Tax implications of converting a sole proprietorship into a legal entity

In a previous article, we discussed that as an independent activity grows, the question of creating a legal entity naturally arises. Although official statistics are limited, several sources confirm that most Swiss entrepreneurs choose the limited liability company (Sàrl) over the public limited company (SA) when taking this step.

This transformation is not without its challenges. It is not merely an administrative formality but a legal and fiscal process governed by the Swiss Code of Obligations and the Merger Act (LFus). These legal frameworks regulate the transfer of assets and liabilities from a sole proprietorship to a capital company.

Tax deferral: a mechanism ensuring fiscal neutrality

Under certain conditions, Swiss tax authorities allow for a tax deferral to avoid the immediate taxation of latent capital gains accumulated within the sole proprietorship. This mechanism is designed to ensure that entrepreneurs are not penalised fiscally when structuring their business.

Hidden reserves

Converting into a limited liability company (Sàrl) can have tax implications regarding hidden reserves (such as unrecognised assets, customer relationships, or depreciated machinery). In Switzerland, these hidden reserves can be transferred without immediate taxation if the following conditions are met (Art. 19 of the Federal Direct Tax Act – LIFD):

• The acquiring company is subject to tax in Switzerland;
• The transaction involves a business or autonomous business unit taken over at book value;
• The owner does not sell their shares within five years of the conversion.

When these criteria are met, the restructuring is considered fiscally neutral, allowing the entrepreneur to avoid taxation on any extraordinary gain at the time of the transfer.

Liquidation gain: a special regime

In some cases, an entrepreneur may choose to liquidate the sole proprietorship instead of converting it. If this decision is made after the age of 55, it is possible to benefit from a favourable tax regime provided for under Article 37b, paragraphs 1 and 2 of the Federal Direct Tax Act (LIFD). This regime allows for a reduction in the taxation of hidden reserves, provided that the activity is permanently ceased or in the event of incapacity to continue the business for medical reasons.

We will explore this mechanism in more detail in a future article, outlining the conditions and benefits related to the taxation of liquidation gains.

What’s next?

As part of this series on the legal and tax evolution of businesses, our next article will cover the conversion of a limited liability company (Sàrl) into a public limited company (SA), analysing the motivations, implications and opportunities such a change can offer.

Our wealth planning specialists are available to assist you in these considerations and to support you in implementing your projects.

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