Peter Scheller
Berater für Wirtschaftsprüfer, Rechtsanwälte, Steuer- und Unternehmensberater

„Wenn es knifflig wird.“

LLC – Limited Liability Company and German taxation

von Peter Scheller

LLC – Limited Liability Company and German taxation

There are good reasons to form a LLC in the USA. It combines preferable characteristics such as a far-reaching legal flexibility of the corporate structure with a limited liability of its shareholders. Beside this the shareholders can choose whether the LLC shall be qualified as a corporation or as a partnership for US income tax purposes (check-the-box rules). Most LLC will be taxed as transparent entities and therefore be qualified as a partnership or a disregarded entity (if the LLC has a sole owner). Unfortunately German tax law does not follow the US-tax qualification. This can cause severe tax consequences if the qualification is different in the USA and in Germany.

Taxation in the USA

In most cases the LLC will be taxed in the USA as a pass-through entity. This means that the LLC itself is not subject to taxation. The shareholders are subject to the federal and state income tax with their profit-shares.

Qualification of the LLC in Germany for tax purposes

Germany’s tax law does not follow the US-qualification. In Germany a LLC can either be qualified as a corporation or as a partnership/sole proprietorship. If the LLC is qualified as a partnership the tax consequences are not problematic. The shareholders will be taxed in the USA. In Germany the LLC will not be taxed as long as the LLC has not permanent establishment in Germany. The profit share of shareholders being tax resident in Germany will be tax-free because of the relevant provisions of the Double Taxation Convention USA/Germany.

A tax situation differs if German tax authorities qualify the LLC as a corporation. If the LLC has no permanent establishment in Germany the profits of the LLC will not be taxed in Germany since the LLC is not tax resident in Germany. The problem occurs if profits will be distributed to shareholders who are tax resident in Germany. This income will be taxed at a combined tax rate of 26,375%. German tax authorities disallow the crediting of US income taxes against the German tax. The result is a partial double taxation of the profits received by a shareholder who is resident in Germany.

In this case the tax situation is basically the same one as for shareholders of an S corporation who are tax resident in Germany. For more information see:

https://www.scheller-international.com/blog-beitraege/s-corporation-as-tax-trap-for-us-expatriates.html

Note: If a shareholder who is tax resident in Germany continues to carry out services for the LLC this might be qualified by German tax authorities as a permanent establishment of the LLC in Germany. The same result occurs if the shareholder is seen as a permanent representative of the LLC. In this cases at least parts of the profits will be taxed in Germany.

Criteria for the qualification

The letter of the Federal Ministry of Finance dated 19 March 2004 lines out the general principles. The basic idea is to verify whether a foreign entity’s legal structure is nearer to the legal structure of a typical corporation or a partnership. There are eight points of criteria:

  1. Centralized Management

A centralized management is an indication for a corporation. A centralized management is especially given if persons who are not shareholders or a board of directors are entitled to manage the company.

If only shareholders or members of a business entity are entitled to manage the company this is an indication for a partnership. This is especially the case if all shareholders or members are entitled to manage the company.

2. Limited liability

Limited liability of shareholders indicates a corporation, unlimited liability a partnership.

3. Transfer of shares

The possibility to transfer shares of the company to third parties without any restrictions speaks for a corporation.

Restrictions to transfer shares indicate the existence of a partnership. This is especially the case if the transfer of shares is legally impossible or only possible by approval of other shareholders or members.

4. Profit participation

If profit distributions are subject to a formal decision by the shareholders this speaks for a corporation.

If no decision is required by law, articles or by-laws this indicates the existences of a partnership.

5. Capital contribution

If equity capital is required by law or shareholders decision this speaks for a corporation. The capital contribution can be in cash or assets.

If no capital contribution is required or can be provided through personal services of shareholders this indicates the existence of a partnership.

6. Unlimited lifetime

If the duration of the entity is not limited by law, articles or by-laws this speaks for a corporation.

A limited lifetime indicates the existence of a partnership. This is especially the case if the entity terminates if one shareholder passes away, terminating the company or goes bankrupt.

7. Profit distribution

If profits will be distributed in proportion to the capital share this indicates the existence of a corporation.

If profits will be distributed by heads of shareholders or members this speaks for a partnership.

8. Formal conditions of establishment

If the establishment of the entity requires the approval of a public body and the entity has to be registered (on an official registers) this speaks for a corporation.

If the only requirement to form a business entity is an agreement between founding members this indicates the existence of a partnership.

Qualification of LLCs

A typical LLC shows in general characteristics both of a corporation and a partnership. In this case the majority of characteristics 1 to 5 will define whether the LLC is qualified as a corporation or a partnership. If there is no clear result the other criteria (6 to 8) shall also be taken into consideration.

The qualification of an LLC depends both on the corporate law of the respective US state as well as on the legal agreements between the shareholders or members. In general the by-laws give a good indication how to qualify the LLC for German tax purposes. A careful analysis is required.

Author: Peter Scheller, German Tax Adviser, Master of International Taxation

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Kommentare

Kommentar von Brandon Ernst |

I am an American living in Germany and have questions about my tax situation.

Kommentar von BERNAL |

Hello, I am not a US citizen but I lived in the US and have a LLC. I am now living in Germany and I still perform services for my US LLC. Would you be able to provide tax advice?
Thanks,

Antwort von Peter Scheller

Yes. Send me an e-mail.

