Partnership or Corporation? Liability and Tax Compared.

When choosing a legal form, the first major fork in the road often comes down to a simple question: partnership or corporation? Behind that simple contrast lie major differences in liability, taxation, capital maintenance and employee codetermination.

This article explains why, in practice, the choice is usually not between all conceivable legal forms “in the abstract”, but rather between the GmbH & Co. KG as a liability-limited partnership on the one hand and the classic corporation on the other – above all the GmbH, the UG (haftungsbeschränkt) and the AG.

The corporation & Co. KG (in particular the GmbH & Co. KG)

On the partnership side, only the corporation & Co. KG is usually a serious practical option. The alternatives – in particular the registered civil-law partnership (eingetragene GbR, or eGbR) now possible since 1 January 2024 under the MoPeG reform, the OHG and the classic KG – do not provide comprehensive limitation of liability for the natural persons involved. The sole trader (e.K.) is not, conceptually, a partnership at all, but a sole proprietorship.

But what exactly is a corporation & Co. KG?

A limited partnership (Kommanditgesellschaft, or KG) is a commercial partnership made up of two classes of partners: there is at least one personally and unlimitedly liable partner (Komplementär, general partner) and at least one partner whose liability is limited to the amount registered in the commercial register and freely chosen by the parties (Kommanditist, limited partner). Only the general partner is authorised to represent the company externally, and as a rule it also manages the business.

Practitioners soon came up with the idea of installing a corporation as the sole general partner of the KG. The persons who are economically involved then become the limited partners of the KG and, as a rule, at the same time also the shareholders of the corporation.

The corporate general partner is usually not itself entitled to a share in the capital of the KG and receives no share of the profits. Its only role is to assume liability and represent the KG externally through its organs.

This construction eliminates most of the disadvantages of the pure partnership. The corporation & Co. KG is the only commercial partnership in which:

• no natural person (= a human being) is personally and unlimitedly liable with their private assets,
• management and external representation can be entrusted to persons who are not shareholders/partners, and
• management and external representation are not necessarily linked to the assumption of personal liability.

After fierce initial debate as to whether such a combination of legal types was permissible, the Reichsgericht held already in 1922 that it was lawful. The BGH later adopted that line. It does, however, apply by analogy certain capital-maintenance rules that were originally designed only for corporations. The legislature has also recognised the structure in the meantime by extending certain accounting and insolvency provisions to it (see, for example, § 264a HGB). Under § 19 para. 2 HGB, the legal-form suffix “GmbH & Co. KG” must make clear to third parties that no natural person is personally and unlimitedly liable.

In principle, any corporation can act as general partner. In practice, however, it is almost always a GmbH. The overwhelmingly common form of the corporation & Co. KG is therefore the GmbH & Co. KG. For that reason, what follows speaks only of the GmbH & Co. KG, although the same considerations apply equally, for example, to a UG (haftungsbeschränkt) & Co. KG or an AG & Co. KG.

What are the specific advantages of the GmbH & Co. KG over a pure corporation?

The real question is therefore this: when does this hybrid form justify the extra burden of two companies, two sets of accounting records and usually also two annual financial statements?

Taxation

Historically, the tax advantages of partnerships over corporations were the original reason for the popularity of the GmbH & Co. KG. A series of tax reforms has since brought the burdens closer together by eliminating both some advantages of partnerships and some disadvantages of corporations.

Even so, the legislative goal of “neutrality of legal form” in taxation has not yet been achieved. In some situations, the GmbH & Co. KG still enjoys a tax advantage; in others, the corporation is the more favourable vehicle.

Viewed in the abstract, the advantages and disadvantages largely offset each other, so that one cannot simply speak of the “tax-advantaged legal form”. In the individual case, however, there may be very substantial differences in tax burden. That is why one should be careful not to base the choice of legal form solely on a model tax comparison. Both the circumstances of the concrete business and the tax law itself tend to change over time. All the circumstances of the particular case must therefore always be taken into account, and the chosen legal form should be revisited every few years. Fortunately, German transformation law offers mechanisms for changing legal form after the fact as well – even if not always without tax friction.

In 2021, the legislator created a modern bridge between the two worlds with the opt-in to corporate taxation under § 1a KStG (Corporation Tax Modernisation Act, KöMoG): a commercial partnership – in particular the KG or GmbH & Co. KG – can, on application, be taxed like a corporation without changing its legal form under corporate law. The 2024 Growth Opportunities Act (Wachstumschancengesetz) eased access to this option. For profitable partnerships that retain their earnings, this can bring the tax burden close to that of a GmbH while preserving the corporate-law flexibility of a partnership.

Tip: Anyone weighing a GmbH & Co. KG against a GmbH should factor this opt-in into the comparison – it noticeably shifts the classic trade-off. The option is, however, subject to deadlines and follow-on effects (among them lock-up periods and the treatment of special business assets) and should be coordinated with the tax adviser.

The main tax differences are the following:

1) Income taxes (income tax, corporation tax, trade tax)

Partnership

The structural difference between partnerships and corporations becomes immediately visible in income tax and corporation tax: the partnership does not pay either of them, because for these purposes it is not treated as an independent taxable person.

Instead, the profits of the business are allocated directly to the partners pro rata to their interests and taxed there at the partner’s individual income tax rate. Partnerships are therefore described as tax transparent. One important point: taxation takes place irrespective of whether the profits are actually withdrawn from the company or retained in it.

Trade tax, by contrast, is levied directly at the level of the business, and therefore at the level of the partnership. Partnerships benefit from an annual trade tax allowance of EUR 24,500. The partners can generally credit the trade tax paid by the partnership against their personal income tax up to a current maximum of 14% (credit factor 4.0 under § 35 EStG). Trade tax therefore becomes a real economic burden only to the extent that the local trade tax rate exceeds 14% (which corresponds to an assessment rate of more than 400%).

