As a corporation, a limited liability company (GmbH) is subject to a range of tax obligations. One scenario in which taxes are payable is when profits are earned and distributed. In this article, you will learn how a GmbH calculates its profits and what taxes must be paid on them, and we’ll cover how profits can be used and the conditions for distributing them. We will also share tips on how to avoid hidden profit distributions and which taxes are due on open profit distributions.

What’s in this article?

• How does a GmbH determine its profit?
  
• What taxes does a GmbH pay on its profits?
  
• How can a GmbH use its profits?
  
• When can the profits of a GmbH be distributed?
  
• What taxes are levied on the distribution of profits?
  
• How to avoid hidden profit distributions
  

How does a GmbH determine its profit?

A limited liability company (GmbH) calculates its profits based on its commercial balance sheet, which is an annual financial statement prepared in accordance with the German Commercial Code. Profits in the commercial balance sheet are determined using a profit and loss account (see Section 4 and Section 5 of the German Income Tax Act, or EStG). This involves combining and reconciling all income and expenses for a financial year into one statement.

The calculation also includes profits and losses that have not yet been received or paid—for example, outstanding bills. Vacation entitlements or overtime that have not yet been paid out must also be included. Inventories, on the other hand, do not have to be recorded in the income statement unless the value of the inventory has changed due to new purchase prices or a reduction in the value of goods.

If the earnings exceed the expenses, the GmbH has made a profit. Losses from previous years may be carried forward up to a specified amount. This means that the business can reduce its taxable profit.

A GmbH must submit its annual financial statements—consisting of the balance sheet, income statement, notes and, if applicable, a management report—to the German Federal Gazette for publication. Generally, the deadline is three months after the end of the financial year; but for a small GmbH, it can also be six months. The published annual financial statements can then be viewed by third parties in the commercial register. The purpose of the publication is to provide banks, creditors, and potential customers or business contacts with insight into the GmbH’s financial situation.

What taxes does a GmbH pay on its profits?

There are essentially two types of taxes levied on a GmbH’s profits: corporation tax and trade tax.

Corporation tax is 15% across Germany in accordance with the German Corporate Tax Act KStG. For example, if a GmbH generates a profit of €100,000, then it must pay corporation tax in the amount of €15,000. In addition, the GmbH must pay a solidarity surcharge of 5.5% on the amount of corporation tax. With a corporation tax of €15,000, this amounts to €825. Of the €100,000 profit earned, the GmbH retains €84,175 after corporation tax and the solidarity surcharge.

There are no standard regulations for trade tax that apply across Germany. The amount depends on the trade tax rate applied by the municipality where the GmbH is registered. The differences here can be considerable. For example, the assessment rate in Berlin in 2023 was 410%, while 50 kilometers away in the town of Zossen in Brandenburg, it was 270%. On the DIHK website, you will find the assessment rates for German cities and municipalities in 2023.

To calculate the amount of trade tax, the profit of the GmbH is multiplied by the base tax rate of 3.5 and the tax multiplier. Therefore, with a profit of €100,000 and an assumed assessment rate of 400%, the calculation is as follows:

100,000 x 0.035 x 4 = €14,000 Trade Tax

If a GmbH is not commercially active, trade tax does not apply. For example, asset management businesses with income that comes primarily from the management and rental of their own real estate may qualify.

You can find more detailed information in our article on saving taxes with a GmbH in Germany.

How can a GmbH use its profits?

In addition to the taxes mentioned above, other taxes may be levied on the profits of a GmbH depending on how the profits are used. This is decided jointly by the shareholders. The decision must be recorded in a resolution on the use of profits. There are three options for the use of profits:

• The profits can be distributed to the shareholders after the deduction of tax. The distribution will be proportional to the number of shares—provided that no other agreements have been stipulated in the articles of association.
  
• Profits can be withheld and carried forward to the following financial year. This carried-forward profit can then be used as a capital reserve to offset future profits or losses.
  
• The profits can be transferred to a profit reserve. This essentially fulfills the same function as carried-forward profits: strengthening equity. However, while carried-forward profits can be used for several purposes, profit reserves are usually earmarked for a specific purpose. In addition to strengthening equity or securing liquidity, this can also be a specific investment. In contrast to profit reserves, carried-forward profits may be distributed in the following financial year without being earmarked for a specific purpose and without a new resolution being required.
  

When can the profits of a GmbH be distributed?

A GmbH may only distribute its profits if certain conditions are met. For example, sufficient profits must be recorded in the balance sheet. Profit distribution is only allowed if it does not affect the share capital of the GmbH. The business must always retain the reserves required by law. In addition, profits that are required to meet liabilities may not be distributed.

Additionally, profit distribution may not violate any provisions of the articles of association and requires the consent of all shareholders. A corresponding resolution can be adopted at a general meeting of shareholders.

What taxes are levied on the distribution of profits?

In principle, two different tax procedures can be applied to a GmbH’s profit distribution: taxation with capital gains tax or at the shareholders’ personal tax rate.

Capital gains tax is a flat rate of 25%. This is in addition to the solidarity surcharge of 5.5% and, where applicable, church tax. As the tax office classifies profit distributions as income from capital assets, advertising costs or interest on debt cannot be deducted from the distribution except for the tax-free amount of €1,000. In individual cases, exemptions from capital gains tax may be possible—for example, if employees participate in the profits. Employees can benefit from a tax-free saver’s allowance. The tax-free amount is €1,000, or €2,000 for married couples as of 2023.

The second option for taxing profit distributions is the partial-income method (TEV), which shareholders can choose under certain conditions as an alternative to capital gains tax. Whether or not the partial-income method can be used depends, among other things, on the size of the shareholders’ stake in the GmbH.

If one of the shareholders is also a managing director, a shareholding of 1% is sufficient. With TEV, the profit distribution is taxed at the shareholders’ personal tax rate. However, this only applies to 60% of the amount, as 40% is exempt from tax. Advertising costs are also taken into account in full.

Anyone who has the option of using capital gains tax as well as TEV should compare their individual tax burden under the two tax regimes. It should always be considered which option offers greater tax savings on a case-by-case basis. The decisive variables are the income tax rate and the profit distribution received. However, it is not possible to change the tax regime from year to year. Once a partial income method has been decided on, an application must be filed to revoke it.

How to avoid hidden profit distributions

Any open profit distribution requires a resolution on the use of profits to be adopted at a general shareholders’ meeting. This is in contrast to a distribution of profits without a resolution and the legally prescribed taxation. This type of hidden profit distribution is not permitted. Hidden profit distributions might not be intentional and made unknowingly.

A hidden profit distribution could be, for example, an inappropriately high salary or excessive salary increases for the managing directors. Compensation should always be in line with industry standards. This is based on the taxable profit of the GmbH as the assessment basis for corporation tax. As salaries are deducted from the business’s profit, they reduce the tax burden. This is acceptable within reasonable limits, but inappropriately high salaries are considered attempted fraud. The same applies to inappropriate benefits such as discounts or rebates, the private use of business vehicles, financing private parties, or interest-free loans from the business to shareholders.

If the tax office discovers hidden profit distributions, this often results in a tax audit. If this suspicion is confirmed, the hidden profit distributions must be taxed retroactively. For this reason, it is particularly important for shareholders who have a dual role as managing directors to strictly separate income and profit distribution through accurate accounting.

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