New situations are encountered and circumstances change during the life cycle of an entrepreneur and their company. The company form that served well at the beginning of business operations may no longer serve in the changed circumstances as intended. This is when changing the company form may become relevant. For example, a need to change the ownership base by including new owners in the business might arise. When circumstances change, the need to change the company structure may also need to be assessed.
THE MOST COMMON SITUATIONS OF A CHANGE OF COMPANY FORM
The most common change of company form occurs when, as the business grows, a sole trader is changed to, for example, a general partnership or a general partnership is changed to a limited liability company. In this case, new partners may also join the business.
The provisions of company law enable various changes in the form of a company to a large extent, but due to tax regulations, not all options are feasible in practise without significant tax consequences. From the company law point of view, a private entrepreneur can change their business form to, for example, a general partnership, a limited partnership, or a limited liability company – a general partnership and a limited partnership can be changed to a limited liability company or vice versa, a limited liability company to a general partnership, a limited partnership, or a sole trader. However, it is often more important to consider the tax effects of a change in company form than company law regulations.
A CHANGE OF COMPANY FORM IS WORTH CAREFULLY PLANNING TO AVOID EXCESSIVE TAX CONSEQUENCES
A change in company form does not necessarily cause income tax consequences if the principle of continuity is followed and the identity of the company is preserved. According to the continuity principle, the assets and liabilities related to previously performed activities must be transferred to the continuing company at the same values, while the preservation of identity means the continuation of business with the same main features and with the same ownership relations.
The scope and nature of the transferred business must not change substantially due to the change of company form. If, for example, the identity of a general partnership is not preserved in the change of company form, the general partnership will be considered dissolved in taxation. The result is that the new company and the dissolved general partnership are considered different taxpayers. In practice, the liquidation of the company leads to the realization of taxation.
The most significant difference between company law and tax law concerns the transformation of a limited liability company. In terms of taxation, a limited liability company is basically the final form of a company, i.e. it is dissolved when the legal form of the company is changed, which can result in significant tax consequences for both the company itself and its shareholders. As a result of liquidation, it is considered that the shareholder has sold their shares, and this may constitute taxable capital income.
The change in company form does not affect existing VAT liabilities, because the business operator is not considered to change. If real estate or securities are transferred during the change of company form, the transfer tax liability must be resolved on a case-by-case basis. However, for example, converting a general partnership into a limited liability company is exempt from transfer tax.
Changing company form may have significant impacts to both the company’s and the owner´s taxation and legal relationships. The effects may become effective immediately or they can be realized years later. Changing the company form also requires administrative work when the change must be notified to the trade register. For these reasons, it is more than recommendable to use a help of an expert. In this way, both the present and the future are taken into account. Although the future cannot be predicted, different options can be considered in advance.