High local trade tax rates can therefore work quite materially against the partners. Since the trade tax can also only be credited up to the amount of income tax actually arising in the relevant year, situations can occur – for example because other losses reduce the income tax burden – in which part of the trade tax cannot be offset. These cases are often referred to as credit overhangs.

Corporation

Corporations are, by contrast, currently subject to corporation tax at a flat rate of 15% until and including assessment period 2027 (plus solidarity surcharge). From 2028, the statutory corporation tax rate will be reduced in stages to 10% from 2032. In addition, there is trade tax of roughly 7-19%, depending on the municipality (national average around 15%; Berlin 14.35%). Tax is then levied again at shareholder level only on distribution, either in the amount of final withholding tax (25%) if the shares are held as private assets, or under the partial income method (that is, 60% taxable at the individual’s personal income tax rate) if the shares are held as business assets. Unlike in the partnership context, there is no credit for the trade tax paid by the company at shareholder level.

Comparison calculations

Note on the legal position: The following sample calculations are based on the 2026 German income tax schedule. Solidarity surcharge on personal income tax is calculated using the 2026 exemption threshold and mitigation zone. The corporation tax rate remains 15% until and including 2027, but is reduced in stages from 2028. For simplicity, the savings allowance is not reflected in the tables; if it were fully available, the corporation would perform slightly better.

The examples are for illustration only, not for determining the tax payable in a specific case. Actual taxation may differ in particular because of personal allowances, other income and the concrete use of the savings allowance.

Below is a comparison assuming that all profits are withdrawn from or distributed by the companies. The income tax figures are those of 2026 and apply only if the shareholder has no other taxable income. Separate assessment is assumed. Church tax is ignored. It is assumed that the shares in the corporation are held as private assets. The trade tax multiplier used is the Berlin rate of 410%.

	Partnership (GmbH & Co. KG)	Corporation
I. Company level
Profit before tax	100,000.00 €	100,000.00 €
less trade tax (partnership incl. allowance)	10,834.25 €	14,350.00 €
less corporation tax (15%)	–	15,000.00 €
less solidarity surcharge on corporation tax (5.5%)	–	825.00 €
= Profit after tax	89,165.75 €	69,825.00 €
(Company tax burden)	10.8%	30.2%
II. Shareholder level
less income tax (30.9%) / final withholding tax (25%)	30,864.00 €	17,456.25 €
trade tax credit (14.0%)	10,570.00 €	–
less solidarity surcharge on income tax / withholding tax	0.00 €	960.09 €
Taxes on withdrawal / distribution at shareholder level	20,294.00 €	18,416.34 €
= Income after tax	68,871.75 €	51,408.66 €
Overall effective tax rate	31.1%	48.6%

Comparison at annual pre-tax profits of EUR 100,000.

In this scenario, with profits of EUR 100,000, the partnership therefore enjoys a clear advantage, reducing the overall tax burden by roughly 17 percentage points. Because of the progressive income tax system, however, that advantage shrinks as the company’s profits increase or as the shareholder has further taxable income from other sources.

If one assumes profits of EUR 2,000,000, for example, the total effective tax rate would be roughly 46.0% for the partnership and (still) 48.6% for the corporation. The same is true if the shareholder has other taxable income that already uses up the progressive part of the income tax schedule.

Compensation paid by the company to the shareholder

There is, however, one lever available in the corporation: instead of paying part of the return as a dividend, the corporation can pay the shareholder-managing director a reasonable (!) salary and deduct that amount at company level as a business expense. That portion is then burdened only with the managing director’s personal income tax, not with corporation tax and trade tax. This means that the progressive zone of the personal income tax schedule can also be exploited by shareholders of corporations.

Comparable compensation paid by a partnership to one of its partners is not recognised for tax purposes in the same way, because for trade tax purposes it is added back to the partnership’s trade earnings. That means compensation paid to one partner increases the trade tax burden for all partners (it may therefore be sensible to provide for an internal equalisation mechanism in the partnership agreement). In a corporation, by contrast, such payments increase only the personal income tax burden of the receiving shareholder, while reducing the corporation’s tax burden for the benefit of all shareholders.

In the example above (profits of EUR 100,000), this structure substantially levels out the tax advantage of the GmbH & Co. KG:

	Partnership (GmbH & Co. KG)	Corporation
I. Company level
Profit before tax	100,000.00 €	50,000.00 €
less trade tax	10,834.25 €	7,175.00 €
less corporation tax (15%)	–	7,500.00 €
less solidarity surcharge on corporation tax (5.5%)	–	412.50 €
= Profit after tax	89,165.75 €	34,912.50 €
(Company tax burden)	10.8%	30.2%
II. Shareholder level
less income tax (30.9%) / withholding tax (25%)	30,864.00 €	8,728.13 €
trade tax credit (14.0%)	10,570.00 €	–
less solidarity surcharge on tax	0.00 €	480.05 €
Taxes on withdrawal / distribution	20,294.00 €	9,208.17 €
Managing director salary	–	50,000.00 €
less income tax on salary	–	10,548.00 €
less solidarity surcharge on salary	–	0.00 €
Taxes on managing director salary	–	10,548.00 €
= Income after tax	68,871.75 €	65,156.33 €
Overall effective tax rate	31.1%	34.8%

Variant: payment of a managing director salary in the corporation.

This picture – a modest residual advantage for the partnership – remains relatively stable even at higher profit levels, paired with correspondingly higher managing director salaries. That small advantage can shift in favour of the corporation where low local trade tax rates apply, because the available trade tax credit then shrinks correspondingly. Comparable tax advantages may also be generated in the corporate structure through other compensation arrangements, for example loan interest or rent paid to the shareholders. But those arrangements bring follow-on risks of their own, including accidental creation of a tax split business (Betriebsaufspaltung) if core operating assets are leased to the company, or triggering the German interest limitation rules through harmful shareholder debt financing. Another practical issue is that in order not to endanger tax recognition, such payments generally also have to be made in loss-making years, which can put pressure on the company’s liquidity.