Kommentar von Sven Muchow |

Hey,
I lived in the USA and opened up an LLC. I’m back in Germany (German citizen) now and have some questions regarding taxation. Would you be able to help?

Antwort von Peter Scheller

Yes, please contact me per e-mail

Kommentar von Steven Knox |

I am an american living in the U.S. currently. I would like to transfer my company to a German address. What would the steps be to do this and what would the implications be on my company?

Antwort von Peter Scheller

Why do you want to do this? Transfering a US company to Germany is seldom a good idea (double taxation).

However, you need an expirienced tax adviser to avoid unnecessary risks.

Kommentar von David Rose |

I would like to set up a company entity in order to sell products on Amazon in USA and Germany. I am a resident in Germany. Is it possible to do this by setting up an LLC, or do I need to set up a Germany limited company (GmbH)?

Antwort von Peter Scheller

You can set up a LLC. However, this needs careful planning and professional advice, so that taxation in Germany and the US does not result in an ugly double taxation scenario.

Kommentar von Christine De Eusebio |

I'm being asked to become a trustee,of an LLC on the USA that would like to carry out services in Germany. The LLC beneficiaries are in a Trust and established in USA. How will the LLC pay VAT tax on services rendered? What should we know prior to beginning our relationship? How is this type of arrangement taxed?

Antwort von Peter Scheller

I think that you need a good tax adviser in Germany to answer questions. It is not only about VAT but under certain circumstances about income taxation as well.

Kommentar von Consulting |

Dear Mr. Scheller,

Thanks for this great informative site!

I have a question about my situation:
I'm German but living permanently in the US.
I offer different services (consulting, data entry, web design, etc.) for German customers.
I have an LLC and was wondering if that results in any reporting/taxes to German tax authorities (like "beschränkt steuerpflichtig").

also in reference to "tax resident in Germany": does that refer only to where you reside? I don't have a residence there but I have other income from Germany (like income from rental property)

Antwort von Peter Scheller

If you are not tax resident and the LLC has no permanent establishment in Germany there are no reporting issues for you or the LLC.

About the tax residence you can find an article in this blog.

Kommentar von James |

Thank you for this informative post!

I'm a non-US citizen, resident in Germany. I have an LLC in the States and have an independent agent (Amazon FBA), which makes the LLC as a disregarded entity in the US. Up to my understanding, this means I don't have to pay taxes for it in the US. However as a tax resident in Germany, I'm wondering if I have to pay taxes or reoprt to German tax authorities, even if there is no passive income generated in by the company.

Antwort von Peter Scheller

You need a expirienced tax adviser. There are various questions:

Where is the place of effective management of the LLC?

How ill the LLC be classified in Germany (US tax treatment is irrelevant)?

There are various articles on this website covering these topics.

Kommentar von Mattia |

Thank you for the great post!

I'm a non-US citizen, resident in Germany. I plan to start a dropshipping business with a US based company providing the products. I require to have an LLC to do so. Should I also set up a business in Germany to declare the profits from the LLC and pay taxes here?

Thank you

Antwort von Administrator

To answer your questions more information and an analysis  is required.

Kommentar von Kaan |

Thank you for the detailed post.
I am living in Germany and paying my taxes here. I am planning to have a LLC in the US and start selling on Amazon. In this case, do I have to pay taxes also in Germany?
Will US authorities share LLC and my financial status, my LLC ownership etc?

Thank you.

Antwort von Peter Scheller

You have to report any kind of participation in foreign business entities to German tax authorities (see another article on this website).

... and you need a good planning in order to avoid a double taxation scenario.

Kommentar von Leon Shpilsky |

Hello, in your blog dated 15.03.2018 entitled "LLC - Limited Liability Company and German taxation", you state that "If the LLC is qualified as a partnership the tax consequences are not problematic. The shareholders will be taxed in the USA. In Germany the LLC will not be taxed as long as the LLC has not permanent establishment in Germany. The profit share of shareholders being tax resident in Germany will be tax-free because of the relevant provisions of the Double Taxation Convention USA/Germany."
However, according to the applicable DTC, a U.S. partnership's residency is based on residency of its partners, so with respect to a German resident partner's income, the treaty benefits would have to be claimed on the partner's level. The partner would then be taxed in Germany on his/her share of an LLC's income, and, depending on the classification of income (business, real estate, passive, etc.) could also be subject to tax in the U.S. (of course, after applying foreign tax credits). Why did you reach a conclusion that the income would be taxed only in the U.S. and be free of tax in Germany under the applicable DTC?

Antwort von Peter Scheller

Residente is insofar of no significance:

(a) If the LLC does not have a permanent establishment (management, office etc) in Germany and the LLC is treated in Germany and the U.S. as a partnership the profits will be taxed in the U.S. (Article 7 (1) DTC).

(b) The profit share of members who are tax resident in Germany will be tax exempt in Germany (Article 23 (3) a DTC).

Note, that a interests in a partnership will be treated as (partial) permanent establishment of the member. If there is not permanent establishment in Germany the member with residence in Germany will have a permanent establishment in the U.S.

Other consequences may occur if

(a) the place of effective management of the LLC is situated in Germany (because the managing member relocate to Germany) or

(b) the LLC is treated in the U.S. as a pass-through-entity and in Germany as a corporation or vice versa.

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