tax law is unclear.

BMF specifies criteria for qualification

In principle, an LLC is qualified for German tax law on the basis of the BMF letter of 19 March 2004 (BStBl. I 2004 p. 411 = DB 2004 p. 901) using various criteria (management, liability, transferability of shares, Allocation of Profits, Raising of Capital, Life of Society and Distribution of Profits). Depending on the characteristics and weighting of the individual criteria, an overall picture of the company is determined that corresponds either to that of a partnership or that of a corporation.

The BMF letter does not comment directly on the question of the classification of a one-person LLC. It notes in passing that the number of partners is not suitable as a characteristic for the distinction between corporation and partnership. Whether this also meant the special case of a one-person LLC appears to be questionable. In the case of a commercial activity of the LLC, however, the BMF letter states: "For German taxation purposes, an LLC can be classified as an independent tax subject (entity subject to corporation tax) or as a partnership and, if applicable, as a dependent branch (permanent establishment) of the sole shareholder" . Obviously, the Federal Ministry of Finance assumes that with a single shareholder the LLC is neither a corporation nor a partnership but, from a German tax point of view, represents a legally dependent unit of the shareholder, i.e. H. in the case of commercial activity, a foreign commercial permanent establishment of the shareholder.

No mandatory qualification as a corporation

The criteria mentioned in the BMF letter basically represent a suitable set of instruments for assessing an LLC according to German legal principles. In the case of a one-person LLC, however, the question arises as to whether these criteria can even be applied sensibly. The BMF letter itself leaves this question open.

A consideration of the criteria shows that only the criteria of liability, capital raising and lifetime in the case of a one-person LLC remain unreservedly meaningful. In contrast, the other criteria are usually not very helpful for qualification in the special constellation of a single shareholder. In this way, the individual partner has complete control over the management, the transferability of the shares and the allocation and distribution of profits.

However, if one were to restrict the qualification of the LLC to the aforementioned three criteria, this should regularly lead to the LLC being classified as a corporation, especially since the German tax authorities attach particular importance to the criterion of limited liability, as it basically applies to the LLC and, as a rule, a capital increase in the form of a contribution will be agreed.

However, this would inadmissibly shorten the legal assessment of the LLC. Only because the majority of the criteria in the case of a one-person LLC because of the special "power position" of the sole shareholder in the examination scheme drawn up by the Federal Ministry of Finance lose their selectivity, it is in our opinion not permissible to shorten this examination and the rest Hide criteria. Incidentally, the BMF itself does not seem to assume that this is the case. Otherwise, the aforementioned assessment is not to be understood as a foreign permanent establishment.

Not a one-person partnership

On the other hand, there is no doubt that a one-person partnership does not exist. If the legal structures of the LLC were chosen in such a way that the position of the partner is more similar to that of a partnership, in our opinion this can only lead to the conclusion that the LLC is not assessed as an independent legal entity from a German tax law perspective, but as a dependent legal entity of the shareholder, ie in the case of commercial activity as a foreign commercial permanent establishment or in the case of asset management activity as the "extended (tax law) arm" of the German shareholder, but without German tax implications since the structure is completely transparent from a German tax law perspective.

Based on the information in the BMF letter, we assume that a one-person LLC does not necessarily have to be qualified as a corporation, but as a permanent establishment (commercial activity) or fully tax-transparent (asset management activity). Since the BMF does not expressly comment on this, however, it should be advisable for advisory practice in cases where the qualification of the LLC as a partnership under German tax law is important. For this purpose, another shareholder (possibly with a very small share) should be included in the LLC and the articles of association should be designed as a partnership according to the criteria of the BMF letter.

Category: Best, Michael, Guest Posts | Tags: dividend taxation, double taxation, corporation, limited liability company, partnership

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