Retention of profits

What if profits are not withdrawn from the company or distributed, but rather retained?

In that case, the corporation remains subject to a tax burden of roughly 30% at company level until 2027; from 2028, that burden decreases somewhat because of the phased corporation tax reduction. In the case of the partnership, taxation remains independent of any withdrawal and therefore tends toward roughly 48%, depending on the partner’s personal tax rate. This gives the corporation a significant liquidity advantage. If the retained earnings are profitably reinvested within the company, compound effects over time can generate substantial additional returns. Even if those retained profits later have to be taxed on distribution, the corporation still enjoys an economic benefit. In addition, the shareholder of the corporation can largely control the timing of the distribution and shift it into a year with a lower personal tax rate, for example because of losses elsewhere.

Partners in a partnership can, however, elect for the German retained earnings regime in their personal tax returns. The tax rate on profits not withdrawn is then reduced for that partner to 28.25% plus solidarity surcharge. Without actual withdrawals, however, the partner must pay that tax out of other assets, so the investment in the KG effectively produces a negative cash flow. In practice, many partners therefore withdraw at least the amount needed to pay the tax. To the extent such withdrawals are made, however, the reduced rate no longer applies. In practice, the effective burden under the regime often ends up at around 36%, and therefore still noticeably above the burden of a profit-retaining corporation.

The retained earnings regime is also only a tax deferral. If in a later year the partner withdraws more than the profit earned in that year, sells or discontinues the business, the company becomes insolvent or is restructured, or the profit-determination method changes, there is a subsequent recapture taxation of the amounts that were originally taxed at the privileged rate. At an effective retained-earnings rate of 36%, the overall burden after that recapture rises to around 53%. Even for taxpayers who are permanently subject to the top personal income tax rate on their partnership income, the retained earnings regime cannot therefore be recommended across the board.

These latent income tax liabilities can, over time, grow into a substantial tax risk for the entrepreneur or the entrepreneur’s heirs and require a high degree of forward-looking tax planning. If some, but not all, partners have accumulated high latent taxes, those latent taxes can also become an obstacle to otherwise sensible restructurings and thereby trigger shareholder disputes. Against that background, commentators are not wrong when they regularly describe the retained earnings regime as a legislative misfire.

For those reasons, many entrepreneurs simply do not use it at all.

Conclusions on income taxation

1. For companies with medium to high profits that regularly retain earnings, the pure corporation is often preferable from an income tax perspective.
2. If the entrepreneur is subject to a low personal income tax rate and profits are always withdrawn, the partnership may offer income tax advantages.
3. Corporations have an advantage in municipalities with a trade tax multiplier of 300% or less.
4. A corporation can be disadvantageous where profits are not intended to remain in the company, but the circumstances do not permit the creation of adequate arm’s-length service relationships with the shareholders. In that case, the full amount flowing to the shareholders is subject to triple taxation: corporation tax and trade tax at company level, and income tax or withholding tax at shareholder level. At higher company profits or where the shareholders have other substantial income, this disadvantage is increasingly levelled out by tax progression.

2) Tax treatment of losses

Compared with a corporation, the corporation & Co. KG offers very interesting advantages when it comes to the utilisation of losses. Because the results of the partnership are attributed directly to the partners, they can in principle offset those losses against taxable income from other sources. In a corporation, by contrast, losses remain “trapped” at company level and can be used only by that company itself against its own positive income. (Tip: it is possible, through structuring, to shift losses up to the shareholders of a corporation by creating an atypical silent partnership or a tax consolidation. The latter, however, effectively means giving up the limitation of liability.)

In both partnerships and corporations, loss carryforwards may in principle be used for an unlimited period. As to amount, they are unrestricted up to EUR 1 million of total income. For the years 2024 to 2027, offset above that amount is currently limited to 70% of the excess. From 2028 onward, the threshold is expected to revert to 60% (§ 10d para. 2 EStG). There is also a loss carryback limited to two years and to EUR 1 million in amount (§ 10d para. 1 EStG). In the partnership context, however, this loss carryback limit applies per co-entrepreneur (!). In partnerships with several partners, the aggregate carryback potential is therefore considerably higher. For a married partner assessed jointly with their spouse, the limit even doubles to EUR 2 million.

Restriction of cross-use of losses for limited partners

There is, however, a catch. For limited partners, § 15a EStG imposes important restrictions on the use of losses compared with fully liable partners of a partnership. Since limited partners do not have to cover the losses of the company personally once they have paid in an amount equal to their liability sum, they also cannot deduct losses without restriction.

If the capital account of the limited partner is negative, losses cannot therefore be offset against other income of the limited partner. They can only be offset against future profits from that same limited partnership interest. (The logic is this: to the extent losses create a negative capital account, the limited partner does not have to pay that deficit in. But the partner is still “liable” through future profit shares, because those future profits first restore the capital account before any payout claim arises – § 169 para. 1 sentence 2 HGB.) If, by contrast, the limited partner still has external liability because the registered liability amount has not yet been fully paid in, immediate offset against other income is possible to that extent. Put differently: immediate cross-use of losses can be bought at the cost of assuming a higher liability amount, which depending on the partner’s personal circumstances and the business risk profile may well be sensible.

Forfeiture of loss carryforwards

Corporations are also at a disadvantage because of the possible forfeiture of tax losses: whereas in a corporation all loss carryforwards are in principle forfeited in the event of a “harmful acquisition of shares” within the meaning of § 8c KStG (roughly speaking: transfer of more than 50% of the shares or voting rights within five years), the income tax losses accumulated by the individual partners of a partnership generally remain untouched by a transfer of the partnership interest. Trade tax loss carryforwards at the level of the partnership are, however, forfeited pro rata to the transferred interest. If therefore less than 50% of the interest is transferred, the partnership is disadvantaged in that respect. If a larger transfer takes place, the partnership has the advantage, because in a corporation the trade tax losses are lost completely, whereas in the partnership they are lost only pro rata.

