Doing Business in Germany from a legal and tax perspective

Doing Business in Germany with your own German entity/or without?

In order to develop and grow your business activities in Germany, founding and running a subsidiary in Germany is often required.

In some cases, a representation office of your foreign/international company without separate legal personality or even just a German-language website may be sufficient. Sometimes, a branch office (“Zweigniederlassung”) may also be appropriate. Developing business activities in Germany without a local company can of course reduce costs.

In most cases, however, the establishment of a separate company/entity in Germany is likely to be the means of choice. Here is why:

• Customers, business partners or third parties in Germany could possibly hold your (parent-)company located outside of Germany directly liable in case of any breach of contract, tort or for other reasons.

• Our long-term advisory practice and our clients show that market participants without their own local company/entity in Germany are often not sufficiently heard in Germany and are not seen as partners to be taken seriously.

• If you, for example, wish to hire employees or rent premises in Germany, a German entity is often required.

• In case you operate here in Germany without a local entity, your company based abroad can quickly become a tax debtor in Germany (keyword: restricted tax liability – “beschränkte Steuerpflicht”) without being prepared for this.

We are looking forward to discussing with you whether or not founding a German subsidiary is the right choice for you or if it is advisable for you in certain cases to begin business in Germany right away through a company located elsewhere.

Choosing the type of entity

The first step for establishing your entity in Germany is to choose the appropriate type of entity. At SCHOMERUS, we are happy to advise you on all the steps involved in setting up and managing a German entity, starting with finding out what the best tax and legal arrangement for your needs is. Since different business models and foreign or international group structures may require different solutions, we can show you which type of entity is most suitable for you and what advantages are associated with the individual choices possible.

Often the choice will fall on a GmbH (limited liability company); however, other entity types are also conceivable, such as the Aktiengesellschaft (public limited company), GmbH & Co. KG (a special type of limited partnership), a Stiftung (foundation) or others.

The German GmbH as your subsidiary

Probably the most popular type of business entity for foreign groups and investors is the German GmbH (short for: "Gesellschaft mit beschränkter Haftung" – limited liability company). This type of entity combines high flexibility with reasonable formation and administration costs. In addition, you benefit from the limitation of liability and the good reputation of this type of entity in German markets and in the DACH region.

How to incorporate a GmbH – basic steps

The incorporation/formation of a GmbH basically proceeds in the following steps:

• Notarial certification of the formation process

• Deposit of share capital

• Registration of company in the commercial register

There are a few points to consider in each of these clear basic steps, which we will be happy to discuss with you, taking into account your individual needs. You can also find more information in the posts on this series. From our many years of consulting experience, we are able to give you practical tips and accompany you comprehensively.

Preliminary considerations

If you have decided to establish a German GmbH, there are some decisions to be made in advance:

• Who will be the shareholder(s)?

• Which name do you choose for the company?

• What amount of share capital would you like to use?

• What is the official corporate purpose of the company?

• Who will be the managing director(s) (“Geschäftsführer”) of the company?

• What wording should the articles of association have?

Shareholder(s)

Usually, a suitable company from your group acts as founder and sole shareholder of the new GmbH. Several companies or a joint venture of companies from several groups are also possible.

By having only one shareholder, the effort involved in founding and, above all, managing the GmbH can be slightly reduced. In any case, however, it should be taken into account which tax effects arise with regard to distributions and possible later sales proceeds on the part of the shareholder. We can assess the tax effects for you in any given case – in international contexts with our partner network HLB International – or discuss it with your local advisers.

When selecting the shareholder, care should also be taken to ensure that its official representatives are actually available in the context of establishing the subsidiary and for any administrative act that may be necessary from time to time, and that their power of representation can be officially proven. As our advisory practice shows, both points are often neglected.

Company name

In principle, you are free to choose a company name. However, a GmbH must always include a reference to its type “XYZ GmbH”. Furthermore, misleading or protected designations are to be avoided. Also, there must be no danger of confusion with other company names with the same registered office.

The company name may, but need not, contain a reference to the membership of your company group. In any case, it is advisable to check whether the name of your choice infringes the trademark or labelling rights of third parties or other regulations. In addition to legal advice on this topic, the chambers of commerce and industry can also help in this regard.

Amount of share capital

In order to establish a corporation such as a GmbH in Germany, it is necessary to raise and designate a fixed amount of share capital. In terms of a GmbH, the share capital (“Stammkapital”) must be at least 25,000 euros. Alternatively you can opt for a so-called "UG" (officially: “Unternehmergesellschaft (haftungsbeschränkt)” - Entrepreneurial company (limited liability)). This type of entity can be operated with a share capital of only one euro. However, due to weaker market acceptance and minor additional disadvantages, the UG is usually only chosen for micro-enterprises.

If a German public limited company (“Aktiengesellschaft”) is to be founded, the share capital must be at least 50,000 euros. Due to stricter requirements for the formalities of day-to-day administration, the German public limited company is chosen less frequently, at least in the SME sector and as a group subcompany.

To improve creditworthiness or in the case of high start-up costs, companies are sometimes founded and equipped with higher share capital. Practical recommendation in this respect: Unless necessary in individual cases due to mandatory requirements of the group's top management or the banks, only the minimum statutory share capital should be chosen; any further financial resources required can be paid into the so-called capital reserve (“Kapitalrücklage”) or made available as debt capital. This saves additional costs in setting up and managing the company and prevents larger amounts from being subject to the strict regime of capital maintenance regulations.

Raising/depositing share capital

The share capital is usually raised in the course of the incorporation as a cash deposit into an account of the company. Alternatively, a so-called contribution in kind (“Sacheinlage”) can be made, which, however, is often not recommendable due to further formalities then required.

