Recognizing scope of action in business split-ups

A business split-up is one of the more complex structures in German tax law. In practice, it often occurs unintentionally – between a corporation and its shareholder, who may be either another company or an individual. The split-up is typically triggered by the combination of ownership of significant economic assets – such as real estate – and their transfer to the company for use.

Especially in grown corporate structures with privately owned assets used for business purposes, family-owned companies, or the separation of holding and operating companies, an unintended business split-up may occur – sometimes with significant tax consequences.

The logic of business split-ups: unit despite separation

The business split-up is based on the fundamental tax principle that economically closely interlinked entities should not be artificially separated and treated differently for tax purposes. Even if there are two legally independent areas – such as privately held real estate and an operating corporation – tax law does not always recognize this separation. From a tax perspective, the transfer of essential operating assets and a controlling person or group of persons creates a uniform commercial activity. The legislator aims to prevent arrangements in which operating profits and undisclosed reserves are transferred to asset management structures in order to achieve lower taxation or tax deferral. The business split-up therefore ensures equal treatment and is intended to ensure that the economic reality – not just the legal form – is decisive.

Requirements: When factual and personal interdependence coincide

A business split-up for tax purposes occurs when a shareholder – either an individual or another company – transfers a significant asset to a corporation in which they hold an interest and at the same time has a controlling influence over both entities. Two key conditions must be met:

• Factual interdependence:
  A factual interdependence exists when the shareholder of the company transfers a significant asset – for example, a commercially used property or production facility – for use. The asset must be of considerable importance for the company's business operations.
• Personal interdependencies:
  A personal interdependence requires for the shareholder to be in a position to exercise significant influence over both the transferring holding company and the using company – for example, through a majority of votes or a controlling position in management.

In practice, such a structure is often established unnoticed – for example, when a property that was originally privately rented is later transferred to a company for commercial use in which the landlord has a significant stake.

Trade tax, undisclosed reserves, and more: an overview of the tax consequences

Once a business split-up has taken place, it has far-reaching tax implications – often with unexpected consequences for entrepreneurs. What initially appears to be a simple leasing or investment arrangement can have profound tax implications. The following consequences are particularly relevant in practice:

• Trade tax liability of the holding company:
  Even if the holding company is actually only engaged in asset management – for example, simply renting out real estate – it is liable for trade tax because it is considered a permanent business due to the business split-up (Art. 15 (1) sentence 1 no. 1 EStG (German Income Tax Act); Art. 2 (1) GewStG (German Trade Tax Act)).
• Disclosure of undisclosed reserves in the event of transfers or termination of the business split-up:
  The sale or withdrawal of significant assets – in particular real estate – can lead to immediate taxation of undisclosed reserves. If the personal or material interdependencies no longer exist – for example, through the sale of shares, contract amendments, or restructuring – this constitutes a cessation of business, which leads to the termination of the business split-up. This can lead to the disclosure of a cessation gain (Art. 16, 34 EStG).

The sale or withdrawal of significant assets – in particular real estate – can lead to immediate taxation of undisclosed reserves. If the personal or material interdependencies no longer exist – for example, through the sale of shares, contract amendments, or restructuring – this constitutes a cessation of business, which leads to the termination of the business split-up. This can lead to the disclosure of a cessation gain (Art. 16, 34 EStG).

In addition to these tax aspects, a business split-up can also make strategic sense: separating holding and operating units creates clear liability relationships, protects assets, and facilitates business decisions – for example, in relation to financing, human resources, or the realignment of operational business. However, it is crucial that the structure is well thought out from a tax perspective and designed to be legally compliant from the outset.

Structuring options: Check and optimize structures in good time

In practice, there are several ways to avoid the effects of an (impending) business split-up or to structure it in a tax-efficient manner. Depending on the initial situation, the following approaches may be considered in particular:

• Avoidance of personal interdependence, e.g., by changing ownership structures or management powers
• Merger of holding and operating companies, e.g., within the scope of a merger under the German Transformation Act (UmwG) in accordance with the German Transformation Tax Act (UmwStG) (see Art. 20 UmwStG).
• Contribution of assets – in particular real estate – to a corporation or a GmbH & Co. KG (limited partnership)

If the property is subsequently resold, it is also possible to create a reserve in accordance with Art. 6b EStG. This allows the capital gains to be transferred to future investments in a tax-neutral manner – a tax planning option that is also highly relevant for medium-sized companies.

Alternatively, the property can also be transferred to a GmbH & Co. KG. Under certain conditions, this transaction remains exempt from real estate transfer tax (Art. 5 (1) GrEStG (Real Estate Transfer Tax Act)), which is particularly important in the case of high property values.

The choice of legal form for this structure depends not only on tax issues – distribution policy, investor structure, succession planning, and corporate law preferences are relevant as well.

Common sources of error: When everyday arrangements become costly from a tax perspective

In day-to-day business, many decisions are made for practical, family, or organizational reasons – often without in-depth tax review. Especially in grown corporate structures, this can lead to the unintended development of tax-relevant structures. A business split-up often does not occur deliberately, but rather results from everyday activities such as the leasing of real estate or changes in ownership structures. Common sources of error include:

• Real estate is held within the family and used for business purposes – often without written contracts or at non-arm’s-length terms.
• Ownership structures change gradually, for example, in the course of company succession, and unintentionally lead to personal interdependencies.
• Parts of the business are spun off without analyzing the ownership and usage relationships in advance from a tax perspective.

If a business split-up is only discovered during a tax audit, this can have significant consequences. Retroactive trade tax payments, the disclosure of undisclosed reserves, and in some cases even criminal liability may result.

Recognize business split-ups in good time to avoid risks

Tax-related business split-ups are not a special case for large structures, but particularly affect medium-sized companies with separate ownership and usage situations.

Checking for an existing business split-up in good time allows to identify and assess risks and avoid them through targeted planning – whether through clear contracts, adjustments to shareholdings, or tax-neutral structural measures. This also allows advantages to be exploited, such as step-up on the sale of land, the creation of reserves, or the separation of ownership and operation in terms of liability law.