Conclusions on the loss situation

1. Partners in a partnership are in several respects in a better position than shareholders in a corporation when it comes to using company losses for tax purposes.
2. The GmbH & Co. KG is therefore particularly attractive for entrepreneurs with several businesses, some of which incur substantial start-up losses and may need many years to reach profitability. In that case, the entrepreneur can directly offset the initial losses (within the limits of § 15a EStG) against income from the other businesses, creating significant liquidity and interest advantages.
3. Especially where a company that is initially loss-making is later intended to be sold, a partnership may in some cases be the only way to make practical use of the tax losses, because in a corporation they may be lost under § 8c KStG.

3) External financing (financing costs of the company; refinancing costs of the shareholders)

External financing means the provision of equity or debt capital to finance the business by shareholders or third parties – in other words, “from outside”. Equity can be injected as nominal capital or through other payments into capital reserves. Debt is typically provided in the form of loans, sometimes bonds or comparable instruments.

From a tax perspective, the interesting question is the extent to which there are differences between the partnership and the corporation in relation to the refinancing costs borne by the shareholders where they themselves borrowed the funds. At company level, the issue is how the trade tax add-back for certain financing components affects the overall burden.

Financing costs at company level

Both the partnership and the corporation can in principle deduct their own financing expenses as business expenses. For trade tax purposes, however, part of the financing components listed in § 8 no. 1 GewStG is added back. What matters is therefore not only interest expense, but the total of all relevant financing components. Since 2024, the threshold has been EUR 200,000 per year. In partnerships, the resulting trade tax burden is largely offset by the credit against the shareholders’ personal income tax. In a corporation, by contrast, the burden is final, because it is not compensated at shareholder level.

Shareholder refinancing costs

If shareholders finance either their capital contributions or even the acquisition of their interests through borrowings, the tax deductibility of their own refinancing costs – above all loan interest – becomes highly relevant. And this is where a major legal-form-specific disadvantage of corporations appears.

If the shareholder is subject to final withholding tax because the shareholding is held as a private asset, deduction of income-related expenses is excluded (§ 20 para. 9 EStG; the taxpayer receives only the lump-sum savings allowance of EUR 1,000 per year). The shareholder can therefore not offset the income received from the shareholding against the shareholder’s own interest expense and thus has to tax the full income – a clear departure from the net-income principle of taxation.

A simple example shows how drastic this can become:

A shareholder (a natural person) participates in a capital increase of a GmbH and subscribes for new shares by paying nominal amount plus premium totalling EUR 1 million. The shares are held as private assets. To finance the acquisition, the shareholder takes out a bullet loan at 6% interest p.a., repayable in full with accrued interest after eight years. Over those eight years, the company distributes profits of EUR 1 million to the shareholder. The calculation looks as follows:

Profit before tax	1,000,000 €
less corporation tax, solidarity surcharge, trade tax	301,750 €
Distribution	698,250 €
less refinancing interest	480,000 €
less final withholding tax and solidarity surcharge (no deduction of refinancing costs)	184,163 €
Remaining	34,087 €
Burden by reference to the pre-tax net result (profit minus refinancing costs)	93.4%

Illustration of the gross-taxation effect under the final withholding tax regime.

Instead of the “normal” overall tax burden on distributed GmbH profits of 48.6%, the actual burden in this example rises to 93.4% because the refinancing costs cannot be deducted.

The effect can be mitigated if the shareholder opts out of final withholding tax into the partial income method, which is possible only under certain conditions (§ 32d para. 2 no. 3 sentence 1 EStG). In that case, 60% of the profits are taxed at the personal income tax rate, but in return 60% of the income-related expenses are deductible (including 60% of the interest). The same rules then apply as would apply if the shares were held as business assets. The result still does not invite celebration:

Profit before tax	1,000,000 €
less corporation tax, solidarity surcharge, trade tax	301,750 €
Distribution	698,250 €
less refinancing interest	480,000 €
less income tax and solidarity surcharge (60% taxation / 60% deduction)	62,169 €
Remaining	156,081 €
Burden by reference to the pre-tax net result (profit minus refinancing costs)	70%

Variant: opt-in to the partial income method.

Refinancing an equity contribution is therefore highly disadvantageous in a corporation. In a partnership, by contrast, the refinancing costs are fully deductible as business expenses, so the effective tax burden does not exceed what was described above under income taxation. (It is true that 25% of the refinancing interest is added back for trade tax purposes, but that effect is offset through the trade tax credit.)

In the example above, the partner in the partnership would retain EUR 271,170, corresponding to an effective burden of “only” 47.9% on the pre-tax net profit of EUR 520,000. In the corporate context, there is therefore much to be said for injecting borrowed funds by way of shareholder loan rather than equity, because in that case the deduction prohibition does not apply provided the shareholder holds at least 10% of the company (§ 32d para. 2 no. 1 sentence 1 lit. b, no. 1 sentence 2 EStG). The problematic cases are those in which the shareholder does not have a free choice between debt and equity. For example, a shareholder may have no real alternative to injecting equity if the other shareholders resolve on a capital increase and the shareholder wants to avoid dilution. (Tip: in those cases it may make sense to hold the corporate shares indirectly through another, debt-financed corporation. Depending on the circumstances, a tax consolidation may also help.)

Conclusions on external financing

1. Refinancing the entrepreneurial investment of a natural person in a corporation can be so tax-disadvantageous that, in individual cases, the whole economic rationale of the investment becomes questionable.
2. If a shareholder of a corporation wants to finance the funds to be injected with borrowed money, shareholder loans are generally preferable to equity contributions. Gross taxation of the latter can only be avoided through more elaborate tax structuring, which in turn requires its own cost-benefit analysis.

