There are many reasons for closing a business: No suitable successor can be found, you realise self-employment is not for you, you can’t find enough staff or possible insolvency. While giving up a business can be complicated for companies, sole traders – whether Gewerbetreibender or Freiberufler – can benefit from tax advantages when winding up their businesses. This article explains what you need to consider when giving up your business and how to make a tax-efficient transition to employment.
- Sometimes life gets in the way of business
- Permanent closure vs. taking a hiatus
- Liquidation vs. dissolution
- Winding up a Gewerbetreibender or Freiberufler business
- Tax advantages of selling a business
- Avoiding tax pitfalls
- Want to know more?
Self-employment isn’t easy. Many in this camp often find themselves making the difficult decision to close down their businesses. Perhaps they want more security and less financial responsibility. Or their income is no longer sufficient because their tax burden is too high. Then there are things like better access to parental leave or statutory health insurance that employment offers that self-employment often does not. The list goes on.
Wanting to give up self-employment is not uncommon in Germany. In fact, according to the German Institute for Economic Research (DIW), every fifth solo self-employed person changes back to dependent employment.
If you are in this camp, be aware that giving up self-employment extends over an extended period, i.e. an “overnight change” is not legally possible. Preparing a closing balance sheet and everything that goes with it, plus terminating current contracts and dismissing employees takes time.
Want to take a break from being your own boss and not necessarily close your business forever? You have the option of registering a ruhendes Gewerbe (dormant trade). But, there is a catch: You will lose the potential tax benefits from winding up your business. Nevertheless, a dormant trade can have clear advantages over a permanent closure of your business because it means that you can still keep your business in existence without the heavy bureaucratic and tax burden that comes with running an active business. This option really does give you the most flexibility because you can quickly reactivate your business when you want to resume operating. This option can be attractive if you need to take parental leave or want to take a sabbatical.
A company is liquidated by being dissolved, wound up and finally deleted from the commercial register. Whereas in the case of corporations such as the AG, GmbH and UG cessation of operations is usually referred to as Liquidation (liquidation), for the GbR it’s referred to as Auflösung (dissolution). Although sole proprietorships and freelancers must also liquidate their assets, the term “Liquidation” is rarely used in this context.
More on dissolution & liquidation
The definition of a cessation of business: A cessation of business occurs in the following cases:
- If you permanently cease your self-employed activity
- If your business ceases to exist as a lebender Organismus (living organism) of economic life
- If you sell all essential business assets or transfer them to your private assets.
In short: You must give up your entire business and thus sell all essential business assets in a single transaction or convert them into your private assets – if you want to benefit from various tax advantages.
You can take your time winding up but not forever
If you want to close your business, you don’t have to notify the tax office immediately, as the cessation of the business is related to a timespan and not to a reference date. Giving you breathing room to collect outstanding debts and wind up your business. That is, you have a time window of six to twelve months to do this. Anything longer than this no longer counts as a complete cessation of business.
Take care of the accounting
Draw up a closing balance sheet
The first step in giving up the business is to draw up a Schlussbilanz (closing balance sheet) and determine the Aufgabegewinn (profit from business closure or discontinuation profit). This profit is the sum of the stille Reserven (hidden reserves) minus possible discontinuation costs such as tax adviser, lawyer, estate agent, etc. The profit is calculated based on a balance sheet, therefore, it’s important to work with a tax adviser and other professionals involved with the winding up of your business that are trustworthy.
What are stille Reserven (hidden reserves)? Stille Reserven (also: stille Rücklagen or Bewertungsreserven) are the components of equity that are “hidden” in the balance sheet. They can arise both from the undervaluation of assets and the overvaluation of liabilities.
The hidden reserves your business may have such as land, furniture or even business cars, make up the discontinuation profit, as they are usually shown in the balance sheet at a lower value than the market value. In practice, this may well lead to an increase in value when the business is wound up and the hidden reserves are relinquished, especially in the case of business property that continuously increases in value. For example, if you want to transfer your company car to your private assets, the market value is applied; this also applies to the rental of business premises from private assets.
