Conversion of shareholder loans. What companies should pay attention to in terms of legal and tax aspects when converting shareholder loans into equity. – Company / Commercial law
NOZZLE Rechtsanwälte Steuerberater
Germany: Conversion of shareholder loans. What companies should pay attention to in terms of legal and tax aspects when converting shareholder loans into equity.
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Tax payments and exposure to debts in insolvency are imminent.
A simple loan waiver can be declared quickly. It is also not complicated to transfer a loan receivable to the capital reserve as a voluntary contribution or to reclassify it from the loan account to the equity account of a partner in a partnership. This way, a shareholder loan is converted into equity in no time. Even though things need to be done quickly, the consequences of such a transaction should be carefully considered and optimally structured before implementation. whether the corporation is a corporation or a partnership. This recommendation applies particularly if the company is already in crisis. Despite the “right goal” of building equity, significant drawbacks are imminent if the wrong arrangement is made.
What can happen?
- Taxable profit: In the case of companies (limited liability companies or German joint-stock companies, etc.), a waiver of the loan or a contribution of the loan to be received by the shareholder may result in a profit subject to corporation tax and business tax. . This happens if the shareholder’s debt had already been written down due to a threat of default. This will regularly be the case for companies in crisis. The taxable profit is the difference between the market value of the debt and the face value of the loan (German Federal Tax Court of June 9, 1997, GrS 1/94). The worst case is that there is a tax outflow during the crisis affecting the liquidity of the company. This happens if the company does not have enough losses available or if the minimum tax applies.
- Donation tax: If the company has several shareholders, often not all have granted loans to the company. If a shareholder waives a loan receivable beyond his participation or brings a loan receivable without increasing his participation, this may constitute a gain for the other shareholders subject to gift tax. The German Federal Tax Court (Bundesfinanzhof, BFH) has already ruled that this is the case for a disproportionate contribution to a partnership (BFH of February 5, 2020, II R 9/17). This is not just the case between family members. If the ownership structures are suitable, the gift tax can still be triggered. This is the case if the shareholders do not agree in advance on a valuation of the company and there is over- or under-compensation. Reservations or hidden losses were often not taken into account in such cases.
- Insolvency Law Challenge: If the company subsequently becomes insolvent despite the increase in equity, the prior conversion of a shareholder loan to equity may be considered repayment of the loan if it is poorly structured. The insolvency administrator can challenge the repayment of a loan. This is possible if it is done in the year before the insolvency of the company. The consequence would be that the shareholder would have to advance the loan amount back to the company. He can then file his claim in the insolvency table – with an uncertain repayment ratio. As the amount of the loan has not been reimbursed to the shareholder in cash when it is converted into equity, the re-advance of the loan can constitute a fundamental threat to the liquidity of the shareholder.
- If the company has obtained not only shareholder loans but also bank loans, shareholders often have to subordinate their loan. Such subordinations often restrict repayment and the shareholder’s right to transfer the loan receivable. The conversion of the shareholder loan into capital may constitute a violation of the terms of the loan agreement and of the subordination. The shareholder could then be exposed to claims for damages from the banks. Where appropriate, the conversion of the shareholder loan should be coordinated with the banks.
When carefully structured, these risks can often be avoided without detracting from the objective of the arrangement. In terms of taxation, there are even structuring opportunities, for example when it comes to optimizing the use of losses.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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