4) Flexibility in shifting assets and in restructurings

The legal form also affects the ability to restructure the business tax-neutrally through asset transfers and changes of legal form. In partnership businesses, the transfer of individual assets – including real estate – from one business asset pool of a co-entrepreneur to another is generally possible without triggering tax. There is particular flexibility where the taxpayer operates several partnerships or businesses. It is, for example, possible to transfer an asset from the taxpayer’s special business assets in one partnership to the taxpayer’s special business assets in another partnership without income tax consequences. A shareholder can also transfer real estate that he or she held as business assets of a sole proprietorship to a GmbH & Co. KG and back again without triggering income tax, and to the extent of the shareholder’s interest in the KG even without real estate transfer tax. This opens up interesting structuring options.

In corporations, by contrast, there is no comparable ability to transfer real estate and other assets to or from the company tax-neutrally at book value, unless the assets exceptionally constitute a business division and can therefore be transferred under the transformation tax rules (cf. § 20 UmwStG). Instead, such transfers crystallise the hidden reserves in the assets – that is, the difference between book value and fair market value – and trigger taxation. If real estate is involved, real estate transfer tax also arises.

There are also asymmetries in the tax obstacles to a change of legal form from partnership to corporation and vice versa.

When a corporation is transformed into a partnership, all open reserves of the company are taxed at shareholder level as if distributed. Loss carryforwards are extinguished as part of the transformation. Where substantial reserves or loss carryforwards exist, the change of legal form may therefore be effectively impossible in practice. The same applies to interest carryforwards under the interest limitation rules. A transformation from one corporate form into another (for example GmbH into AG), by contrast, is usually straightforward.

When a partnership is transformed into a corporation, all profits for which the retained earnings privilege was used are subject to subsequent recapture taxation. In other respects, however, the transformation is usually easier to handle from a tax perspective. The GmbH & Co. KG also has one particularly elegant route into a pure corporation: if all limited partners withdraw from the company, the assets of the company accrue automatically to the corporate general partner, which can then continue the business. In principle, this would not even require notarisation, which depending on the assets of the company can save significant cost. (To achieve tax neutrality, however, the limited partnership interests generally have to be contributed into the corporation in exchange for shares.)

Conclusions on restructuring flexibility

1. The partnership enjoys substantial flexibility advantages in shifting assets between different business asset pools of an entrepreneur and in changing legal form.
2. From a tax perspective, the corporation can turn into a one-way street once substantial reserves, interest carryforwards or tax losses have accumulated.
3. Use of the retained earnings privilege in a partnership creates an obstacle to later transformation.

5) Inheritance and gift tax

A large proportion of German mid-sized businesses are family businesses. It is therefore highly relevant whether the business can be transferred to the next generation on death or by way of gift during lifetime without triggering tax burdens that endanger the existence of the company.

In that context, the partnership has one specific advantage, although it matters only for minority owners:

In simplified terms, an inheritance/gift tax relief of 85% or 100% applies if a business is inherited or gifted and the acquirer continues it for a certain period under defined conditions (in particular by maintaining certain cumulative payroll levels).

That applies both to co-entrepreneur interests in partnerships and to shares in corporations. In the case of corporate shares, however, the relief is granted only if the deceased or donor held more than 25% of the nominal share capital. No comparable minimum shareholding is required in the case of partnership interests.

The minimum-shareholding hurdle for corporations can be circumvented only through certain voting pooling and transfer arrangements among several shareholders, so that their interests are aggregated for the relief test.

Conclusion on inheritance tax

The partnership has the advantage that no minimum shareholding is required in order to benefit from inheritance and gift tax relief. This matters only for shareholders holding less than 25%.

6) Sale of the business

Many entrepreneurs build a business with the aim of one day selling it at a profit. The different tax treatment of the sale of partnership interests and corporate shares should therefore be considered in good time. The sale of partnership interests generally results in full taxation of the capital gain with income tax (or with corporation tax and trade tax if the interests are held by a corporation).

In the sale of corporate shares, natural persons and partnerships holding the shares are taxed under the partial income method (even if the shares are held as private assets – unless the interest is less than 1%). Only 60% of the gain is therefore taxable. If the corporate shares are held by another corporation (a holding company), the capital gain is effectively taxed at only around 1.5% until 2027; from 2028, that rate decreases slightly because of the corporation tax reduction.

The sale of corporate shares is therefore often more favourable from a tax perspective.

Three important qualifications must, however, be kept in mind:

1. Taxpayers who have reached the age of 55 or are permanently incapacitated for work can claim, once in a lifetime, a special tax relief on the sale of their entire partnership business, bringing the burden closer to that arising on the sale of corporate shares. This applies only to gains up to EUR 5 million.
2. If the sale results in a capital loss, only 60% of that loss is effective for tax purposes in the case of corporate shares, whereas the loss on the sale of a partnership business is generally deductible in full.
3. The purchase of a partnership business is usually more attractive for the buyer from a tax perspective, because the buyer can step up the assets of the business in the balance sheet to their fair market values and then amortise the purchase price over time in line with the hidden reserves (step-up). The buyer can also offset financing interest for the purchase price without major structuring gymnastics. The buyer will therefore often be prepared to pay a higher price for a partnership business, which may at least partly compensate the seller for the seller’s tax disadvantage.

