When the company’s accounts show a negative financial result, it is necessary to indicate how this result is to be covered. This obligation is vested in the body responsible for approving the company’s financial statements. The currently applicable provisions allow for a number of possible options when it comes to covering losses by limited liability companies.
SUMMARY:
- If a loss in incurred, the approving body must indicate how the company’s negative financial result is to be covered.
- The company may cover a loss in several different ways. These include: retained earnings (or profits of a subsequent period), reduction of share capital to cover losses, use of capital reserves (agio) and additional contributions (an option available only to limited liability companies).
Covering a loss by retained earnings
One of the available options is to cover a loss by retained earnings accumulated by the company in prior years. In principle, the net profits generated by the company in the given financial year are divided into the portion distributed to the owners (in the form of dividend) and the portion retained by the company. In other words, retained earnings represent the difference between net profit and the amount of dividends paid. They also provide a sort of a protective cushion in case losses are recognised in the balance sheet in the years to come.
Losses can also be covered by the profits of future financial years. This solution is a good option if there are reasonable prospects that the company’s financial condition will improve in the future and, at the same time, the company is able to meet its current obligations. Otherwise, the management board should consider filing an application for bankruptcy.
It is worth remembering that the legislator has provided for tax benefits in CIT in relation to retained earnings when they are not earmarked for profit distributions or covering balance-sheet losses. As of 2020, pursuant to the provisions of article 15cb of the CIT Act, companies which are CIT taxpayers are able to include in tax costs the amounts allocated to supplementary capital representing the amount of retained earnings multiplied by the NBP reference rate plus 1 percentage point.
Additional contributions – an option for limited liability companies
In limited liability companies, there is an option of making additional contributions (also referred to as “additional capital contributions”). In order to make additional contributions, the company’s articles of association must include provisions allowing for making additional payments in cash to the company – which will not constitute an increase in the share capital, and the shareholders’ meeting must adopt a relevant resolution. Additional contributions should be imposed and paid by all shareholders equally in proportion to their shares. In principle, the additional contributions paid by shareholders are reimbursable. However, this does not apply to additional contributions required to cover a loss recognised in the company’s financial statements.
Moreover, just like in the case of retained earnings, the legislator has provided for an option to include in tax costs the amount representing additional contributions multiplied by the NBP reference rate plus 1 percentage point, as long as these additional contributions are not allocated to covering balance-sheet losses.
Share capital reduction to cover a loss generated by the company
A loss can also be covered by share capital reduction earmarked for loss coverage. This solution is allowed as long as the existing share capital is higher than the statutory minimum (respectively, PLN 5,000 for limited liability companies and PLN 100,000 for joint-stock companies).
Share capital may be reduced either by voluntary redemption of part of the shares or by reducing the nominal value of all the shares. In both cases, it is important to remember that the statutory minimum amount of share capital must be maintained. When adopting the resolution on capital reduction, its purpose – loss coverage – must be explicitly indicated.
The procedure requires relevant resolutions adopted by the shareholders and registration of the capital reduction in the competent registry court. Please note as well that share capital reduction will entail a mandatory convocation procedure (notification to creditors).
Use of agio in the event of a business loss
The company may also decide to cover its losses by supplementary capital, including the part derived from agio, representing the difference between the nominal value of the shares issued and the issue price. Please note that the agio accumulated in supplementary capital is the result of contributions made to the company by the shareholders (those made originally, when the company was formed, and subsequently, when increasing capital), which are in principle subject to the tax on civil law transactions. However, when making these contributions, the tax base corresponds to the paid in (stated) share capital, i.e. the nominal value of shares, and not the actual amounts paid in, which often exceed the nominal value (the so-called agio or share premium). In the company’s balance sheet, agio is recognised in supplementary capital or capital reserves. Please note that in some situations this may be regarded as a tax scheme (MDR), because of satisfying the so-called generic hallmarks and the main benefit criterion, and creation of agio will entail disclosure obligations.
Negative equity and continuing business operations
If the loss generated by the company exceeds the sum of supplementary capital, capital reserve and half the share capital (1/3 of share capital in the case of joint-stock companies), the management board is obliged to convene a shareholders’ meeting in order to adopt a resolution regarding the company’s continued existence. Alternatively, the board may file for bankruptcy. It is important to remember that management board members are personally liable for the company’s obligations if enforcement against the company’s assets should prove ineffective. There is also criminal liability for failing to declare insolvency.
In the event of recognising a loss in the balance sheet, the company has a wide range of options at its disposal to cover it. The company should consider which of the available options is the most appropriate, also taking into account the tax consequences. In some situations, the grounds for reporting a tax scheme should be examined as well.
From the point of view of the management board, it is essential to evaluate the company’s financial condition on an ongoing basis, so that in the event of loss of financial liquidity the company can file for bankruptcy in a timely manner.
CO-WRITTEN BY: Jakub Babańczyk, Assistant, Transaction Tax Advisory Team
