The distribution of profits a GmbH makes at the end of a financial year requires several important decisions to be made by the shareholders. Under the German Law on Limited Liability Companies (GmbHG), the shareholders of a GmbH are entitled to the entire net profit for the year. However, unlike joint owners of a partnership or sole proprietorship, the shareholders of a GmbH cannot simply withdraw these profits. A right to payment only arises once a corresponding distribution resolution has been passed. This article explains the relevant regulations and important aspects relating to the distribution of profits.

What’s in this article?

• What regulations must be observed when distributing a GmbH’s profits?
  
• How does a GmbH distribute its profit?
  
• Who decides on the distribution?
  
• What is incongruent profit distribution?
  
• What is the difference between salaries and profit distribution?
  
• What if the GmbH is making losses instead of profits?
  
• Mistakes to avoid when distributing profits
  

What regulations must be observed when distributing a GmbH’s profits?

The statutory provisions, financial position of the business, and any provisions in the articles of association (also known as the articles of incorporation or GmbH agreement) must be considered when distributing the profits of a GmbH. The following points are particularly important for the distribution of profits to the shareholders of a GmbH at the end of the financial year.

Ordinary resolution

Resolutions on the distribution of profits are usually passed at the general meeting of shareholders. However, a resolution on the distribution of profits can also be passed by written vote. As a rule, a simple majority of the voting shares is deemed sufficient. However, these provisions only apply if the articles of association do not stipulate an alternative.

Special provisions in the articles of association

The articles of association may contain special provisions regarding the distribution and allocation of profits. For example, they may stipulate that only a certain percentage of the profit may be distributed, with the remainder being allocated to a reserve. Similarly, minimum distributions may be set, which the shareholders must follow.

Principle of capital preservation

An important requirement for the distribution of profits is that the share capital is not reduced. This rule is based on the principle of capital preservation. Losses and profits carried forward from previous years are offset against each other. Profit can only be distributed if the balance is positive after offsetting.

Distribution of profits and inheritance tax

For family-run businesses, a discount of up to 30% applies when calculating the value of the business for inheritance tax purposes, if the articles of association stipulate that the profit distribution may not exceed 37.5% of the taxable profit. This strengthens the economic situation of family businesses and means lower inheritance tax.

Special statutory regulations for mini-GmbHs

Special legal regulations apply to entrepreneurial businesses (limited liability), also known as mini-GmbHs or €1-GmbHs. Once carried-forward profits and losses from previous years have been offset, these businesses may distribute a maximum of 75% of their profits. The remaining quarter must be allocated to a statutory reserve. This provision does not apply if the business’s share capital is increased to €25,000. This measure is intended to protect the creditors of mini-GmbHs, which can be founded with a share capital of just €1. The share capital should be increased to €25,000 as soon as sufficient funds have accumulated in the statutory reserve in order to avoid the restriction on profit distribution. However, to do this, a notarized shareholders’ resolution on increasing the share capital is required; it is not sufficient for the reserve and equity to simply exceed this limit.

How does a GmbH distribute its profit?

The profit of a GmbH is usually distributed based on the shares held by the shareholders. However, the articles of association may stipulate an alternative distribution of profits.

The shareholders must pass a resolution on the distribution or allocation of the profit before the GmbH’s profit can be distributed. Unless otherwise stipulated in the articles of association, this resolution will usually specify whether part of the profit is to be withheld for reserves or whether the entire amount is to be distributed to the shareholders.

It is important to note that the distribution of profits to the shareholders of a GmbH is not a salary payment. Salaries are deducted from the GmbH’s profit and paid out in advance, thereby reducing the profit available for distribution. The salaries of the individual shareholders depend on their particular role in the GmbH, not on the amount of shares they hold.

In contrast, profit distribution generally depends on the shares held, not on how and to what extent a shareholder is involved in the GmbH. It may be the case that a “shareholder managing director” receives less in the GmbH’s profit distribution than a “shareholder only” who does not work for the business but owns more shares. There may be exceptions to this if the articles of association provide for an alternative.

However, it is important to note that the profit of a GmbH does not necessarily have to be distributed. The shareholders can choose to leave profits in the business and use them for investments or reserves. This gives GmbHs a certain degree of flexibility to invest in long-term development and reinforce their financial stability. Additionally, the shareholders of a GmbH can usually also make individual agreements to govern the distribution of a GmbH’s profits. These agreements can stipulate, for example, that certain shareholders will receive a higher share of the profits or that profits will be used for certain purposes.

Who decides on the distribution?

Typically, in a GmbH, the decision on the distribution of profits is the responsibility of the shareholders. The articles of association provide the basis for these decisions. The articles of association are a legally binding document governing the GmbH’s internal affairs, including the provisions for the distribution of the GmbH’s profits.

The articles of association usually include provisions that govern the distribution of profits. This may include the following provisions, for example.

• Distribution formula: The agreement stipulates the formula with which profits will be distributed among the shareholders. This can be proportional to the shares they hold in the business or can be determined individually, depending on the agreements between the shareholders.