Conclusion on sale of the business

1. In the sale context, especially at higher gains, the corporation is generally more favourable for the seller. The opposite is true where a sale loss is expected.
2. If the interest is held through a holding company, an almost tax-free sale (effective rate around 1.5% until 2027 and slightly lower thereafter) can be achieved only in the case of corporate shares. That advantage disappears, of course, once the proceeds are distributed from the holding company to a natural person and therefore only has lasting value where the gain is reinvested.
3. The general tax disadvantage in selling a partnership business is less pronounced for lower gains – in particular where the one-off relief for sellers above 55 can be used.
4. Where the purchase price materially exceeds the aggregate book values of the individual assets of the business, the buyer of a partnership business enjoys a significant depreciation volume, which may be reflected in a higher price. In the corporate context, a similar result can be achieved by structuring the sale as an asset deal, although in individual cases that may fail because consent of all counterparties to the business contracts is required.

Interim conclusion on taxation

If the discussion above shows one thing, it is probably this: there is no blanket answer as to the tax superiority of one legal form or the other. What matters is the assessment and weighting of the individual factors in light of the entrepreneur’s plans and circumstances.

A schematic overview may nevertheless help:

Criterion	Partnership	Corporation
Income taxation:
Withdrawal / distribution / compensation payments	+ [where personal income tax rate is low]	+ [in particular at low trade tax rates; compensation payments]
Retention of profits	(–)	+
Use of losses	(+), with restrictions for limited partners	–
Refinancing costs for acquiring the interest and funding equity	+	–
Flexibility in restructurings	+	–
Inheritance tax	+	(–), problematic mainly for shareholdings ≤ 25%
Sale of the business	(–)	+
Tax risks	Subsequent taxation under retained-earnings regime; trade tax credit overhangs	Hidden profit distributions if compensation paid to shareholders is not at arm’s length

Liability and capital protection

The GmbH & Co. KG and the pure corporation have one thing in common: no natural person is personally and unlimitedly liable with private assets for the debts of the company. Beyond that, however, the existing limitation of liability differs in the details, especially where capital protection is concerned.

Capital maintenance

For corporations, there is a strict system to ensure the raising and maintenance of the nominal capital. In a GmbH, all shareholders are in effect jointly responsible for ensuring that the share capital is paid in and is not later returned to the shareholders through impermissible payments. In a stock corporation, there is no comparable joint liability of the shareholders for unlawful payments, but the rules restricting asset extraction are even stricter and create higher liability risks for the management board.

In a GmbH & Co. KG, the liability of the limited partners is limited to the liability amount registered in the commercial register, provided that amount has not yet been paid to the company. This is so even if a limited partner has withdrawn from the company a multiple of that liability amount. Problems arise only in edge cases when one has to determine whether a withdrawal by the limited partner amounts to a liability-relevant repayment of a liability contribution already made.

That said, the capital maintenance rules applicable to the corporate general partner also apply by analogy to the GmbH & Co. KG. As a result, the limited partners may also be obliged to reimburse payments made by the KG that cause or deepen a balance-sheet deficit in the general partner (by analogy to §§ 30, 31 GmbHG or §§ 57, 62 AktG).

(Background for the curious: if assets flow from the KG to a limited partner without adequate consideration, this may affect the balance sheet of the corporate general partner. If a creditor of the KG proceeds against the general partner, the general partner in turn has an indemnity or reimbursement claim against the KG. The liability for the debts of the KG is therefore offset, on the asset side, by a corresponding claim against the KG. If the KG is over-indebted, however, that claim is no longer valuable and can no longer be recognised in the balance sheet of the general partner. If payments to the limited partner thereby indirectly create or deepen a deficit in the general partner, BGH case law gives the KG a reimbursement claim against the limited partner and, where appropriate, also against the managing directors of the general partner.)

Even so, the scope of capital-maintenance liability in the GmbH & Co. KG is smaller than in a pure corporation. In a corporation, whether a balance-sheet deficit exists depends on the commercial accounting valuation rules. In the GmbH & Co. KG context, by contrast, the value of the general partner’s reimbursement or indemnity claim depends on the actual value of the KG’s assets. That actual value may – because of depreciation and the like – be materially higher than the book values shown in the commercial balance sheet. A repayment claim against the limited partners therefore comes into consideration only if the KG is materially over-indebted, not merely if there is a notional balance-sheet deficit. For that reason, the statement sometimes found in the literature – namely that, as a result of the BGH’s case law, capital-maintenance liability in the GmbH & Co. KG is ultimately the same as in the GmbH – is not entirely correct.

Freedom of withdrawals

Beyond preservation of the nominal capital of the corporate general partner, the GmbH & Co. KG as a partnership enjoys greater flexibility in relation to the tying-up of company assets. Whereas corporations may in principle distribute only the (adopted or expected) annual surplus, the partners of a partnership are generally free – depending on the partnership agreement – to withdraw all available liquidity from the company, even if no corresponding profit has been earned. In a GmbH, such a profit-independent withdrawal right can be created only to a limited extent in the articles and remains unusual and risky in light of the capital maintenance rules; in a stock corporation such a withdrawal right is entirely excluded.

Capital increases and capital reductions

Capital protection must also be observed in corporations when capital measures are undertaken. Capital increases and capital reductions are highly formal procedures requiring the involvement of notaries, sometimes experts and the register court. In the GmbH & Co. KG, by contrast, the capital relationships can be adjusted, so to speak, with the stroke of a pen – by amending the partnership agreement and making the relevant booking on the partners’ capital accounts. This saves time and cost and avoids the liability risks tied to capital contribution rules. In a partnership, unlike in capital increases of a corporation, services performed by a partner can also in principle be a valid contribution for increasing the partner’s capital participation. Promised contributions can also be made by leaving profits in the business and reclassifying them, which is not permitted in a corporation.

Conclusion on liability and capital protection

The GmbH & Co. KG does have a more complex liability structure because it combines limited partner liability with the analogical application of capital maintenance rules. In practice, however, limited partner liability is usually very small because the registered liability amounts are typically kept low. In the result, the GmbH & Co. KG offers an effective limitation of liability.

Its flexibility with regard to withdrawal rights and changes in the capital participation structure is a major advantage of the GmbH & Co. KG over pure corporations.

