I. Overview

Increasing internationalization and global division of labor are leading more and more German companies, including small and medium-sized enterprises, to invest directly abroad. These investments are often realized through the establishment of subsidiaries, where the choice of legal form is crucial for tax and liability aspects.

The US LLC (Limited Liability Company) is a popular form of company in the USA, notable for its flexibility and liability limitation. But how is this legal form classified from a German perspective? This question is of great importance, as it has significant tax implications.

The fundamentals are explained in the first part: US-LLC - Part I - General Introduction

II. Comparison of Legal Forms and Its Criteria

The classification of a US LLC in Germany is carried out through a so-called comparison of legal types. It examines whether the US LLC exhibits more characteristics of a partnership or a corporation. The Federal Fiscal Court (BFH) and the German tax administration have developed extensive criteria for this:

Centralized Management and Representation: It is crucial whether the management is conducted by an independent body (e.g., managing director or board) or by the members themselves. Example: The BFH has ruled that a US LLC, whose management is carried out by an external manager, should be treated more as a corporation (BFH, judgment of May 25, 2011, I R 95/10).

Liability Limitation: Partnerships are characterized by the personal liability of the members, while in corporations, liability is limited to the contributions. In another judgment, the BFH emphasized that the limited liability of the members of a GmbH is a strong indication of qualification as a corporation (BFH, judgment of May 19, 2010, I B 191/09).

Free Transferability of Shares: Corporations allow for free transferability of shares, while in partnerships, the approval of the other members is often required. The BFH has decided that a GmbH, whose shares can be transferred without the consent of the co-shareholders, should be classified as a corporation (BFH, judgment of May 4, 2011, II R 51/09).

Profit Distribution: In corporations, profit distribution is made through a resolution by the shareholders' meeting. In partnerships, members can dispose of their share of profits freely. In one judgment, it was established that profit distribution occurring without a formal resolution of the shareholders' meeting indicates a partnership (BFH, judgment of September 8, 2010, I R 74/09).

Capital Contribution: Corporations require a binding capital contribution from the members. The BFH has decided that a GmbH without mandatory capital contribution is classified as a partnership (BFH, judgment of November 29, 2017, I R 58/15).

Unlimited Duration of the Company: Corporations have an unlimited duration, while partnerships are often dissolved upon the death or departure of a member. Jurisprudence has clarified that an unlimited duration speaks for being a corporation (BFH, judgment of April 28, 2010, I R 81/09).

Formal Establishment Requirements: Corporations require registration in a public register, which is not necessarily required for partnerships. The BFH has ruled that the registration of a GmbH in the commercial register is an indication of the existence of a corporation (BFH, judgment of May 25, 2011, I R 95/10).

III. Tax Consequences of Classification

The tax treatment of the US LLC depends on its classification:

Classification as a Partnership

• Profits are directly attributed to the members and are subject to income tax.

Classification as a Corporation

• The GmbH is considered its own tax subject.

• Profits are subject to corporate tax.

• Distributions to German members are treated as dividends and are subject to withholding tax or the partial income procedure.

IV. Examples for Illustration

Example 1: Treatment of an LLC as a Partnership

A German entrepreneur participates in an LLC that is treated as a partnership in the USA. The profits are directly attributed to the entrepreneur and are subject to German income tax. The double taxation agreement (DBA) between Germany and the USA avoids double taxation by crediting the taxes paid in the USA.

Example 2: Treatment of a GmbH as a Corporation - Differences between Business Assets and Private Assets

An LLC (Limited Liability Company) based in the USA is treated as a corporation in Germany based on a type comparison. The LLC generates profits in the USA that are subject to US federal income tax and possibly state and local taxes there. When distributing the profits to the German shareholder, the question arises as to how these dividends will be taxed in Germany.

Tax Treatment of Distributions in Business Assets

If the shares in the LLC are held in the business assets of a German company, the following regulations apply:

• Partial Income Procedure: The distributed dividends are subject to the partial income procedure in Germany. This means that 60% of the dividends are taxable, and the remaining 40% are tax-free.

• Credit for US Withholding Tax: The withholding tax deducted in the USA on dividends can be credited against the corporate tax payable in Germany, provided it relates to the distributed profits.

• Progression Reservation: The tax-free portions of the dividends may affect the tax rate for other income, which usually only concerns natural persons.

• Deduction of Business Expenses: If business expenses arise in connection with the participation in the LLC, these can be deducted as usual as business expenses.

Example Calculation of Business Assets

• Profit of the LLC before US taxes: EUR 100,000

• US taxes (Federal and State Tax, total 30%): 30,000 EUR

• Distribution to German shareholders after US taxes: 70,000 EUR

• Dividends taxable in Germany (60% of EUR 70,000) 42,000 EUR

• German corporate tax (15% of 42,000 EUR) 6,300 EUR

• Creditable US withholding tax: up to 6,300 EUR (depending on the actual US withholding tax paid)

Tax Treatment of Distributions in Private Assets

If the shares in the LLC are held in the private assets of the members, the following regulations apply:

• Partial Income Procedure: Here too, the distributed dividends are subject to the partial income procedure, with 60% of the dividends being taxable and 40% tax-free.

• No Direct Credit for US Withholding Tax: The withholding tax paid abroad cannot be directly credited against the income tax of natural persons. Instead, it is taken into account in the tax return.

• Application for Withholding Tax Reduction: The members must individually apply for the refund or reduction of the US withholding tax under the DBA. Depending on US regulations, this can be complex and time-consuming.

Example Calculation of Private Assets

• Profit of the LLC before US taxes: EUR 100,000

• US taxes (Federal and State Tax, total 30%): 30,000 EUR

• Distribution to German shareholders after US taxes: 70,000 EUR

• Dividends taxable in Germany (60% of EUR 70,000) 42,000 EUR

• Income tax on the dividend (top tax rate 45% plus solidarity surcharge): 45% of 42,000 EUR = 18,900 EUR plus solidarity surcharge (5.5% on 18,900 EUR) = 1,039.50 EUR

• Total tax burden in Germany: 18,900 EUR + 1,039.50 EUR = 19,939.50 EUR

Summary

The tax treatment of distributions from an LLC classified as a corporation in Germany differs depending on whether the shares are held in business assets or private assets:

• Business Assets: Advantages through crediting of US withholding tax and deduction of business expenses.

• Private Assets: No direct credit for US withholding tax; higher tax burden on dividends.

Careful planning of the participation structure and possibly tax advice are therefore essential to ensure optimal tax treatment.

The correct classification and tax treatment of a US LLC can be complex and have significant financial implications. If you need assistance in classifying your international holdings or have questions regarding optimal tax structuring, I am at your service as a specialized tax advisor. Contact me today for individual advice and benefit from my expertise in international tax law. Let's work together to optimize your tax burden and avoid legal pitfalls. Contact us today for an initial consultation.