Further practical advice: Even if a contribution in kind is necessary for reasons of the individual case, it is often preferable to pay in the minimum share capital in cash and then make the contribution in kind as a payment into the capital reserve. In this way, you save yourself time-consuming valuations and increased formal requirements.

At least half of the share capital must actually be paid in before registration of company can be achieved. The other half may, as long as the company does not need the money, be designated as outstanding shareholder contribution.

Bank account opening

As a rule, the new company to be founded needs its own bank account. This is necessary in order to provide the share capital for the free disposal of the management as required by law. In many cases, it may be advisable to choose a bank that is known in Germany in order to avoid unnecessary reservations on the part of suppliers and customers. However, it would also be possible to choose a bank authorised in the European Union.

Especially due to the high requirements for money laundering prevention (keyword: Know Your Customer), banks are often hesitant about business connections with companies controlled from abroad. Therefore, preliminary talks with the desired banks should be held in good time during the start-up process. Otherwise, there may be considerable delays if a bank account is not yet ready and the deposit of the share capital, which is required for the registration of the company in the commercial register, cannot take place as a result. If you do not have a good connection to a bank operating in Germany (or the EU), we will be happy to accompany you through the necessary steps.

In Germany, you can open a bank account at any time after the notary has given you the certificate of incorporation. This document is sufficient for the bank to open a bank account, despite the fact that it still has to be entered in the commercial register. For banks operating outside Germany, further proof or other procedures are sometimes required. 

Shareholder loan

In their start-up phase, new companies are often provided with loans from the shareholders or their group. This type of financing often seems preferable to providing increased share capital, as it avoids the rigid rules for raising, lowering and maintaining share capital in German GmbHs (LLCs) and Aktiengesellschaften (stock corporations).

However, there are a few points to be considered here that are often overlooked in practice:

• Firstly, due to the provisions of German insolvency law, it is not readily possible to repay the loan to the lender in a financial crisis of the company. If, after repayment of the shareholder loan to the shareholder, an application for insolvency of the company is filed within one year, the loan must typically be reimbursed to the insolvency estate; satisfaction of the loan is subordinate to the other creditors of the company and, in reality, often does not take place.

• The granting of a loan results in the company's balance sheet showing the amount of loan on the assets side and the repayment liability in the same amount on the liabilities side. If, as is often the case, parts of the loan amount are spent in the course of the first loss-making business steps, without assets that can be recognised in the balance sheet as company's assets in the same amount, the company quickly becomes over-indebted. The consequence is customarily an obligation to file for insolvency, the violation of which in principle leads to criminal liability and personal liability of the managing directors.

However, because a shareholder loan is typically intended to be used for start-up losses and – as mentioned above – the repayment of the loan is difficult to enforce in the event of a crisis, it is advisable to agree on a subordination of the loan. It is hereby agreed that the repayment (and any interest) of the loan shall be subordinate only after the satisfaction of all other creditors out of the free assets of the company. If this subordination agreement is structured correctly, the – subordinated – repayment obligation will not be taken into account in the context of the examination of the company's over-indebtedness, which would prevent the insolvency problem described above.

Preliminary company

Already with the notarisation of the formation documents of a GmbH or an Aktiengesellschaft and even before the registration of the company in the commercial register, a so-called Vorgesellschaft (preliminary company) comes into existence. This Vorgesellschaft can already be the bearer of rights and obligations and participate in business life as a legal entity.

Accordingly, the first business steps can already be taken with the notarisation of the formation. However, it must be taken into account that this may give rise to personal liability on the part of the shareholder and the acting managing directors, so that a careful decision must be made in each individual case as to the extent to which business steps should already be taken before registration in the commercial register.

Formation procedure – formal requirements

As already described in an earlier part of the series, the formation of a GmbH as well as a public limited company requires the notarisation of the formation documents. Until 2022, this required the personal appearance of the authorised representative of the parent company or a proxy at the notary's office. In the meantime, the legislator has introduced possibilities to carry out a notarisation of a GmbH founding without being present in person, i.e. via an audio-video conference. The incorporation of a GmbH via online notarisation is still relatively new in practice and causes difficulties from time to time. Nevertheless, this new opportunity naturally results in the invaluable advantage of the representative of the parent company or the founder not having to be present in person at the notary's office in Germany.

In this context, however, it must be noted that the incorporation is only possible by online notarisation if the authorised representative has an electronically readable e-ID card according to the European model. For persons without an identity card of a European country, online notarisation in Germany is unfortunately not possible; a person can, however, issue a notarial power of attorney to a person which is a holder of a German or European e-identity card.

The formation documents usually include the notarial formation protocol, the articles of association, the commercial register application and the letter of instruction for the managing directors. The GmbH’s articles of association are to a large extent freely formable. Nevertheless, customs have developed so that the drafting of such articles, in particular for a subsidiary, is often possible without major effort.

By means of the notarised formation protocol, a bank account can then be opened into which the share capital is to be paid. The company can afterwards be registered in the commercial register. Important: The bank account may only be opened and provided with the share capital after the incorporation has been notarised. Otherwise, the payment of the share capital is deemed not to have been made and the shareholders might be liable for the company’s debts. Although the share capital in the GmbH can be spent for the purposes of the company once it has been paid onto the company’s bank account, it should always be noted that the raising and (formal) maintenance of the share capital is subject to strict requirements, the violation of which can lead to the liability of the shareholders.

Sample protocol

A simplified incorporation of a GmbH is possible via the so-called sample protocol. This combines the various documents of the incorporation process. The use of the sample protocol is somewhat cheaper, but also leads to the fact that there is little flexibility in the design of the company to be founded, which is why the insignificantly more expensive standard procedure is often resorted to.