Flexibility in separating capital and control

The corporation & Co. KG – especially the GmbH & Co. KG – offers interesting structuring possibilities where capital and control are to be separated, possibilities that cannot easily be replicated in a pure corporation.

In the typical GmbH & Co. KG, the limited partners hold shares in the general-partner GmbH in the same proportions (“GmbH & Co. KG with identical participation ratios”), or, which comes to much the same thing, the limited partnership itself is the sole shareholder of the GmbH (“single-entity GmbH & Co. KG”). That keeps capital and control – the general partner ultimately holds the management and representation powers – aligned.

Since the MoPeG reform, it is also now expressly clarified by statute who exercises in the shareholders’ meeting of the general-partner GmbH the shareholder rights that belong to the KG in the single-entity structure. Unless agreed otherwise, those rights are exercised by the limited partners (§ 170 para. 2 HGB).

This alignment is, however, by no means mandatory. A GmbH & Co. KG without identical participation ratios is also possible, in which the limited partners do not hold shares in the general-partner GmbH. In that case, the limited partners are effectively excluded from participation in the formation of the company’s will even though the company “belongs” to them economically.

That restriction of the rights of the capital providers goes further than in a GmbH with an external managing director. In a GmbH, the shareholders’ meeting still remains the highest body, appoints and removes the managing directors and can issue instructions to them. GmbH shareholders also have inalienable control rights, in particular the right to receive information about the affairs of the company and to inspect the books and all business records, including electronic documents.

The limited partners of a GmbH & Co. KG, by contrast, may not object to the day-to-day management of the general partner. They only have a right to object in relation to extraordinary management measures, and even that can be restricted further in the partnership agreement. The information rights of a limited partner are also heavily restricted compared with those of a GmbH shareholder and are essentially confined to receiving a copy of the annual financial statements and reviewing them.

Even compared with a stock corporation, which is conceptually built around the separation of control and capital, the legal position of the capital providers can be restricted more sharply in a GmbH & Co. KG without identical participation ratios. In an AG, after all, the shareholders in the general meeting appoint the members of the supervisory board, which monitors the management board and can impose approval requirements on it. A comparable supervisory body can also be installed in the GmbH & Co. KG – but that is by no means mandatory.

Conclusion on flexibility in control arrangements

The GmbH & Co. KG offers specific advantages in special constellations in which a strict separation between capital and control is desired. In practice, this occurs, first, in family businesses, where the owner wants to hand over management to one suitable heir or a third party while excluding less suitable heirs from management permanently without disadvantaging them economically.

Second, such a structure is suitable for fund-like arrangements in which the role of the capital providers is meant to be limited to a pure investment. In fact, venture capital funds are almost always organised as GmbH & Co. KG structures, although their “ordinary” corporate law framework is in part overlaid by the German Capital Investment Code or the EuVECA Regulation.

Incorporation effort and ongoing costs

Notary and court fees on incorporation

The incorporation effort of the GmbH & Co. KG is generally higher than that of a simple GmbH because two companies have to be formed. It is, however, usually still less burdensome than incorporation of a stock corporation, where depending on the circumstances an external formation audit may be required.

The notary and court fees for the incorporation, filing and registration of a GmbH amount – very roughly – to around EUR 900 gross, depending on a variety of factors. There is some room for savings, for example if the managing directors are appointed privately rather than in the notarial deed. Registration of the limited partnership itself generally requires another roughly EUR 300 in notarial and court fees, again depending on the number of limited partners and their liability amounts.

Advisory costs

The flexibility already mentioned in drafting the partnership agreement of the KG also means higher advisory costs when establishing a GmbH & Co. KG compared with a simple GmbH. The GmbH Act itself already contains many sensible default rules and was comprehensively modernised in 2008. KG law has also been updated by the MoPeG reform. Even so, it remains much more dependent on the fine calibration of the partnership agreement and does not in every respect fit seamlessly with the corporation & Co. KG.

The partnership agreement of the GmbH & Co. KG is therefore the central rulebook for the internal life of the company, and it needs to be drafted accordingly. In a GmbH – and even more so in an AG – the statutory framework plays a more dominant role alongside the articles, so there is less room and less need for customised drafting. If the partnership agreement of the KG is not notarised, the notary will usually not advise on its contents. Depending on the complexity of the relationship among the partners, one must therefore expect additional costs for a lawyer specialising in corporate law.

Ongoing costs

In a GmbH & Co. KG, both the general-partner GmbH and the KG itself must prepare annual financial statements. The financial circumstances of the general partner are usually relatively simple, however, so the accounting costs for it should not be exorbitant (roughly in the range of EUR 500). In addition, the general-partner GmbH must keep its own accounting records and file its own tax return.

There are also often initially higher advisory costs because handling the GmbH & Co. KG involves one or two practical hurdles. Who represents the general partner in the partners’ meeting of the KG? Are two separate meetings required? When do voting prohibitions apply? Who represents which company in internal transactions between the two entities?

The GmbH is easier to handle by comparison. More cumbersome still, however, is typically the stock corporation, where compliance with the many mandatory formalities is difficult without specialist support.

Conclusion on incorporation effort and ongoing costs

If the overriding priority is the simplest and cheapest possible company formation, the GmbH & Co. KG is not the ideal choice. The differences are, however, not so dramatic that incorporation effort should normally be treated as a decisive criterion in choosing the legal form.

The same applies to the ongoing costs. The GmbH & Co. KG is indeed noticeably more burdensome than the GmbH (though less so than the AG), but other factors will usually matter more than a few hundred euros per year in additional administrative expense.

Transfer of interests

One feature particularly appreciated in the GmbH & Co. KG is its flexibility in transferring interests in the company. Unlike the transfer of shares in a GmbH, the transfer of a limited partnership interest is in most cases possible without costly notarisation of the purchase and transfer agreement. The change in the limited partnership interest merely needs to be filed with the commercial register.

