We are often asked which one is better: a branch office or a GmbH (Limited Liability Company).
Mostly two issues are incorrectly estimated.
- Many believe that the effort and costs for establishing and administering a branch office are much less than for a subsidiary.
- Others incorrectly think that they can conduct business in Germany or comprehensively prepare for commercial operations in Germany without any tax liability.
You should take the time and thoroughly walk through the mental process of setting up a company in Germany, as many factors depend on the foundation; factors that can be very expensive and irreversible.
The following factors must be particularly taken into account:
- Costs for the foundation of a company
- Ongoing taxation
- Liability for obligations related to the company and the shareholders
- Costs for ongoing administration
- Business aspects, e.g. the size and duration of the activities planned in Germany.
For foreign companies that want to conduct business in Germany, three forms are predominantly offered: rep office, branch office and subsidiary.
Permanent Establishment / Branch office
A branch office is a legally dependent part of a company. It bears the name of the parent company with “branch office” added to the name. Entry in the commercial register is mandatory.
A permanent establishment is a purely fiscal term. Furthermore, a permenent establishment exists in case certain prerequisites are met; entry in the commercial register is not among of them.
Prerequisite conditions for a permanent establishment
- Permanent Establishment: a fixed setup, from where the commercial operations are carried out,
- Permanent Establishment: is present only for a certain period of time,
- Permanent Establishment: entrepreneurs may freely dispose of the establishments (power of keys).
Even a warehouse or a construction site which exists for over six months, can be a permanent establishment. If a branch office is entered in the commercial register, it always involves a permanent establishment.
The rep office / representation office which is customary abroad does not exist in this form in Germany. Apart from commercial agents, the minimal form for business activities in Germany by foreign entrepreneurs is already there, when employees of the foreign company start working in Germany without fulfilling the above mentioned criteria for a permanent establishment. It must also be considered here that the employees working in Germany may have to be registered for wage tax and social security here. At an international level, major changes are planned so that the preliminary sales activities lead to the emergence of an agency permanent establishment.
Even in matters of invoicing, German VAT law can be applicable in some cases. Currently, this is often ignored for online trade / e-commerce. Learn more about VAT in Germany here.
GmbH (Limited Liability Company)
A GmbH is a separate legal entity. It is legally independent of the shareholders or the parent company. It is represented in public by its managing director(s). Its name can contain the name of the parent company or it can have a different name. The involvement of a notary public and its entry in the commercial register are mandatory.
GmbH is created with the notarial deed
Articles of incorporation are necessary for this. They can be individually drafted by a lawyer according to the given legal framework. This can be quite helpful if disputes arise between the shareholders at any time in the future. The founding shareholders are personally liable without limitation until the entry in the commercial register. Afterwards, the shareholders are liable only up to the amount of their investment share. If the shares are fully paid in, the shareholders are no longer personally liable and the GmbH itself is liable only up to the amount of its equity capital (including any profits carried forward). This is a huge advantage of the GmbH. If the liability of the GmbH shall be practically restricted, profit distributions should be regularly carried out to reduce the profits carried forward.
The nominal share capital of the GmbH is at least € 25,000
At least half of the share capital must be deposited before the entry in the commercial register is done. The nominal share capital must be freely available to the managing directors in the beginning. After entry in the commercial register and receipt of a tax number, it may the share capital may be used e.g. for the purchase of fixed assets, however, within certain limits.
If the GmbH is to be closed, it can be wound up. A one year waiting period must be considered for the same. In case of insolvency or excessive debt, the managing directors have to file for insolvency with the responsible local court without undue delay, which is no later than three weeks. Violation of this rule can represent a criminal offense of the managing directors and possibly lead to a personal liability of them. Thus, in their own interest, the managing directors should always keep an eye on the financial development of the GmbH.
The GmbH must be registered with respect to taxation and must regularly file tax returns. This includes advance VAT returns, which must be filed monthly, quarterly or annually, and the annual tax returns for corporate income tax, trade tax and VAT. If the GmbH appoints employees, it has to fulfill statutory employer obligations, such as the calculation and payment of wage tax and social security contributions.
The GmbH must prepare annual financial statements
The statutory content and elements of the annual financial statements arise out of the size criteria, which are defined in the HGB (German Commercial Code). The same is applicable for disclosure of financial data. If the shareholders want to invest or withdraw money, it is possible only through deposits in equity or through dividend payouts or loans. A shareholders’ resolution must be undertaken in case of dividend payouts. In addition to this, a declaration on the withholding tax on investment income must be prepared and submitted to the respective tax authorities. If necessary, up to 25% withholding tax on investment income and 5.5% solidarity surcharge must be paid so that the receiving shareholders do not receive the complete amount of the dividend.
We gladly assume responsibility for these obligations and other tasks related to taxation and accounting for you. We are here to help you with any questions.
Advantages and disadvantages
The advantages of a GmbH are the limitation of liability to its assets and its good reputation in business relations in Germany. Whereas the minimum nominal share capital and the requirement of having notarized articles of association prepared notary public are disadvantages. Thus, the costs of setting up a GmbH are generally higher than for setting up a branch office. One also has to keep in mind that the costs to liquidate a GmbH are considerable and that a GmbH can be dissolved only after a waiting period of one year, during which time all liabilities towards third parties are paid off.
The advantages of maintaining a branch office include somewhat less formal requirements for the ascertainment of profits. Up to a certain turnover limit, a branch office only has to prepare a cash basis accounting and not annual financial statements with notes, like the GmbH. Thus, it also has more scope of profit allocation for specific years, in which the payments are held back or are made early.
The fact that all legal changes in the parent company must also be entered in the German Commercial Register, in case a branch office is registered in the German commercial register, is a certain disadvantage. Furthermore, administrative costs are almost as high as for a GmbH. The primary disadvantage is that the parent company is directly and fully responsible for all liabilities of the branch office, and therefore, a small mistake can turn out to be quite expensive.
Tax wise, there is no difference as both GmbH and branch office are subject to corporate income tax and trade tax, and also to the same tax rates.
Our recommendation: We recommend that our clients set up a GmbH based on the limitation of liability and the better reputation.
More about the choice of legal form