Next to dividend distributions and (early) repayment of intercompany loans, a group may also consider a capital reduction to repatriate cash to the upper tier structure. Whereas a reduction of fiscally paid-up capital is in principle tax neutral between corporates, it may still have some (unexpected) tax consequences.
Item #6: A capital reduction is not always a capital reduction
Although capital reductions did the trick for quite a while, the Belgian legislator introduced a deemed dividend rule for capital reductions as of 1 January 2018. Pursuant to this provision, (most) capital reductions are – for tax purposes – assumed to originate proportionally from fiscally paid-up capital, taxed reserves and tax-free reserves incorporated in share capital. As opposed to the past, a Belgian company can thus no longer suspend its dividend distributions until it fully repaid its share capital. Depending on the company’s equity snapshot, corporate income tax and withholding tax (WHT) may now be due as of the first capital reduction.
Another complexity – that we inherited from the new company code – is that the Belgian income tax code now has its own definition of capital to provide for a fallback if the governing (Belgian or foreign) company law does not award statutory capital to the company. Hence, one needs to consider or the company law definition or the tax definition to determine the fiscally paid-up capital. Note that this is relevant to capital reductions of both Belgian and foreign subsidiaries. Especially in cross-border context, determining the amount of fiscally paid-up capital and the analysis whether the contemplated repayment qualifies as a capital reduction may be quite a challenge.
In the hands of the company performing the capital reduction, a 30% WHT is due on the part of the capital reduction that is assimilated to a dividend distribution (unless a WHT exemption or reduction can be applied). In addition, the capital reduction will be subject to corporate income tax if it is deemed to be distributed from tax-free reserves.
Another important topic in this respect, is that the Belgian tax authorities – backed by recent case law – are rather reluctant to accept the tax deductibility of interest expenses resulting from so-called leveraged capital reductions. Although we believe that one may come to opposite conclusions on the basis of the full fact pattern underlying the leveraged capital reduction, it is clear that one should carefully consider all aspects before engaging in this type of transaction.
At the other end of the spectrum – i.e. in the hands of the parent company – the impact on the tax position of the beneficiary company will be rather limited insofar the repayment qualifies as fiscally paid-up capital or the parent company meets all conditions to benefit from a full participation exemption on the deemed dividend.
However, this does not imply that capital reductions are without any tax risk in the hands of the parent company. Indeed, if a parent company would receive a repayment of capital exceeding the acquisition value of the shares it holds in its subsidiary (e.g. because it acquired the shares when the subsidiary was in financial distress for a value below the statutory capital amount of the latter) a taxable profit will arise. Although this position is not new, recent case law (re)confirmed that no participation (or capital gains) exemption can be applied to such exceptional income, resulting in a tax cash out of 25%.
Finally note that capital reductions may also trigger secondary tax effects (e.g. adversely impact the 5:1 debt-to-equity ratio for grandfathered or tainted intercompany loans), may result in financial implications (e.g. pressure on bank covenants) or may have unexpected legal implications.
Should you have any questions in this respect, please contact us.
While most companies have applied for the COVID measures available by now, we see that quite some groups struggle to monitor closely their short-term (and certainly mid-term) cash position and how to manage and optimise it further to steer their company through this crisis in the best way possible. We meanwhile have created the following email platform: email@example.com in order to give you a sounding board in these challenging times.