(If, in order to preserve identity of participation, the shares in the general-partner GmbH must be transferred at the same time as the limited partnership interest, notarial fees will of course arise in relation to that part. Since the value of the GmbH shares is regularly low, however, those costs are usually manageable. By creating a “single-entity GmbH & Co. KG”, in which the KG itself is the sole shareholder of its general partner, the transfer can generally be carried out entirely without a notary, because the interest in the GmbH passes only indirectly through transfer of the KG interest. It then remains a pure commercial register filing.)

By comparison, if a shareholding in a GmbH worth EUR 1 million is sold and transferred, the notarial deed and the preparation of the new shareholders’ list typically cost between EUR 4,000 and EUR 5,000 plus VAT, depending on the details.

Compared with a stock corporation, these advantages of the GmbH & Co. KG do not apply, because shares in an AG can likewise generally be transferred without formal requirements. No commercial register filing of the change in ownership is necessary. Anyone who values maximum transferability of the interests may therefore prefer the stock corporation for that reason. The GmbH & Co. KG is also not suitable for stock exchange listing. If the company’s interests are to be admitted to trading on a public capital market, the company must be organised in one of the forms of stock corporation – although in practice a later change of legal form into an AG is often only carried out once an IPO actually comes into view.

Conclusion on transfer of interests

The reduced formal requirements for transferring limited partnership interests, compared with transfers of GmbH shares, speak clearly in favour of the GmbH & Co. KG. In valuable businesses, this can save substantial transaction costs. (The tax differences already described in relation to transfers of interests should, however, not be overlooked.)

Where form-free and, in part, anonymous transferability of the interests is a decisive objective, a stock corporation is even better suited.

Employee codetermination

The corporation & Co. KG has decisive advantages when it comes to avoiding entrepreneurial employee codetermination.

To be clear: this does not concern workplace-level employee participation under the Works Constitution Act. That regime applies independently of legal form and allows, for example, the establishment of a works council from five employees and an economic committee from more than 100 employees.

What matters here instead is corporate-level codetermination under the One-Third Participation Act and the Co-Determination Act. Under the DrittelbG, corporations with regularly more than 500 employees must have a supervisory board one third of whose members are employee representatives. Under the MitbestG, corporations with more than 2,000 employees must have a supervisory board composed half of employee and trade union representatives.

With the significant influence that a supervisory board can exert on corporate management, most entrepreneurs do not enjoy this degree of employee influence. For businesses with a large or growing workforce, avoiding employee codetermination is therefore always part of the legal-form analysis. The corporation & Co. KG has an advantage here from the outset: the DrittelbG contains no rule under which the employees of a controlled company are attributed to the controlling entity. The employees of the KG are therefore not attributed to the corporate general partner, so no supervisory board has to be formed there merely because of them. The first threshold of 500 employees is therefore irrelevant for the corporation & Co. KG. As long as the business remains below 2,000 employees, the issue largely disappears.

If the limited partnership and its general partner are controlled by the same persons, then from 2,000 employees onward a parity-codetermined supervisory board must be established at the level of the general partner, and its sphere of responsibility extends to the business operated by the KG. Unlike the DrittelbG, the MitbestG does provide for attribution of the KG’s employees to the general partner. If, however, the majority of the limited partners do not simultaneously hold the majority of the capital or voting rights in the general partner, the employees of the limited partnership are not attributed to the general partner. In such a GmbH & Co. KG without identical participation ratios, there may therefore be no employee codetermination at all.

Another structuring tool is to appoint as general partner a corporation under foreign law. Since neither the DrittelbG nor the MitbestG applies to foreign corporate forms, employee codetermination can also be avoided in this way. The operating business is still run by a German company, which limits the practical difficulties of using a foreign entity. If the foreign legal form later proves unsuitable (one only needs to think of the English limited company after Brexit), the general partner can be exchanged relatively easily without interfering with the continuity of the operating business. (Tip: an elegant option is the use of an Austrian GmbH as general partner, since it is relatively similar to the German GmbH.)

For pure domestic corporations, by contrast, the classic route out of looming codetermination is essentially only the European Company (SE). There, however, avoiding employee codetermination generally requires a formal negotiation process with the employees and is typically a project of roughly one year.

Conclusion on codetermination

For mid-sized companies likely to employ more than 500 but fewer than 2,000 employees, the GmbH & Co. KG offers substantial advantages over corporations – assuming, of course, that a codetermined supervisory board is to be avoided. If the employee headcount is moving toward 2,000, the main structuring route on the partnership side is the use of a foreign-law general partner; on the corporate side, the route leads to the SE.

Partnership vs. corporation – overall comparison

So which is better – partnership or corporation?

Anyone who has made it this far will understand the answer: “it depends”. In many of the areas discussed here, the GmbH & Co. KG comes out ahead. But if your business neither benefits from the special tax advantages of a partnership, nor needs unusual structuring flexibility, nor is likely to approach employee codetermination thresholds, the simpler GmbH may well be the better fit.

The condensed overview:

Criterion	Winner
Taxation	Draw (but it depends on the facts)
Liability and capital protection	Partnership (GmbH & Co. KG)
Flexibility in control arrangements	Partnership (GmbH & Co. KG)
Incorporation effort and ongoing costs	Corporation (but only GmbH/UG)
Transfer of interests	Draw between GmbH & Co. KG and stock corporation
Employee codetermination	Partnership (GmbH & Co. KG)

If, after this analysis, you conclude that a partnership is the right vehicle for your project, the legal-form analysis ends here and a GmbH & Co. KG may be the appropriate structure. If you lean toward a corporation, Part 3 of this guide explains the criteria relevant to the choice between the GmbH and the stock corporation.

Choosing the legal form is an important step on the path to establishing a business. But even an existing company should revisit its legal form every few years and adjust it in good time to changing circumstances.