The liquidation reserve is an important tool that SMEs can use to reduce the tax burden on dividend distributions. Recent developments in company law have created new opportunities for companies with mixed shareholder profiles. We take a quick look at the most important aspects and recent developments.
Liquidation reserves
Dividend distributions to individuals are in principle subject to a withholding tax of 30%. To mitigate this rate of tax to some extent, SMEs have the option of reserving profits in a separate liability account, the liquidation reserve, instead of immediately paying them out as dividends.
Advantages of the liquidation reserve for dividend distributions
When the reserve is formed, a 10% tax advance is payable by the company. A further 20% or 5% of withholding tax is then due when profit distributions are made from the reserve, depending on whether they take place within a period of five full financial years after the reservation or later. When the company is wound up, the liquidation reserve can even be distributed completely tax-free.
Based on the coalition agreement, the rates of tax and the waiting period may be changed in the near future. See our section on the coalition agreement (personal income tax) for more details.
Mixed shareholder profiles
It is not worth forming a liquidation reserve in a company if all or some of its shares are held by another company (a holding company). The reason for this is that if the corporate shareholder is eligible for the DRD deduction (DBI-aftrek/régime RDT), dividends received are free from tax without the need to form such a reserve. The formation of a liquidation reserve is therefore similarly inadvisable if shares will be sold to another company in the short or long term.
This is especially true as the Minister of Finance, when questioned about this in 2015, stated that it is not possible to prioritise shareholders who are natural persons when distributing the liquidation reserve because all shareholders have identical profit entitlements
Since then, however, the new Companies and Associations Code has come into force, giving rise to more situations in which provision can be made in the articles of association for an unequal distribution of dividend rights between different share classes.
Asymmetric allocation of the liquidation reserve
In an asymmetric allocation of reserved profits, the liquidation reserve is distributed to, for example, shareholders who are natural persons (who can benefit from the reduced tax rates). Other distributable reserves are then paid out to the corporate shareholders.
Amendment of articles of association
Carrying out an asymmetric allocation in an existing company requires an amendment of the articles of association in order to create two classes of shares: for example, ‘A shares’ (held by natural persons) and ‘B shares’ (held by companies).
Tax Ruling Committee: confirmation of validity for tax purposes
The Tax Ruling Committee has now confirmed in several prior decisions that this approach is not considered to be a form of tax abuse, as the creation of different share classes is not contrary to the tax objective of liquidation reserves. Moreover, there are economic reasons that justify amending the articles of association in this way.
Such an amendment enables a mixed shareholder profile to be managed more effectively and removes a barrier to entry for new investors of different types, which is of course important for the company’s long-term continuity. The fact that the liquidation reserves were created before the amendment of the articles of association does not present a problem in this context either.
Conclusion
When a company’s shares are transferred to a corporate shareholder, unless a ‘preventive amendment to the articles of association’ is made, the benefits of the liquidation reserves are lost. Moreover, the 10% tax that has already been paid becomes – in retrospect – a pointless expense, as it cannot be offset or reclaimed (either by the company itself or by the corporate shareholder).
The timely creation of different share classes with different profit rights offers a solution whose validity for tax purposes has now also been confirmed. Companies with a mixed shareholder profile that want to make optimal use of the liquidation reserve should therefore consider this option.
Professional advice: essential for proper implementation
Given the complexity of this area and the importance of proper implementation, professional advice tailored to your needs is highly recommended. Your regular advisor at Grant Thornton advisor will be happy to help!
