Provisions at a GmbH: Advantages & Rules

With provisions, you reduce your GmbH's annual profit — and thereby your tax liabilities. But when may you form such provisions? What are their consequences? And how do you release provisions?

These are questions you should address. Provisions are an important instrument in financial reporting, enabling you to plan ahead and avoid unnecessary tax payments. Bear in mind that forming provisions can also have disadvantages, such as lower profit distributions.

Provisions represent liabilities that will probably arise in the future with a reasonable degree of certainty. The specific obligation does not yet exist, but you must reckon with it. You form a provision in order to be able to meet this future obligation. The amount of the provision must correspond to the probable amount of the liability.

The key characteristics of a provision are:

- The liability will arise with a sufficiently high degree of probability.

- The cause of the liability lies in the current balance sheet year.

- Whether the liability will actually materialise, or its amount, is uncertain.

When forming provisions, you must exercise sound commercial judgement. This means: first, you should be able to give a comprehensible justification for why the risk of the relevant liability exists. Second, the amount of the provision should be based on a well-founded calculation.

For which probable liabilities may you actually form provisions? The legislator clearly delimits the permissible provisions for GmbHs and other legal forms. Note that there are some differences between the commercial balance sheet and the tax balance sheet. As a general rule, the requirements for the tax balance sheet are stricter.

Typical provisions are:

- Pension provisions

- Tax provisions

- Provisions for warranty obligations

- Provisions for litigation costs

With pension provisions, the basic mechanism and purpose of a provision are self-evident. Where companies give employees a direct commitment to pay them a pension, they form provisions for this purpose. The legislator explicitly requires this.

Tax provisions relate to tax liabilities that have arisen during the financial year but whose exact amount cannot yet be determined. As a business owner, you must await the tax assessment. Get in touch with your Guhr Steuerberatung! Our experts forecast the tax liabilities and recommend the appropriate provisions.

A further item comprises provisions for warranty obligations. Whether you sell products or services, in both cases your GmbH is exposed to risk. Customers return purchased goods and demand replacements, for example. Or they insist on reworking in the case of services. In addition, claims for damages may arise that are not covered by insurance. For all such potential liabilities, you may form GmbH provisions in a justifiable amount.

The same applies to costs that could arise in the course of legal proceedings. However, you may only form provisions for litigation costs if the proceedings are already pending!

Commercial and tax balance sheet law contain a number of prohibition rules on recognition of liabilities (Passivierungsverbote). Since 2009, for example, there has been a broad prohibition on forming provisions for maintenance. A company wishing to commission maintenance of its heating system, for example, may only form a provision if the work is carried out within three months after the balance sheet date. Otherwise, the legislator prohibits the provision — in that case, companies recognise the expense as a business expense in the relevant year.

There are many other situations in which you are not permitted to form provisions. If retailers distribute free discount vouchers in large numbers, for example, they may not include provisions in the balance sheet. The rules are often complex and the details frequently matter — if in doubt, contact your experts at Guhr Steuerberatung!

When you form provisions in your balance sheet, this reduces your annual profit or increases your annual loss — it thus directly affects your annual financial statements and the profit that serves as the basis for tax calculation.

Whilst no liquid funds have yet flowed out in respect of the relevant liabilities, the tax office accepts provisions as profit-reducing where there is a sufficiently high degree of probability.

When you subsequently call on the provisions, you release the relevant items. The following scenarios may arise if the provision amount differs from the actual liability:

- Your provision is too high: Book the excess amount as other operating income. It increases your income and thereby the profit on which you pay tax.

- Your provision is too low: Book the shortfall as additional operating expense. This step reduces your profit.

When you form provisions in your balance sheet, this reduces your tax burden. However, further negative effects also arise: your equity ratio falls, and your debt ratio increases. Combined with a lower profit, your creditworthiness deteriorates. This can lead to higher interest rates on borrowed capital, and loan applications may also be refused as a result. You should therefore exercise careful judgement when using the scope available for forming GmbH provisions.

Also bear in mind the potential tax implications in subsequent years. If provisions are set too high, your annual profit increases when you release them. If GmbH provisions are set too low, your operating expenses rise.

Forming provisions: consult your tax advisory firm!

Provisions are regarded as an important instrument of balance sheet policy — the scope for judgement is considerable. This raises the question: how do you deploy this instrument to best effect? Get support from an established tax advisory firm!

What are GmbH provisions?

Provisions are liabilities that will arise with a sufficiently high degree of probability in future balance sheet years. However, there is no certainty as to whether — or in what amount — a liability will actually materialise. By forming GmbH provisions, you make provision for the future; under balance sheet law, they are classified as debt capital. At the same time, this reduces the annual profit — and minimises tax liabilities.

For what purposes can provisions be formed?

Provisions may be formed for a wide range of situations. A classic example is provisions for future pension payments from the GmbH's budget. Provisions are also common in connection with warranty obligations, frequently as blanket provisions. In addition, there are further possibilities for forming provisions — for example for future tax liabilities and litigation costs.

How high may a provision be?

The amount of potential liabilities is uncertain, so provisions are based on estimates. These estimated values should be comprehensible. Depending on the type of provision, various methods are available for this purpose. Your GmbH may draw on historical data or industry-wide metrics, for example. In other cases, the amount is fixed — but it is uncertain whether the liability will actually arise.

When are provisions permissible?

A key requirement is that there is a sufficiently high degree of probability for the underlying liability. In addition, the potential claim must originate in the current tax year. If a tradesperson carries out work this year, for example, they may form provisions for warranty obligations in the following year. It is also important that no explicit prohibition on recognition (Passivierungsverbot) applies.