Since the Summer Agreement was concluded there has been much discussion on the pro rata rule for capital reductions. Given that to date no definitive legislative texts have been published, this aspect of the corporation tax reforms remains murky and changes might still be introduced to the proposed regulatory measure.
The present legislation
In the event of a capital reduction, one can presently choose which element of the authorised capital will bear the reduction, a choice that can be of some consequence in respect of tax. That is because repaying authorised capital is not deemed to be a dividend payout for Belgian tax purposes, which means it is not subject to withholding tax, if the following two conditions are met:
- the repayment is the effecting of a resolution adopted in a regular manner to decrease the authorised capital;
- the repayment must come from (a part of) the authorised capital made up of contributions actually paid in by the company’s shareholders.
The future legislation
The planned legislation will ditch the current rule that capital reductions can be allocated to that part of the authorised capital decided on by the company. When authorised capital is henceforth repaid it will be subject to withholding tax in proportion to the share of taxed reserves still present in the paid-up capital, plus the taxed reserves not held in the capital (a pro rata division). The underlying reason is that capital reductions should be due to legitimate financial or economic needs in order to be exempted from withholding tax, and they are not deemed to fulfil this condition if taxed reserves are still held by the company.
Pro rata allocation
The pro rata facet is obtained through a percentage that expresses the proportion between:
- in the numerator: the sum of the paid-up capital, the issuance premium and the profit-sharing certificates that are placed on a par with the authorised capital;
- in the denominator: the sum of the taxed reserves, the exempted reserves incorporated into the capital and the amount of the numerator. The sum of the reserves is determined at the conclusion of the previous taxable period, less the interim dividends distributed during that taxable period.
When it comes to calculating that proportionality the following are, according to the latest information received, not taken into account:
- negative taxed reserves, other than the loss carried forward;
- exempted reserves not incorporated into the capital;
- revaluation surpluses, to the extent that they cannot be distributed;
- underestimates of assets/overestimates of liabilities, the liquidation reserve and the special liquidation reserve;
- the statutory reserve up to the legally-required minimum.
The transitional arrangement for liquidation surpluses is likewise safeguarded, which means they can still be distributed tax-free after 8 years for large companies and 4 years for small ones.
Entry into force
The new regulation is expected to take effect ‘as of 1 January 2018’, which makes matters far from clear, given that the repayment of authorised capital happens in two phases:
- firstly, there is a resolution adopted by the general meeting, in the manner required for an amendment to the articles of association, to decrease the authorised capital;
- then there is the effective distribution or repayment to the shareholders. This may only be done once the qualifying creditors have been paid or once their claim to collateral is dismissed under an enforceable court ruling. For the purpose of asserting their rights, the creditors in question have a period of up to 2 months after the decision to reduce the capital is published in the schedules to the Official Journal. In real terms the actual distribution or repayment to the shareholders can only be undertaken once two months have elapsed since the decision to perform a capital reduction was published.
According to the latest information, the reference date will be the date of the general meeting that resolves to reduce the capital. That will also provide the greatest level of legal certainty, as when the second phase is used as a reference date it would mean that the future legislation would also impact all capital reductions that the general meetings decide on in November and December of this year. That would naturally mean much uncertainty indeed, as the general meetings were not yet aware of the actual details of the new regulatory measure.
To pre-empt or not to pre-empt?
Is it advisable to quickly launch a capital reduction in order to avoid the new regulation? In recent years capital reductions – in particular those combined with a preceding contribution of shares – have been the subject of the taxman’s focus. With due regard for the future pro rata division for capital reductions, the tax authorities will view a capital decrease still to be performed in 2017 with increasing suspicion, and will assess them against the anti-abuse provision (article 344.1 of the Income Tax Code). However, they will not be able to argue that the spirit of the (new) tax law was thwarted, as the spirit of a law that is not yet in effect can hardly be frustrated. The authorities can of course argue that there are no economic motives, which could be the case when the capital reduction follows an earlier contribution of shares.
So the risk of such an action being re-qualified as a pro rata allocation, which will result in 30% withholding tax, is probably zero. But if the capital reduction is preceded by a contribution of shares, other risk factors emerge, including the risk that the taxman argues that what happened was a disguised distribution of dividends, for which 30% withholding tax will be payable on the entire payout. Given that this does not fall under the subject of this article, we will not examine it further.
If we look at legislation in other countries, then the principle of a pro rata allocation is not entirely alien, with countries such as Luxembourg having introduced it some time ago. The simultaneous application of the proportionality rule and the ranking of priority of debts together with a selection of qualifying reserves do however require transparency and clear legislation. Working on the assumption that the measures will be applicable to actions performed after 1 January 2018, and more specifically to resolutions to reduce the capital and repay issue premiums and profit-sharing certificates placed on a par with capital adopted by general meetings after that date, it is high time that the legislature drafted clear guidelines – undoubtedly a difficult challenge.