One of the significant issues faced by companies limited by shares planning to become re-established as partnerships (for instance as the recently more and more popular limited joint-stock partnership (spółka komandytowo-akcyjna)) is the issue of taxation of the accumulated equity capital funds. In particular, case-law offers differing views as to whether in case of such transformation the funds of the supplementary or reserve capital are at all taxable. In the light of the above, the judgement of the Regional Administrative Court in Rzeszów of 6 November 2012 (case file I SA/Rz 892/12), which corresponds with the judicial approach that favours the taxpayer and has recently dominated the case-law, is worth noting (see also case file II CSK 522/08, II FSK 1935/10).
The facts surrounding the dispute in the case referred to above were as follows. The shareholders of a limited liability company desired to re-establish it as a partnership. In the previous years the company had generated a profit that had always distributed in accordance with the Commercial Companies Code (“CCC”). Most frequently the meeting of shareholders would resolve to distribute the profit among the shareholders as dividend or to transfer it to the supplementary or some other capital fund. Given the proposed transformation, a question arose whether or not tax would apply to the moneys accumulated as capital funds.
Pursuant to Article 24(5)(8) of the Act on Personal Income Tax (Journal of Laws of 2012, item 749): “Income (revenues) from a share in the profits of legal persons shall be the income (revenues) actually derived from such share, including the value of undistributed profits in companies limited by shares in the event of re-establishment thereof as partnerships; the income shall be determined as at the re-establishment date” (similarly, Article 10(1)(8) of the Act on Corporate Income Tax). In its judgement referred to above, the Regional Administrative Court in Rzeszów held that the expression “undistributed profits” (niepodzielone zyski) has no legal definition in any of the tax acts. Consequently, the Commercial Companies Code laying down the procedure for distribution of profits generated by companies limited by shares and specifying which amounts may be distributed is the legal act to which reference must be made in an attempt to define the above term (Article 192 of CCC).
Pursuant to Article 192 of CCC the amount distributable among the shareholders must not exceed the aggregate of: profit for the last financial year, undistributed profits of previous years, and any distributable amounts drawn from the supplementary and reserve capital funds set aside from the company’s profit. The distinction between undistributed profits of previous years and supplementary/reserve capital is particularly significant, as these are two separate balance sheet items and thus cannot be regarded as equivalent. The more so, the supplementary/reserve capital cannot be considered to be part of undistributed profits. In its discussion, the Court stressed that in the relevant case, in order to ensure correct interpretation, it had to rely on CCC regulations. The Court held that while CCC did not include a legal definition of the term “undistributed profits”, in the event the profit had been distributed in accordance with the company’s Articles of Association, e.g. by setting it aside as supplementary or reserve capital, it could not be regarded as undistributed profits. Moreover, each and every distribution of the profit by the Meeting of Shareholders of a limited liability company, regardless of whether the distributable moneys were retained within the company or allocated among its shareholders, would cause the moneys covered by the profit distribution resolution not to be considered undistributed profits.
Summing up, the interpretation of the expression “undistributed profits” provided by the Regional Administrative Court confirms the opinion presented a number of times by courts that setting aside profits as the company’s reserve or supplementary capital does meet the definition of “profit distribution” and by the same token the provisions of Article 24(5)(8) of the Act on Personal Income Tax do not apply. One can only hope that in the future this view, which is now part of the settled case-law of administrative courts, will be also adopted by tax authorities.