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Tip for every startup: activate self-created, intangible assets in the commercial and tax balance sheet

Innovative start-ups often find themselves in the situation where they have to invest heavily in the development of their products and services before they are marketable. It is important for them to know whether and how they can activate self-created intangible assets and what positive effects they can achieve.

Certainly not every single euro invested will influence the value of the development. But there is agreement that these are largely investments and not ongoing costs. Whether the time and money invested will ultimately be used for business purposes is usually not decided at the beginning of development, but rather at a later point in time. The development process at a startup must therefore be divided into phases, although the demarcation can vary:

  • Startup: from the idea to the invention
  • Decision to start a business
  • Acquisition of investors, further development to series maturity
  • Entry into the market
Table of Contents

Startup: from the idea to the invention

Whether a startup has a brilliant idea or the decision to found a company is born out of necessity: It starts with the idea of ​​developing a solution to an existing problem or a gap in the market. Research is done and time and money are invested. Whether this will ever become a company will only be decided at a later date. Until then, the process takes place in tax privacy. The tax office would only allow a startup to deduct costs if it can prove that a business plan that predicts future profits was already in place at the time. 

Over time, the findings become so concrete that the project is either abandoned or it reaches a level that appears to be useful for business purposes. This is then the point at which a decision has to be made. Those who shy away from entrepreneurial risk either give up or look for a partner or buyer for the development. In the case of a sale, it is then examined and decided whether, and if so, under what type of income, the profit or loss from the sale is to be taxed.

Decision to found a startup company

Anyone who dares to take entrepreneurial risks is now entering a new phase. The development leaves the tax privacy and from now on belongs to the tax business assets. This is exactly where startups often make blatant mistakes when the transfer of a tangible or intangible asset is not treated as a deposit. Anyone who, as a young entrepreneur, brings their previously privately used PCs, their privately purchased machines and equipment or their car into their business assets must value them at the time of the deposit and can write off this value in the future. The different valuation regulations in commercial law and tax law must be observed. However, the actual value is not materially tangible; it consists of intangible assets in the form of the value of development, the value of patents or other rights. A patent or a development is worth as much as it generates future income. That can be a lot.

Contribution to the trade balance - increase in equity

When it comes to accounting, a new business owner is faced with a recognition and valuation problem. When can or must I activate self-created, intangible assets? According to commercial law regulations, there is a right to choose. Afterwards, self-created intangible assets may be capitalized. This leads to a corresponding increase in the balance sheet equity and thus influences the company's creditworthiness. A distinction must be made in terms of tax law.

Deposit in the tax balance sheet - save on taxes

Anyone who, as a startup, places their development or patents in their private assets as business assets will have impressive tax opportunities. The right time is crucial. Because only expected benefits from the use of an idea or development that have not yet been concretized in an intangible right are not yet eligible assets for tax purposes. The highest financial court, the BFH, formulates the requirements for an intangible asset that can be contributed under tax law as follows:

 

  • The assessment of an asset must be carried out on the basis of an isolating approach; Therefore, all that matters is whether another imaginary merchant would pay extra for this particular asset.

 

  • The asset must have become economically independent at least to the extent that it can be used by the receiving company without significant involvement of the person contributing it.

 

  • Patents regularly meet this requirement. But programmed software solutions and developed recipes can also be sold and therefore eligible for investment.

 

It is therefore better not to start or register the company until you meet these requirements. The intangible assets included in the business assets and created by the start-up entrepreneur themselves must then be valued according to general principles. Anyone who has developed a truly marketable solution often has very high values ​​that they do not have to pay tax on privately, but which the young company can depreciate and thus save taxes on. However, if the company sells the contributed asset within 10 years, the contribution will be subject to additional taxation. But then there is usually enough money from the sale to pay the tax.

Startup taxation in the course of financing rounds

The company founders often do not have enough resources to bring the new company onto the market or to really push the market. Additional funds required can be obtained through crowdfunding or loans, for example loans from KfW, or through additional equity.

 

However, capitalization via additional equity usually takes place as part of so-called financing rounds. To prepare for this, the current status of development and the market opportunities are assessed in a due diligence examination and finally the value is determined as part of a company valuation. On this basis, which regularly represents 100% of the company's value, shares in the company are then given to investors. If the investors buy shares from the previous shareholders, then this constitutes a taxable sale transaction. But this is not entirely in the interests of investors, who would rather see their money invested in development than in paying private taxes. Therefore, it will be preferred to increase the company's capital while simultaneously diluting the holdings of the existing shareholders. The tax treatment of the situations differs depending on the country and legal form in which the company in which the investors participate is organized.

