Does the distribution of liquidation reserves affect the favourable regime for family businesses?
A number of conditions must be met in order to continue to benefit from the favourable regime for family businesses. One of these is not to reduce the capital in the three years following a gift or death. For companies without share capital, this relates to the fact that the equity may not fall below the amount of the contributions. Is this reconcilable with the distribution of a liquidation reserve? Vlabel issued a statement.
What does the favourable tax regime for family businesses entail?
For many years now, a favourable tax regime has been in place pertaining to the donation or inheritance of shares in family businesses. Two conditions have to be met in order to benefit from this favourable regime.
- Participation, which means that the donor or testator, and their family, must have a certain degree of control over the company.
- The second condition relates to the company’s specific economic activities.
If the company qualifies as a family business, shares in the company can be gifted without incurring gift tax. If the shares are inherited, an advantageous rate of 3% (direct line) or 7% (other) applies.
Conditions for maintaining the favourable regime
If you or your heirs have used the favourable tax regime for shares in your family business, you still have to comply with a number of conditions. If not, the favourable tax regime will no longer apply.
One of these conditions is the so-called capital maintenance, which implies that no capital decrease may take place in the three years following the gift or death.
However, as the new company law abolished the concept of capital for certain types of companies, such as a private limited company, this condition was amended. For these companies without share capital the equity must not be reduced, through distributions or repayments, below the amount of the contributions made until the time of death or the deed of gift, as shown in the annual accounts, for a period of three years.
What about the distribution of liquidation reserves?
Many companies build up tax-efficient liquidation reserves throughout their existence. The Flemish Tax Administration Vlabel was asked whether the distribution of these liquidation reserves by a private limited company would affect the favourable tax regime, as the distribution of liquidation reserves reduces the company's equity.
The Flemish Tax Administration ruled as follows:
A liquidation reserve is part of the company’s equity rather than the contributions. Depending on the company’s specific circumstances, a distribution of these reserves can indeed reduce the company’s equity to below the amount of the contributions made on the date of the original deed or gift. This will be examined during the a posteriori audit based on the annual accounts
The Flemish Tax Administration is, therefore, applying the decree correctly. It is perfectly possible to distribute the liquidation reserve, but you must be vigilant. The annual accounts are examined at the time of the audit. If this shows that the equity has fallen below the amount of the contributions as a result of distributions, the favourable regime will no longer apply in full. This applies to the distribution amount that reduces the equity capital to less than the contributions.
A brief example
At the time of the gift, the private limited company BV X had the following balance sheet under the favourable regime:
BV X balance sheet
The amount of the contributions of € 500 is the benchmark.
- If BV X makes distributions in the three years following the gift to the amount of € 500 (regardless of whether this is a distribution of contributions or reserves), there will be no problem. The equity will remain at € 500 and will therefore not fall below the benchmark.
- If BV X makes higher distributions, e.g. amounting to € 700, the equity capital will drop to € 300. In this case the condition has been breached and € 200 will be taxed without the application of the favourable tax regime.
The Flemish Tax Administration will have to wait until the end of the three-year period before it can execute an audit.
Distributions and losses?
An important question as yet without a definitive answer relates to what the Flemish Tax Administration intends to do if a family business made equity distributions and recorded losses in the three years following the gift or inheritance. It is unclear whether the chronological sequence is relevant in such cases.
If the loss occurred after the distribution, and it is only due to this loss that the equity fell below the contributions, it would be justifiable to maintain the favourable regime.
Would you like further information on the impact of the distribution of liquidation reserves on the retention of the favourable regime for family businesses? If so, please do not hesitate to contact our Estate Planning team.