Unlike a merger or demerger under Section 1(1)(4) in conjunction with Section 190 et seq. of the German Transformation Act (UmwG), a change of legal form does not constitute a transfer and therefore does not involve an acquisition transaction. Instead, only the legal form of the company changes. In the case of an international change of legal form, however, specific accounting issues may arise, even if the legal entity remains the same.
Effects of a change in legal form:
From a tax perspective, a change in legal form offers the advantage, for example, that no real estate transfer tax is due when a real estate-owning corporation changes its legal form. From a tax perspective, the five-year trade tax holding period applicable when converting a corporation into a partnership (Section 18(3) of the German Transformation Tax Act (UmwStG)) can have adverse tax consequences in the event of subsequent sales by the converted partnership—a fact that is often overlooked in practice.
From an accounting perspective, a change in legal form does not in and of itself alter the accounting regime; in particular, hidden reserves are not brought to light. The balance sheet and income statement therefore remain essentially unchanged. However, the treatment of so-called cross-border changes in legal form within the meaning of the German Transformation Act (UmwG) has been unclear to date. According to Section 333(1) of the UmwG, i.e., the conversion of a legal entity established under the law of an EU Member State or an EEA Contracting State into a legal form governed by the law of another EU Member State or another EEA Contracting State (the “host state”), accompanied by the transfer of the statutory seat to that state.
The current version of the relevant accounting standard issued by the Institute of Public Auditors in Germany (IDW RS FAB 41) resolves the ambiguities regarding the effects—which are not regulated by law (Sections 333–345 of the German Transformation Act (UmwG))—of a cross-border change of legal form on the annual financial statements prepared in accordance with commercial law for partnerships and corporations in other EU/EEA countries.
Effective Date: Resolutions to change legal form adopted on or after July 31, 2024
Issue: A change in legal form preserves the company’s identity and merely involves a change in its legal structure. In particular, there is generally no change in the treatment of assets and liabilities; specifically, no hidden reserves are revealed.
Unlike a change of legal form within Germany, a cross-border change of legal form is characterized by the fact that, despite the legal entity remaining the same, its accounting regime changes, which may result in a different recognition of assets and liabilities.
Here are a few things to keep in mind:
Inbound Change of Status (Moving from an EU/EEA country to Germany):
- A new fiscal year does not begin
- There is no requirement under German accounting law to prepare a closing balance sheet, nor is there a requirement to prepare an opening balance sheet for the new legal entity (however, it is recommended to prepare a reconciliation statement).
- The book values of assets, liabilities, and prepaid expenses must generally be carried over in accordance with the foreign financial reporting standards; however, intangible fixed assets may not be capitalized retroactively.
- Assets and liabilities recognized under foreign law may not be recognized if they are, in substance, not permitted under German accounting law.
- Equity items of the legal entity undergoing a change of legal form that are recognized in accordance with foreign accounting standards are not carried over as such into domestic financial statements (e.g., revaluation reserve); that is, equity is treated as a residual value. The allocation of amounts to the sub-items of equity is carried out as part of the capital determination in accordance with German corporate law provisions.
- A special feature regarding the recognition of liabilities under creditor protection: If these liabilities are valued lower than required under Section 253(1), second sentence, of the German Commercial Code (HGB), they must be written up to the value permitted under commercial law; if they are valued higher, there is an option to adjust the amount.
- Deferred Taxes and Leases: German accounting law takes precedence over foreign law.
- The net amount (“adjustment balance”) of all adjustments made to the carrying amounts of the assets and liabilities of the foreign legal entity undergoing the change in legal form as part of the accounting treatment of the conversion may be recognized either through profit or loss in the income statement or, without affecting profit or loss, directly as a debit or credit to the equity of the domestic legal entity with the new legal form (this requires disclosure in the notes to the financial statements)
Outbound Form Change:
- Similar to the transition to the new system: among other things, there is no requirement to prepare a closing balance sheet under German accounting law
- If a change in legal form occurs before the end of the current fiscal year, there are no domestic accounting, auditing, or disclosure requirements.
- The effective date of the change in legal form is governed by the law of the host country
- Obligations that arise under domestic law prior to departure and have not been fulfilled before departure must be fulfilled before the competent authorities in accordance with the law of the country of destination.
Sources: IDW RS FAB 41