• Retained earnings: The articles of association can specify whether and to what extent profits are to be retained by the business as a reserve. These reserves can be used for future investments, to cover liabilities, or for other purposes.

• Restrictions on distribution: The articles of association may impose restrictions on the distribution of profits—for example, if there is a shortfall in liquidity, or to ensure that an adequate financial reserve is retained.

• Special provisions: The articles of association may also contain special provisions that give preference to certain shareholders or take into account special circumstances that affect the distribution of profits.

The decision regarding a GmbH’s profit distribution is therefore largely based on the provisions of the articles of association, which are jointly determined by the shareholders. Amendments or additions to the articles of association are usually made by resolutions from the general meeting of shareholders, which may require a qualified majority or other agreed procedures.

What is incongruent profit distribution?

Incongruent profit distribution of a GmbH means that profits are not distributed in proportion to the amount of capital held by each shareholder. In other words, the distribution of profits is not in proportion to the shares that the shareholders hold in the share capital of the GmbH. This incongruent profit distribution can be achieved in several ways and can be facilitated by special agreements in the articles of association.

Some examples of incongruent profit distribution are given below.

• Special distributions: The articles of association may stipulate that certain shareholders will receive additional profits, regardless of the capital amount held by those shareholders. This may be based on individual agreements or on a certain shareholder playing a prominent role in the business and therefore receiving a higher share of the profits.

• Priority distributions: Certain categories of shareholders, such as investors or founding members, may have priority in the distribution of profits and enjoy preferential status before the rest of the profits are distributed among the other shareholders.

• Performance-based distributions: The distribution of profits may be dependent on the shareholders’ performance or contribution to the business. This may mean that shareholders who make an above-average financial contribution receive a higher share of the profit, regardless of the capital amount they hold.

Although the German Federal Fiscal Court acknowledges incongruent profit distribution for tax purposes, the tax authorities are still reluctant to do so. The tax authorities only recognize incongruent profit distribution if it is effective under civil law and was decided for economic reasons, such as the sale of shares. They regard a short-term or repeated change in the incongruent profit distribution as misrepresentation if there is no comprehensible, nontax reason for this.

To ensure that incongruent profit distribution is possible, we recommend including a provision in the GmbH’s articles of association that allows incongruent profit distribution under certain conditions. It is important to carefully consider whether the unanimity principle should apply or whether a majority decision is sufficient. If this is the case, it is possible that the entitlements of certain shareholders could be reduced without their consent. Therefore, in most cases, it is recommended that a resolution on incongruent profit distribution only be possible with the consent of the shareholders who are disadvantaged.

What is the difference between salaries and profit distribution?

Salaries and profit distribution are two different types of remuneration paid to individuals by a business, but for different reasons and under different conditions.

In summary, a salary is compensation for work performed that is paid regularly and is independent of the business’s profits. In contrast, profit distribution by a GmbH is the payout of profits to the partners or shareholders based on their shareholdings in the business.

What if the GmbH is making losses instead of profits?

If a GmbH makes a loss instead of a profit, this creates a different situation for the shareholders with the following possible consequences:

• Liability and loss coverage: As a rule, shareholders of a GmbH are only liable for up to the amount of their investment. This means that the shareholders are not personally liable for the business’s losses in excess of their capital contributions. Losses are not distributed—the GmbH’s losses must be covered using the business’s existing assets. This can be done by using reserves or other financial measures.

• Tax implications: Losses can have tax implications, especially if the business generates profits in subsequent years. In Germany, losses can be offset against future profits in order to reduce the tax burden. This is known as a loss carryforward. You should seek advice from a tax advisor or tax authority to understand the specific tax implications of losses for the business.

• Corporate strategy and business development: Losses often require a review of the business strategy and processes to identify and address the causes. Management may need to make changes to improve the business’s profitability and avoid future losses.

• Communication and transparency: Management must inform the shareholders of the business’s financial situation, particularly if losses are incurred. Transparency and open communication are important in these situations to maintain the trust of the shareholders.

Overall, it is important that management responds to losses proactively to ensure the long-term financial stability and profitability of the business. This may include measures to reduce costs, increase sales, improve efficiency, and change the business strategy.

Mistakes to avoid when distributing profits

Here are some common mistakes to avoid when distributing the profits of a GmbH:

• Inadequately informed decisions: Shareholders should be informed about the business’s financial situation before deciding on the profit distribution to ensure that there are sufficient funds for the long-term development of the business.

• Unfair distribution: An unequal profit distribution that does not adequately reflect the contributions and risks taken by all shareholders can lead to tensions and conflicts.

• Noncompliance with legal provisions: It is important that profit distribution complies with all legal requirements and that the tax and legal factors are properly accounted for.

• Inadequate reserves: The business should set aside adequate reserves to cover unforeseen expenses and plan for future investments. If profit distribution is too aggressive, this may jeopardize the financial stability of the business.

• Lack of long-term prospects: Profit distribution should not only aim to maximize short-term profits, but also consider the long-term development and competitiveness of the business.

Avoiding these mistakes and adopting a transparent, fair, and legally compliant approach to profit distribution allows a GmbH to build a solid financial foundation and ensure its long-term success.

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