Right now, no one knows whether we will see a regulated or an unregulated Brexit. However, it becomes more and more likely that there will be an unregulated Brexit, presumably on the 12th April 2019.
The Brexit forebodes legal difficulties for Limited Liability companies (Limiteds) with registered office in England (Companies House in Cardiff) and administrative headquarters in Germany or elsewhere within the EU. In Germany there are around approximately 8,000 to 10,000 of these “Limiteds” right now. The European freedom of establishment and freedom to provide services, confirmed by the European Court of Justice (Inspire Art, Centros and Überseering) ensures and recognises within the EU that a Limited Liability Company properly established outside of a EU country can have its administrative seat within the EU and is regarded as a company with limited liability and legal capacity in all EU countries.
Until now, the so-called foundation theory (head office theory) applied to companies within the EU on the basis of the freedom of establishment regulated in Art. 49, 54 TFEU. The foundation theory also applies to companies of the EFTA states that are members of the EEA (Art. 31 et seq. EEA). Accordingly, companies are subject to the legal system of the country in which they were founded. In all other cases the German Federal Court of Justice (BGH) favours the company seat principle, i.e. it depends on the domicile of the company seat.
As soon as the UK leaves the EU through Brexit the BGH (German Federal Court) case law (BGHZ 178, 192; BGH, judgement of 27 October 2008) on the company seat principle in company law should therefore apply without restriction, so that the Limited company will now only be regarded as a partnership with its unrestricted liability for all shareholders. Furthermore, there could be tax effects. The company seat principle leads to the fact that, in the absence of an effective formation under German law, British companies are to be treated for tax purposes as partnerships (new formation).
I. Legal effects
With the abolition of the European freedom of establishment and freedom to provide services following England’s withdrawal from the EU, English companies with administrative headquarters in Germany or other EU countries will face legal difficulties.
1.The German legislator has already reacted to these legal difficulties with the Brexit Transitional Act. On Friday, 9 November 2018, the German Bundestag for the first time debated the draft law of the Federal Government (19/5313) for the transitional period following the withdrawal of the United Kingdom of Great Britain and Northern Ireland from the European Union (Brexit Transitional Act) and referred it to the Committee for the Affairs of the European Union for lead consultation.
This Act intends to regulate under national law the transitional period of 21 months (until the end of 2020) planned by the EU in the case of a regulated Brexit. This means that British citizens and businesses will be treated as if the UK was still part of the EU by the end of 2020. In theory, this effectively extends the deadline.
As a result of the abolition of the freedom of establishment in the event of the UK leaving the EU, the English Limited Company would then be treated as a partnership with the consequence that the assets of the GmbH as sole shareholder would increase in accordance with sec. 738 (1) sentence 1 German Civil Code (BGB) in analogue application.
Furthermore, it shall be made possible within the scope of the 4th Transformation Act (Umwandlungsgesetz (UmwG)) by supplementing Sec. 122a et seq. Transformation Act, in particular for English Limited Companies, that these may be merged into partnerships – such as a GmbH & Co KG.
In addition, Sec. 22 Transformation Tax Act
(Umwandlungssteuergesetz (UmwStG)) is to be supplemented by a paragraph 8. This
is regarded as pure protection of confidence. Accordingly, the withdrawal of
England from the EU is not considered a negative event in regards to the 7-year
blocking period pursuant to Sec. 22 UmwStG.
2. The cleanest solution for the English Limiteds domiciled in Germany or the EU would be a merger in accordance with EURL 56/2005/EC (Cross-Border Merger Directive), i.e. a merger of the English Limited with a German GmbH: The merger represents a transfer transaction by way of universal succession through a predictable cost and time frame. The German merger regulations of Sec. 122a et seq. UmwG and the English Companies (Cross-Border Mergers) Regulations 2007 will apply and must be followed.
In order to formally facilitate the merger the shares of the English Limited Company should be brought into the absorbing German GmbH within the framework of a capital increase against contribution. This has the advantage that in the context of a mother-daughter (parent/subsidiary) merger many formalities are omitted, e.g. the Independent Expert Report pursuant to Art. 9 of the Companies (Cross-Border Mergers) Regulations 2007. It should also be ensured during the formation of the absorbing GmbH that the company’s charter is worded in German and English. This will save costs later and filed documents with the High Court of Justice (Companies Court) in the UK will not need to be translated afterwards.
The merger plan and report must be worded bilingually and certified by a German notary public. In England, both documents must then be laid out at the registered office for at least two months. The cross-border merger will then be filed with the necessary documents at the Companies House in Cardiff and it will be published in the Gazette.
With the confirmation of the Companies House, an
application must be filed through an English barrister with the High Court of
Justice – Companies Court for the issuance of a merger order (Court Order). After
the oral hearing the court order is issued and must be filed via the notary
public with the German Commercial Register of the receiving company, partly
with apostille and certified translation. The German commercial register entry
must then be submitted to the Companies House in writing with a certified
translation so that the transferring company can be deleted from the English
register (Companies House).
The German legislator inserted Sec. 122m UmwG on 1 January 2019, according to which a transitional regulation for cross-border mergers is still possible after an unregulated Brexit.
