Specific tax features in the sale and acquisition of partnerships

Partnerships as such are only subject to trade tax in Germany. In addition, profits are taxed on the partners’ level (personal or corporate income tax). When shares are sold, this so-called tax transparency triggers tax consequences both for the partnership and the partners.

The partners are obliged to specify their share in the capital gain in their personal income tax return and to pay tax on it. Individual tax rates and tax allowances are taken into consideration, here. In most cases, the highest tax rate of 47 per cent (including solidarity tax) applies to partners being natural persons. In contrast, the sale of shares in a corporation would be taxed at a rate of maximally 28 per cent (so-called partial income procedure). In addition, trade tax (between 13 and 17 per cent) is payable in a situation where only a part of the partner’s share in the partnership is sold or a corporation sells its shares. Depending on the structure and the time of transaction, a sale may result in a double tax burden and, thus, tax rates reaching almost 60 per cent. Transactions during the year are more difficult to implement anyway if they involve partnerships. This is also due to the fact that classic locked box concepts do not work right off the bat. A partner may not depart from the partnership with a retroactive effect as of 31 December / 1 January for tax purposes but is obliged to tax the profit of the partnership until the closing date although these gains should be due to the acquirer in this locked box period. In practice, approaches have been developed to handle these aspects.

It also needs to be considered that the partner’s share not only includes the interest of the selling partner in the collectively owned assets of the partnership but also the so-called separate business assets. These include payments that the (selling) partner received from the partnership in turn for the services for the partnership, for issued loans, or the making available of business assets. If, for example, a partner makes available a plot of land which he owns under civil law to the partnership for a fee, the plot of land will be the partner’s separate business asset in the partnership. Depending on the constellation, it is necessary to find a solution to this scenario, otherwise there will be tax trouble ahead. 

As tax is levied at the individual income tax rate, the sale of interest in a partnership can get very expensive, in particular for natural persons being the partners and sellers. The few existing tax relief options are available only if the partner sells his share in the partnership as a whole; however, if he sells only part of it, no capital gain eligible for tax relief is generated but an operating profit which, in addition, is subject to trade tax. Application of the so-called One-Fifth Rule, a relief which is deemed to ease progression in income tax rates, is not subject to the requirement of filing an application; instead, the authorities examine ex officio whether the relief where tax spreads evenly over five years or normal taxation of the capital gain will be more favourable for the seller. If application of the One-Fifth Rule does not generate a (significant) tax advantage, the seller can alternatively – if certain conditions are fulfilled – apply the average tax rate according to § 34 (3) of the German Income Tax Act (Einkommensteuergesetz,  EStG), the so-called halved rate. Because the average tax rate can be granted only once in a lifetime after a certain age is reached and is only eligible in respect of a specific capital gain, the seller must file an application. The advantage of the halved rate  is that the capital gain is taxed only at 56 per cent of the seller’s average income tax rate – which may bring about a significant tax effect. However, the application is capped at a capital gain of maximally EUR 5 million.

As opposed to the – compared to shares in a corporation – relatively high tax burden on the part of the seller, the buy-side enjoys quite a significant tax relief, which results from the amortisation benefit generated. Unlike under company law (share deal), the acquisition of shares in partnerships is always an asset deal from the tax perspective. Due to tax transparency, it is possible to allocate the purchase price to the acquired assets and goodwill, thus generating a tax amortisation benefit. Via this tax amortisation benefit, the tax office has a significant share in the purchase price, of course somewhat spread over the subsequent periods. 

It is also interesting to know that the scope of liability for the tax history of the partnership taken over is smaller than in the acquisition of shares in a corporation. This is because, as already mentioned, tax consequences are partly triggered on the level of partners and do not only apply directly to the partnership. 

This, last but not least, gives the buyer a very important clue. The partnership itself is subject to trade tax. This also covers trade tax (proportional, if applicable) on the capital gain of the departing partner (which may be triggered in various constellations). Trade tax is thus payable at the level of the target although it refers to the capital gain of the departing partner. This fact should, by all means, be reflected in the transaction documentation and purchase price mechanisms (indemnification, debt item). Otherwise, the buyer will be required to pay the trade tax due from the seller.  

It is important to note that the tax treatment of the sale of a partnership may vary depending on the legal form, asset structure, individual circumstances of the partners, and applicable tax legislation. Early consultation with tax experts is advisable in order to understand tax implications, examine possible optimisation opportunities, and avoid tax pitfalls.