It may happen in the activities of a business association that equity falls below subscribed capital. What can be done about it? We have collected the potential options.
The law stipulates that if a business association’s equity is not sufficient to cover the subscribed capital prescribed for its specific corporate form over two consecutive financial years, the management must remedy the situation. A solution is to be found within a period of three months after approval of the annual account for the second year. Failing this, the business association shall be required to adopt a decision within sixty days of this deadline for its dissolution without succession or transformation (Subsection (2) of Section 3:133 of the Civil Code). In the latter case, they should opt for a corporate form the minimum subscribed capital of which they can meet.
What are the options for settling equity if the business association does not want dissolution or transformation?
– capital increase by increasing the subscribed capital,
– capital increase by share premium,
– additional capital contribution,
– withdrawal of subscribed capital up to the statutory minimum.
I. Capital increase
Capital can be increased in cash or in the form of in-kind contribution. In-kind contribution may be any assets capable of economic assessment, intellectual property, concessions, licenses, and similar rights, including a claim recognized by the debtor or based on a final court decision. Accordingly, it is also in-kind contribution if a member of the business association makes his claim on the loan granted to the business association available to the business association in the form of a capital increase. In the case of in-kind contribution, the contributing individual member should consider the value of the in-kind contribution to be transferred. If the value of in-kind contribution is higher than that for which the individual member acquired it, the difference may result in personal income tax liability. For example, if a private individual grants the right to use software developed by him as an in-kind contribution and is has virtually no recognized cost because the private individual has developed it himself, he will have to pay personal income tax on the in-kind contribution.
It is also possible to increase only the subscribed capital or the subscribed capital and the capital reserve together (capital increase by share premium). In the latter case, the owner transfers part of the contribution made by him in the subscribed capital and, at the same time, another part of it in the capital reserve, thus achieving a smaller increase in the portion of the subscribed capital. However, it has to be made sure that the amount of equity reaches at least half of the value of the subscribed capital.
Both cases must be registered with the court of registration, so this is a somewhat more time-consuming solution than additional capital contribution.
II. Additional capital contribution
An additional capital contribution to cover losses can be considered a simpler solution that capital increase. Nevertheless, the law stipulates that the deed of association must provide for the maximum amount of additional capital contribution that one member can be required to pay, and that the amount to be actually paid must be specified in a resolution of the members’ meeting. This should be the preferred option if the required amount is sufficient to increase the equity accordingly. The additional capital contributions shall be determined and fulfilled in proportion to the capital contributions, however, the amount paid shall not increase the members’ capital contributions but shall only be used to cover losses. When the loss-making management no longer exists, the additional capital contribution must be reimbursed to the members.
III. Withdrawal of subscribed capital
Another option is to reduce the subscribed capital to the minimum amount specified by law. The condition for capital reduction is that the members decide on this by a majority of at least three-quarters.
If the equity is less than the subscribed capital, it is first necessary to decide on the reduction of the share capital to settle the loss, and the subscribed capital must be reduced against the retained earnings. As a result of the capital reduction, not only the subscribed capital, but also the amount of the assets above the subscribed capital must be taken into account when determining the amount due to the members and shareholders, namely in the proportion of the subscribed capital and the equity. In such a case, part of the payment may be subject to personal income tax. It would be worth considering what elements the subscribed capital consisted of. For example, if the capital was increased from the profits of previous years, in the capital reduction it will be taxed in the same way as if the member had got dividends. As the withdrawal of subscribed capital affects the components of equity on a pro rata basis, it is also worth bearing in mind the personal income tax payable on the additional components.
The withdrawal of capital, like the capital increase, must also be registered with the court of registration, so repayments to members may only be made after the official registration.
Based on the above, it would be worth considering the various factors and making the most appropriate decision for the business association to settle the equity accordingly. Of course, it is also possible to make the hitherto unprofitable activity profitable and increase the equity by transferring the after-tax profit in the retained earnings in accordance with the regulations.