3. A short-term solution in order to avoid personal liability without carrying out a merger would be to transfer the shares of the Limited Company into a German Limited Company, such as a GmbH, by way of a qualified share exchange in accordance with Sec. 21 UmwStG. Then the personal liability would also be void. The problem is, however, that in England all mandatory information still has to be provided. Also questions regarding accounting treatment and taxation are likely to arise. But this would be a solution that could be implemented in the short term and could also serve as preparation and facilitation of a cross-border merger.
4. A simple – but not necessarily the best solution from a tax point of view – option is to transfer the assets from the English company to a new German or EU company form, such as a Dutch B.V., and to liquidate the English Limited with the short waiting period. However, this will usually have negative tax effects and a purchase price must be paid.
5. A particular feature also applies to law firms, which will often have been established in the English company form of an LLP in Germany. As a result of the abolition of the freedom of establishment, English companies with their administrative seat in Germany would no longer be recognised as a foreign (limited liable) company. This is a result of the administrative seat theory applicable in Germany (see above). As a domestic company, the English lawyer-LLP then will not consistently fulfil the domestic formation form requirements, with the consequence that they would be treated as a partnership under civil law (Sec. 705 et seq. BGB) in Germany – with the direct and unlimited personal liability of all partners.
This is further aggravated by the fact that first voices can be heard that want to immediately deprive the English law firm in form of a LLP of the ability to provide legal advice when England leaves the EU. Here the development should be observed very closely. It is already certain that from the time of England’s withdrawal from the EU the regulation of Sec. 206 BRAO (Federal Lawyer’s Act) will apply to the individual British lawyer in Germany as well as to WTO members: they would be treated as a third country lawyer and could only be active in the law of their origin country and international law. This was recently confirmed by the Ministry of Justice in Germany. There shall be no transitional provision.
II. Tax effects
As a result of the abolition of the freedom of establishment the English Limited Companies will be treated in terms of their assets in Germany as a newly founded partnership unless a restructuring measure is taken beforehand.
This entails the risk that hidden reserves pursuant to Sec. 12 (1) German Corporate Tax Code (KStG) will be disclosed and taxed in respect of assets located in Germany and that the individual shareholders will henceforth be taxed in a transparent manner.
Decisive for the “Limited’s” level are Sec. 11 and Sec. 12 KStG and for the shareholders’ level Sec. 8b (2) sentence 3 KStG and Sec. 17 (4) sentence 1 German Income Tax Code (EStG).
A taxation according to Sec. 11 KStG (dissolution) will not occur, since the Limited continues abroad. In the case of incorporated companies the conditions for dissolution and liquidation are governed by foreign company law (Münch in Dötsch/ Pung/ Möhlenbruck, Die Körperschaftssteuer, Sec. 11, point 24).
Instead, final taxation would be triggered in accordance with Sec. 12 KStG if domestic hidden reserves are available. Sec. 12 (1) KStG regulates the taxation of a corporation’s hidden reserves when the German right of taxation is excluded with regard to the profit from the sale or use of an asset attributable to a German permanent establishment. Due to the fictitious dissolution under company law of the Limited with its administrative seat in Germany, the German right of taxation is excluded in this process with regard to the profit from the sale or use of an asset of a German permanent establishment (see BFH, judgment of 17 May 2000 in DStR 2000, 1035).
A taxation of the dissolution profit on the level of the partners according to Sec. 8b KStG and Sec. 17 (4) sentence 1 EStG might also be obstructed by the Limited’s missing dissolution in England.
A taxation in accordance to Sec. 12 (1) EStG would be against the previous ruling of the Federal Fiscal Court (BFH, ruling of 23 June 1992 – IX R 182/87) as well as the anti-discrimination prohibition of Sec. 25 (1) DTT UK-Germany.
Contrary to the ruling of the German Courts of Justice, the Federal Fiscal Court applies the foundation theory. The Federal Fiscal Court treats the corporations that move in from third countries as (corporate) tax subjects that are subject to unlimited tax liability, so that it is possible to move into Germany while preserving their identity from a tax law perspective. Through this discrepancy between company law and tax law the Federal Fiscal Court deliberately avoids consequential problems that would arise from the company seat theory. In the absence of a transfer of assets located in Germany to another legal entity and the continued existence of the corporation for tax purposes, taxation within the scope of Sec. 12 (1) KStG, but also at the level of the shareholders, is ruled out.
This may also be relevant in the case of a Brexit.
The DTT UK-Germany will continue to exist as a bilateral agreement between Germany and the United Kingdom. A disclosure of the hidden reserves is therefore contrary to Art. 25 (1) DTT UK-Germany. This regulation states that a corporation established within the United Kingdom and based in Germany may not be subject to any other or more burdensome taxation in Germany than a corporation incorporated in Germany.
Even if there is no direct taxation through the disclosure of hidden reserves there is still a need for action due to the consequences arising from civil and company law. The tax side should also be reconsidered against the background of a striking-off of the Limited in England.
The ideal way of a merger, which is quite cumbersome and associated with certain costs, may be advisable in many cases. If there are no undisclosed reserves the intermediation of a corporation could be chosen first as an alternative.