Resolution on the distribution of profits by a GmbH

The approval of the annual accounts and the appropriation of profits are two separate decisions

The managing director draws up the annual accounts and submits them to the shareholders. Under section 46 of the German Limited Liability Companies Act (GmbHG), the shareholders' meeting is responsible for approving the annual accounts and the appropriation of profits. Both decisions may be taken at the same meeting and set out in a single document. However, their content should remain clearly distinguishable.

By passing the resolution to approve the accounts, the shareholders endorse the submitted accounts as the binding basis for the financial year in question. The resolution on the appropriation of profits then determines what is to be done with the distributable amount. It may provide for a full distribution, a partial distribution, an allocation to retained earnings or a profit carry-forward. A combination is often financially sensible: part is paid out to the shareholders, whilst the remaining amount strengthens the company’s liquidity and equity. The majority required is determined firstly by the articles of association and, secondarily, by statutory provisions. Under Section 47 of the German Limited Liability Companies Act (GmbHG), resolutions are generally passed by a majority of the votes cast. Each euro of a share entitles the holder to one vote. Articles of association may provide for different majorities, approval requirements or special profit rights. The annual accounts, list of shareholders, articles of association and shareholders’ agreement must therefore be reviewed prior to the resolution.

In the case of single-member GmbHs, the sole shareholder must also document the resolution. This applies in particular where the company makes payments to the shareholder-managing director. A clear distinction between salary, bonus, loan repayment and profit distribution prevents subsequent ambiguities under tax and company law.

What amount may be distributed?

The starting point is neither turnover nor the cash balance in the bank account. The decisive factor is the amount available for distribution in accordance with accounting regulations and the chosen method of presenting the results. Loss carry-forwards, statutory or articles-of-association reserves and existing restrictions on distributions may reduce this amount. In the case of an entrepreneurial company (Unternehmergesellschaft), the statutory reserve requirement under Section 5a of the German Limited Liability Companies Act (GmbHG) also applies. The resolution should clearly specify the underlying annual financial statements and state the amount available for distribution. In the case of a partial distribution, it must be specified which remaining amount is to be transferred to retained earnings or carried forward as profit. Ambiguous wording such as ‘the profit shall be distributed as far as possible’ gives rise to avoidable issues of interpretation and enforcement.

A positive set of annual accounts does not automatically mean that the company can afford the payout financially. The annual accounts reflect a specific point in time. Between the balance sheet date, the approval of the accounts and the payout, customers may default, financing may be terminated or significant losses may arise. The managing directors and shareholders should therefore carry out a current liquidity and capital review prior to passing the resolution and making the payment. Distributions must not erode the assets required to maintain the share capital. Section 30 of the German Limited Liability Companies Act (GmbHG) restricts payments to shareholders from the company’s restricted assets. Prohibited repayments may be reclaimed under Section 31 of the German Limited Liability Companies Act (GmbHG). A resolution that is formally valid therefore does not provide protection if the payment materially contravenes the requirement to preserve capital.

What the resolution on the distribution of profits should cover

A practical resolution specifies the company, the financial year and the approved annual accounts. It quantifies the net profit for the year or retained earnings and clearly specifies which amount is to be distributed, set aside or carried forward. Where there are several shareholders, the distribution should be specified either by means of specific amounts or by a clear allocation formula.

Equally important is the due date. In the absence of a clear provision, questions may arise as to when individual shareholders may demand payment and when capital gains tax must be withheld. A specific payment date or a clearly definable deadline simplifies accounting and tax deduction. In the case of larger distributions, payment in instalments may be provided for, provided that entitlement, due dates and conditions are clearly described. The resolution should also stipulate that the payment is to be made only in compliance with capital maintenance requirements and mandatory obligations under insolvency law. Such a clause does not replace the current assessment, but makes it clear that the entitlement to a distribution must not be exercised in contravention of mandatory law. If liquidity is uncertain, it may make more sense to carry forward the profit initially and distribute it later on the basis of a new resolution.

In the case of cross-border shareholder structures, tax formalities must be addressed early in the process. Certificates of residence, exemption procedures and double taxation agreements can influence which tax deduction is to be applied. These issues should be clarified before the due date, not only after the net amount has been transferred.

