The restructuring of the debt of capital companies through the use of the so-called conversion of debt to share capital is often seen in the economic world. A lender who has granted a monetary loan to a limited liability company or to a limited liability company is then often allowed to convert the debt owed to the company in question into shares or shares of that company. How does this process take place, and how do we pay attention to the law?
two debt conversion models
This process takes place according to one of two commonly used models. first The possibility is that the company increases its share capital and offers the creditor shares in the increased capital to be covered by a financial contribution equal to the value of the loan granted, plus, of course, interest.
After the creditor has made a statement of participation (shares) of the company, the parties should subsequently enter into an agreement to set off the lender’s debt to the company resulting from the loan and the company’s debt to the lender for the obligation to make a monetary contribution.
As a result, the two claims and the acquisition of shares in the increased share capital by the lender (the company’s creditor) are waived.
second the model for converting receivables into shares of the company is that the company increases the share capital and offers the lender new shares (shares) to be covered by a non-monetary contribution in the form of a loaner's debt to the company for the loan. This is the result of the agreement to assign claims to the company.
As a result, the company becomes both a debtor and a creditor under the loan agreement, so the claim expires and the lender acquires new shares of the company. Consequently, there is a confusion leading to the expiry of the entity's law as a result of the merger in the hands of the same person of the law and its obligation.
In relation to the company, the conversion will be tax-neutral, as it is not a revenue that has been received to create or increase share capital
Conversion taxation
At this point, it should be pointed out that the conversion will be tax-neutral in relation to the company, as it does not derive revenue from what has been received for the creation or extension of share capital, according to Article 12(4)(4) Act dated 15 February 1992 on corporate income tax (codification Journal of Laws of 2018, item 1036).
The resources obtained by the company as a result of the conversion therefore do not constitute revenue for it. As far as the shareholder is concerned, recapitalisation of the company with a monetary contribution constitutes a tax-neutral activity based on income tax and VAT.
In turn, in the case of a non-monetary contribution to the company, the shareholder is obliged to pay income tax and VAT.
However, while, under civil and commercial law, the nature of the contribution to the company is determined in principle by the wording of the resolution of the assembly of shareholders (of the freely held assembly), it is possible under tax law to determine the type of contribution taking into account its nature and the content of the relevant resolution.
It is ambiguous whether the deduction of claims constitutes a contribution in cash or not.
This is because according to Article 12(1)(7) Act dated 15 February 1992 on corporate income tax (codification Journal of Laws of 2018, item 1036) and Article 17(1)(9) Act dated 26 July 1991 on personal income tax (codification) Journal of Laws of 2018, item 1509 including Article 21(1)(109) on income tax on natural persons, the income of the shareholder shall be the value of a non-monetary contribution other than the undertaking or its organised part.
Therefore, if the contribution is considered to be in cash, the shareholder's side will not be able to talk about the return and any tax consequences will be deferred until the shares are divested.
On the other hand, the acceptance that the shareholder made a non-monetary contribution will entail the recognition that he had made an income on his side, in the amount of the nominal value of the shares/shares covered in exchange for such a contribution, which clearly gives rise to tax consequences towards the shareholder.
This case law of the Supreme Administrative Court
The Supreme Administrative Court’s jurisprudence shows that the contribution of money to the company can only rely on the payment of cash or the transfer of funds. On the other hand, the conversion of claims into shares constitutes in fact a conversion of that debt to other property rights in the form of shares of the company.
Therefore, in the opinion of the Supreme Administrative Court, the conversion of claims into shares cannot be considered as a contribution of money (judgment of the Supreme Administrative Court of 7 June 2017, reference no. II FSK 1374/15, judgment of the Supreme Administrative Court of 13 April 2017, reference no. II FSK 2301/15).
This case law of the Supreme Administrative Court appears to be well established and consistent with the current case law.
Therefore, it should be borne in mind that the execution of transactions in the conversion of receivables into shares, using a cash contribution and a deduction agreement, may result in the obligation to pay income tax and VAT.
Conversion of claims into reserves
It is also important to consider the possibility of converting the shareholder’s loan (reliability) into the company’s capital. The direct conversion of claims into reserve capital appears to be unacceptable. According to Article 154(3) k.s.h. and Article 192 k.s.h.
and also from Article 36 The accounting act of the limited liability company's reserve capital is created from profit, agio (surplus resulting from the shareholder's acquisition of shares at a price higher than the nominal price) or from shareholders' contributions.
Furthermore, a conversion carried out in this way would simply constitute an exemption from debt within the meaning of Article 508 k.c.
The shareholder would not have received an equity equivalent from the company, and this would therefore constitute a contractual exemption from the debt, which is, of course, the taxable income of the company.
Therefore, in order to convert the debt into reserves, it is also necessary to increase the share capital of the company and to cover this increase with the shareholder's claim on the company.
However, in this case, the amount by which the share capital is increased must be lower than the amount of the debt resulting from the loan, while the full amount of the debt must be covered.
Consequently, the amount of the claim resulting from the loan, equal to the amount of the increase, will increase the company’s share capital, while the surplus will be transferred to the company’s capital.
Another way is to adopt a resolution on subsidies to share capital, which is only possible if the company agreement provides for the obligation of shareholders to pay subsidies.
In such a case, the next step is to convert the debt of the loan to the company’s claim against the shareholder for the payment of the aid and to transfer it to the reserve.
It is worth pointing out that according to Article 12(4)(11) Corporate Income Tax Act does not include amounts and amounts of tax revenue which exceed the nominal value of the shares received at their issue and transferred to reserves.
Therefore, under this provision, the amounts and values which exceed the nominal value of the shares or shares (agio) shall not be considered as tax revenue of the capital company if the following cumulative conditions are met, i.e.
the amounts and surplus amounts referred to were received by the company when the shares were issued and transferred to the reserve. The provisions in force do not provide for any legal obstacles to the fact that a company with a minimum share capital owns assets which are many times higher than the value of that capital.
In that case, the shareholders' shares, despite the low nominal value, represent a high balance sheet value, which increases their market attractiveness.
Author: Michał Wasilenko
Lawyer, Associate in the Legal Department, member of the Bar Association in Lublin, graduate of the Faculty of Law and Administration at Maria Curie-Skłodowska University in Lublin. He specializes in commercial and civil law law.