 

The start-ups should consider whether they should accept each investor individually as an additional partner and thereby potentially hinder future developments. It is therefore worth considering whether it would be better to bundle and organize investors in your own investment company. One option for this is a company under civil law. For example, if investors from several countries organize themselves into a GbR, which in turn holds a share in a partnership, e.g. a GmbH & Co KG, not all investors always have to attend the shareholders' meeting in order to establish a quorum. At the same time, the interests and rights of investors are protected as best as possible. Every investor can structure their tax situation in the way that best suits them. Whether someone participates as a private individual, as an entrepreneur, as a partnership or as a corporation is up to everyone, regardless of their country of origin. According to international taxation rules and all common double taxation agreements (DTA), the taxation of capital gains and capital gains from shares in partnerships is only based on the conditions in the company's country of residence if it concerns commercial income. If it involves equity investments, then one speaks of capital income. Their taxation depends on the investor’s country of residence. For the company itself, this means a high degree of flexibility when accepting investors. The strategically clever positioning of the company creates stability and maintains the ability to act in future decisions.

Be careful with hidden deposits in a GmbH

The Income Tax Act contains a trap for cases in which an intangible or other asset is hidden in a corporation. If the start-up entrepreneurs first develop a solution and later set up a GmbH by setting up a cash company, but forget or do not handle the introduction of the development, the description of the patents correctly, then this will be noticed at the latest when investors come in. As part of the due diligence checks, it would be discovered that the patents are still registered in the name of the founders. Of course, this is not in the interests of investors. Consequently, the patents are transferred to the GmbH. This is treated as a deposit for tax purposes. The previous legal owner of the patent is treated as if he had managed the patent as a business asset for tax purposes as part of a so-called business split at a book value of zero and now sold it to the GmbH at its real value. This is a tax disaster. 

 

But even without a description of the patent holder, if the GmbH pays patent fees, incurs further expenses for the development or even grants licenses, an economic transfer of the development is assumed with the same tax consequences. The GmbH becomes the beneficial owner of the patent or solution by way of a hidden contribution. This means that the start-up entrepreneurs find the fictitious sale of their development reflected in their income tax assessment. The mostly high values ​​from current financing rounds are documented. The tax will be correspondingly high.

 

In order not to fall into the trap, a share capital increase with a share premium should be carried out if the company forgets to re-register or transfer it to a GmbH founded in cash. To do this, the share capital would be increased by a manageable amount and a premium in the form of the patent would be agreed upon in the notarial deed as an additional deposit.

Further investments in the IP in the young company

When the company is founded and the IP is contributed, the development process is usually not yet completed. Future costs would be charged to the result and therefore to the equity, which brings with it the risk of over-indebtedness. This also increases the risk of an obligation to file for insolvency in accordance with Section 19 InSO. In order to avoid this and to make the young company look good in terms of its external image/publicity, you can exercise the option under commercial law to capitalize self-created, intangible assets. This requires that the costs are clearly separated and recorded correctly. 

 

Activation means that the costs for producing the IP (intellectual property) are attributed to a valuable asset in accounting and that these production costs are then depreciated under commercial law and for tax purposes from the time the IP is used commercially. With this choice, German commercial law comes closer to international standards. According to IFRS, the capitalization of research and development services on IPs is also mandatory. However, if a self-created, intangible asset is capitalized due to the option under the HGB, the development costs must also be included. Research costs on the other hand are not allowed to to be activated.

Internally generated, intangible assets: development costs versus research costs

Representation rules apply in all of the companies mentioned, according to which every partner is at least involved in the representation. The KG is available as another legal form, which is also a partnership. Although the KG is covered in the HGB, not every KG has merchant status. The most important exception is the asset-managing KG. Otherwise, all statements regarding the OHG also apply to the KG with the following differences:

 

  • At least one partner must be fully liable, analogous to the OHG, this is the general partner
  • Several general partners can also be involved
  • General partners can also be limited liability companies
  • The KG also has one or more other partners who are only liable for a fixed amount, these are the limited partners

 

A general partner does not need to make a contribution; he can participate without any assets. The general partner can be a natural person or a legal person, i.e. a corporation. Unlike other partnerships, management and representation is solely the responsibility of the general partner. The limited partners only have information and voting rights at the shareholders' meeting.

There can be several general partners. If there are only legal entities as general partners, this must be listed in the name of the company, e.g. GmbH & Co KG. Limited partners are only liable for their investment, but can have a higher liability amount entered in the register. The deposit has no legal minimum amount. The KG is only a tax subject for sales tax and trade tax. The KG's income is determined in a notification uniformly for the company and with a separate allocation of the respective share for the partners. Tax losses are also determined uniformly and separately. Losses can only be offset up to the amount of the liability; excess losses are carried forward and offset against future profits. Taxation is carried out separately for each partner in his or her personal tax return.

Important startup knowledge: Development costs can be capitalized

You have to know the terms and keep them apart:

  • The production costs of a self-created, intangible asset are the expenses incurred in developing it.

 

  • Development, on the other hand, is the application of research results or other knowledge for the new development of goods or processes or the further development of goods or processes by means of significant changes.

 

  • Research is the independent and planned search for new scientific or technical findings or experiences of a general nature, about whose technical usability and economic prospects of success fundamentally no statements can be made.

Corporation: not always the right corporate form for startups

A corporation is over-indebted when the assets no longer cover the existing liabilities, unless the continuation of the company is overwhelmingly probable given the circumstances. 