Distribution according to shareholding or non-proportional distribution

Under section 29(3) of the German Limited Liability Companies Act (GmbHG), distribution is generally made in proportion to the shareholdings. The articles of association may specify a different basis. In practice, deviating or non-proportional profit distributions are considered, for example, where one shareholder requires liquidity, other shareholders wish to retain profits, or there are different classes of shares.

A deviation from the standard distribution should not be decided upon casually. First, it must be checked whether the articles of association expressly permit it or contain a sufficiently broad discretionary clause. Case law has also treated certain unanimous, non-voidable individual resolutions as valid under civil law. Whether such an ad hoc departure from the articles of association holds up in a specific case, however, depends on the content, the lasting effect and the voting outcome. For recurring deviations or those requiring a majority decision, a clear provision in the articles of association is generally the more robust basis. Amendments to the articles of association generally require notarisation and only take effect upon registration.

Even where a resolution is valid under civil law, its tax treatment must still be examined separately. Tax case law recognises inconsistent distributions under certain conditions, but requires a valid basis under company law. Spontaneous profit transfers, hidden consideration or recurring arrangements lacking a consistent strategy may raise further questions. Particularly in the case of family-owned companies or related parties, the economic background and the resolution should be documented.

A shareholder’s waiver of a distribution claim that has already arisen is not the same as a profit distribution resolution that deviates from the norm from the outset. The timing and legal structure can have different tax consequences. Anyone wishing to structure the distribution non-proportionally should therefore align company law and tax law before the resolution is passed.

Interim dividend and interim payment

Shareholders often wish to withdraw profits during the current financial year or before the annual accounts have been finalised. Such advance distributions carry significantly greater risk than a regular distribution based on approved financial statements. They require a sound basis under company law, a robust interim financial statement and a forecast that a distributable profit will in fact remain at the end of the period.

If it later transpires that the expected profit did not materialise or that the capital maintenance requirement has been breached, claims for repayment may arise. The managing director bears the risk of making payments without a sufficient basis. A mere expectation of good business results or a monthly ‘profit withdrawal’ as in a sole trader business is not consistent with the separation of assets characteristic of a GmbH.

In the case of shareholder-managing directors, ongoing payments are often incorrectly treated as a flexible hybrid of salary and profit. Remuneration for management services requires an employment contract agreed in advance and valid for tax purposes. Profit, on the other hand, arises at the level of the company and is only distributed via the process of profit appropriation under company law. Both grounds for payment should remain clearly separate from one another in the accounts, contracts and bank transfers.

Taxes and actual payout

When making distributions to shareholders, the GmbH must, as a general rule, check whether capital gains tax and the solidarity surcharge are to be withheld, declared and paid. The specific tax liability of the shareholder cannot be described in general terms using a single tax rate. It depends, amongst other things, on whether the shareholding is held by a private individual or a company, the size of the shareholding, and whether the recipient is resident abroad.

The resolution, the due date and the actual receipt of funds must therefore be coordinated. Tax obligations may arise as soon as the payment is made or on the legally relevant date of receipt. Special rules regarding the date of receipt apply to controlling shareholders. The company should not simply transfer the gross payment amount and clarify the tax issue retrospectively.

A clear implementation process is recommended for the managing director. Prior to payment, the resolution, shareholding structure, tax status, bank details and capital maintenance requirements are checked. The accounts department receives a clear gross-to-net calculation and documents the declaration and payment. In the case of foreign shareholders, it should be clarified whether a reduced withholding tax rate may be applied directly or whether a refund procedure is required first.

Common mistakes and how to avoid them

The most common mistake is making a payment without an adequate resolution. Equally problematic are resolutions that do not specify the underlying financial statements, do not state a clear amount, or leave the distribution and due date open. Where there are several shareholders, further issues arise, such as incorrect notices of meeting, failure to observe majority requirements and inconsistencies with the articles of association.

The situation becomes financially risky if the decision focuses solely on the net profit for the year and ignores current liquidity. A limited liability company (GmbH) may be profitable on the balance sheet yet still be insolvent in the short term. If insolvency is imminent or has already occurred, safeguarding liquidity and obligations under insolvency law take precedence over shareholders’ interests.

Finally, the resolution should be consistent with the accounting records. If an amount is resolved to be carried forward as retained earnings, it must not be treated simultaneously as a free distribution liability. If reserves are created or released, the annual financial statements must reflect this in a transparent manner. The resolution under company law, the tax return and the payment should be organised as a single, coherent process.