Adjust advance payments
Before you close your business, you should apply for a reduction of your Vorauszahlungen (advance tax payments) to zero, otherwise, the tax office will continue to debit higher amounts. Although the tax office receives notification that you are giving up your business, it does not automatically change the advance payments. Always be wary of the extra bureaucratic hoops you have to jump through.
Terminate employment contracts
Before dismissing employees, you should carefully consider whether you are legally transferring all or part of your business. In this case, the legal consequences are different from those of a cessation of business. In addition, you should find out in advance about the various ways of terminating an employment contract: apart from giving notice, there is, for example, the termination agreement, which can help you and your employees to get out of an unfavourable employment relationship more quickly. Please note, however, that a notice period of up to seven months may apply when terminating the employment of long-term employees.
If you have to dismiss a trainee, be aware that, as the trainer, you may be obliged to make timely efforts to continue the training in another suitable company, ideally with the help of the Agentur für Arbeit (employment agency).
If you employ more than 20 people, find out in good time about the rules on when you have to notify the employment agency regarding a so-called Massenentlassung (mass dismissal).
Cancel long-term contracts and insurance
When closing down your business, remember to cancel long-term contracts and insurance policies. Check the relevant contract documents to find out what the notice periods are and whether you have the right to extraordinary termination due to the closure of the business.
Contracts that can be terminated include utility contracts (electricity, internet, water, etc.) and your rental or lease agreement. Your business bank account and standing orders are also among the contracts you must terminate when you close down your business. You should also cancel any advertising contracts and notify the post office. Any current loans or credits must also be cancelled, terminated and, if necessary, repaid in good time.
Notify your health insurance company that you are closing down your business, as your monthly contribution will change. For self-employed persons who give up their business and were previously privately insured, giving up the business offers the possibility of returning to the statutory health insurance scheme.
You will also need to inform the Berufsgenossenschaft (employer’s liability insurance association) and the pension fund within two weeks of giving up your business. Also cancel any other types of insurance, such as public liability insurance, now. Act quickly with regards to cancelling your insurance coverage as the process may be bureaucratic and slow.
Deregister, re-register & delete
Closing a business involves the following steps with different authorities:
- If you are a sole trader, deregister your business with the Ordnungsamt. (this process is called “Gewerbeabmeldung” in German).
- If you have a trade license or permit, return it.
- If you are registered in the Handwerksrolle (crafts/skilled trades register), you must apply for the deletion of your registration.
- If necessary, get a notary to delete your entry from the Handelsregister (commercial register). You must also inform the tax authorities that you are no longer self-employed.
- For Freiberufler, deregistration is easier. They only have to deregister with the Finanzamt (tax office)
As well as the official registrations finalise the process by:
- Re-registering or selling business vehicles
- Selling surplus goods at a clearance sale
- Renovating rented premises if necessary
Store the mandatory records in a safe place
Even if you give up your business, you are obliged to keep all business documents for a set period. So before you destroy all your documents, wait until the legal retention periods have expired.
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If you give up self-employment, you can benefit from many tax advantages when you sell the business and receive the capital gain. For example, the sale of a business as a whole may be exempt from VAT. You may also benefit from a tax allowance when you sell your business. You can find out more about the tax advantages in our article on selling a business as a whole.
If you do not give up your self-employed activity in a short, coherent way, there is no longer a single economic process and therefore no capital gain tax benefit is available when you give up the business. How long a period is reasonable to qualify as a unitary transaction varies from case to case. As a rule of thumb, a period of approximately three months can be assumed for current assets and up to ten months for fixed assets. However, if the business assets are to be transferred to private assets only temporarily, the disposal is not deemed to have taken place until the sale to a third party has been completed. This is a method to keep the liquidation period short and to dispose of the business assets to third parties a short time later.
Observe these restrictions on the selling of assets
If you have transferred your business property to your private assets as part of the winding up of your business, there is a five-year lock-up period before you can sell the property to a third party without subsequent taxation on the sale proceeds. If you fail to comply with the lock-up period, you can expect to be taxed subsequently. This can be either through the property tax (25%) or, optionally, through the standard income-related tax.