 

A startup may quickly become over-indebted. Apart from the temporary special situation regarding Corona, there is then an obligation to file for insolvency despite the liquid assets still available, unless countermeasures are possible and taken immediately, but at the latest within three weeks. However, with regard to the obligation to file for insolvency, the balance sheet is not important if there are hidden reserves in the capitalized assets. It is worthwhile for startups to make use of the existing options. As described, this requires clean documentation and accounting with strict cost allocation in advance. 

 

The managing director must check the results of a continuation forecast particularly carefully to determine whether the company's financial strength is sufficient to continue as a going concern in the medium term. As soon as the “losses” of a corporation, however justified, are higher than half of the paid-in share capital, an insolvency check must be carried out or even bankruptcy must be filed. Otherwise, the managing directors will be personally liable to prosecution and will also be liable for all losses.

 

The question therefore arises as to whether a GmbH is always the right legal form for a startup or at what point, if necessary, the GmbH should be founded. In the case of a partnership, with the exception of GmbH & Co KG, excess indebtedness is not a reason for insolvency. As long as the investment is increased by increasing equity capital, this means increases in liability capital, premiums, deposits, etc Corporate loan with “hard” subordination, as long as there is no obligation to file for insolvency.

If you have decided on a corporation, then a startup also needs other solutions in the event of excessive indebtedness. A pair of  strategic solution approach could be to assign the IP (intellectual property) not to the development company from the outset, but to a company that was specifically set up to hold and manage the patents. Whether you set up a so-called license box in a state that particularly favors this or whether you do this with another company must be examined on a case-by-case basis. The fact is that, in case of doubt, the unfinished IP (intellectual property) does not belong to the otherwise loss-making developer company, but is protected in a “treasure chest” or patent box. This orders the development service from the company that has the necessary capacity. This will usually be the affiliated company, but you may also buy from third parties. The developer company thus receives sales that compensate for the expenses incurred. If the contracts are designed accordingly, this leads to a risk and functional analysis, which then results in the billing of services based on the cost-plus method (cost+). The developer company therefore makes slight profits and can continue to exist unhindered regardless of the costs invested. An obligation to file for insolvency could only arise if the company is no longer financially viable. In this respect, equality with the partnership is established.

Special feature of the patent or license box

The “treasure chest” or patent or License Box is nothing more than an IP company. It has no self-created intangible assets and no research and development costs. It receives the patent and the intangible assets through a contribution, purchases services from a related company or from third parties. The services are therefore not considered personal contributions and must be fully activated. The costs are easier to identify and separate because a contract is usually concluded between the buyer and seller regarding the purchase price paid. From this it can be concluded that this represents a secure and valid value for the intangible asset, which can be capitalized as a value and shown on the balance sheet.

 

Otherwise the buyer would not normally have been willing to pay the quoted price. Of course, the necessary care should not be ignored, especially when it comes to affiliated companies. In essence, activation is easier and the administrative effort is also recorded via cost+ billing. Because the invoice issued by the “external” developer company includes all costs. The incoming invoice is posted to the asset by the recipient and thus the client and owner of the IP. This is received very differently by potential investors than a company with over-indebtedness, as is the case in the standard case.

License box, founded in Liechtenstein - based in Switzerland

If you set up the ownership company (license box) in Liechtenstein and then move it to Switzerland, then you have a company that is founded under the law of an EEA state (Liechtenstein), but is nevertheless based in Switzerland, which has favorable tax rates. This is important with regard to possible later changes in the shareholder structure or in the legal form of the company. When setting up the license box in another country in Europe, a startup does not need to take this special feature into account. 

 

Activate intangible assets in Switzerland. In Switzerland, the accounting standard is not the HGB, but rather Swiss GAAP FER.

 

The company then prepares its accounting according to this standard and adheres to the specialist accounting recommendations, or FER for short. FER users are neither required nor prohibited from using application recommendations from other standard setters unless Swiss GAAP FER itself has closed the interpretation gap. For the startup company, this is particularly important for the question of activating intangible assets. In this respect, the international standard IAS 38 is also used, as it requires control over the use of intangible assets in addition to the criteria not mentioned in FER 9.

As a result, the IP, i.e. the development, is capitalized in the Swiss balance sheet; in the German development company, a small profit is shown as a result of offsetting the costs plus the profit markup. This means that the company as a whole has positive balance sheet equity.

Surrender of use for a license fee

If the IP is marketable, the use of the development will be left to external third parties or, if necessary, to affiliated various national companies founded specifically for this purpose, whether designed as production or sales companies. The transfer of use takes place against payment of a license fee. It goes without saying that this has to be seen against the background of national tax laws and international agreements, for example in double taxation agreements (DTA). But it is a practice practiced and recognized worldwide that one holds an IP in a country or a company and the Use available to other companies via a license fee (royalty fee).

Jürgen Bächle
Jurgen Bachle

has been working as an independent tax consultant and expert in international tax law since 1989 and has been a member of the board of the German Association of Tax Consultants Baden-Württemberg, DSTVBW, for over 20 years.

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