Contribution to property, a specific instrument of financing Russian limited liability and joint-stock companies, allows to contribute to the assets of the companies without increasing the authorized capital, the nominal value of the shares and changing the allocation of shares among the shareholders.
With the introduction of the possibility of tax-free return of contribution to property to the contributing party as well as the right to deduct the contribution to property in the event of shares sale or liquidation of the company, this financing option shall gain in popularity with the investors.
Key Words: Contribution to Property, Limited Liability Company, Joint-Stock Company, Exemption From Profit Tax, Return of Contribution to Property.
Contributions to property, alongside with loans and contributions to share capital, constitute one of the possible forms of financing Russia-based companies, subject to certain limitations described below.
The concept of the contribution to property is likely to be of Germanic origin1.
The main feature that distinguishes a contribution to property from other financing options is that it does not increase the authorized capital and does not imply any consideration from the receiving company, whether in the form of a share in the company or an obligation to return the contribution after some time.
Initially the contributions to property were allowed in Russia with respect to the limited liability companies only. However, starting from 2016 the possibility to make contributions to property was offered to the shareholders of the joint-stock companies.
I. LEGAL ASPECT
Contribution to property requires the will of the person making such a contribution (the shareholder) and the will of the person receiving it (the company). The latter can take different forms: a decision made at the level of the general meeting of shareholders (with respect to mandatory contributions) and a decision made by the board of directors (with respect to voluntary contributions).
Contribution to property can be considered both as a right and an obligation of the company's shareholders. Whereby art. 27 of Federal Law dated 08.02.1998 No. 14-FZ "On limited liability companies" describes only the situation associated with the obligation of the shareholders to contribute, art. 32.2 of Federal Law dated 26.12.1995 No. 208-FZ "On joint-stock companies" emphasizes the shareholders' right to make contributions at any time.
With respect to the limited liability companies, the obligation of the shareholders to make contributions to property shall be stated in the company's charter. If the initial version of the charter does not contain such a provision, it can be amended through a resolution made unanimously by the general meeting of shareholders.
By default, the shareholders shall contribute money proportionally to their shares in the limited liability company's authorized capital.
However, the company's charter can impose different rules, including: (i) deviation from proportional order of contributions; (ii) possibility to contribute other property and property rights; (iii) upper limits of the contributions' value for all or designated shareholders.
Contributions to property are made pursuant to a resolution passed by the general meeting of shareholders with the 2/3 majority of votes (unless a larger number of votes is required by virtue of the company's charter).
In the joint-stock companies, the shareholders shall have the right to make contributions to property based on an agreement to be concluded between the shareholder(s) concerned and the company, subject to prior approval of such an agreement by the board of directors (supervisory board).
In non-public joint-stock companies (similar to the limited liability companies), the charter may provide for the upper limits of the contributions' value for all or designated shareholders and other restrictions concerning the contributions to property. The charter can also set an obligation for the shareholders to contribute to the company's property pursuant to a resolution of the general meeting of shareholders to be adopted unanimously and describe the procedure, grounds and conditions thereof. Should the obligation to make contributions to property be imposed on holders of a certain category of shares only, the resolution shall be passed by the 3/4 majority of votes provided that all the shareholders concerned unanimously express their consent.
As a general rule, contributions to property can be made in a form of money, things, shares in the authorized capital of other companies, state and municipal bonds, exclusive, other intellectual rights and rights under license agreements subject to monetary valuation, unless the above list is restricted by applicable laws or the company's charter2.
Irrespective of the scenario chosen within a particular company, the contributions to property would never impact the amount of the company's authorized capital and its allocation between the shareholders (nominal value of their shares). Therefore, contributions to property do not somehow alter existing shareholding rights. Re-allocation of voting rights could be, however, agreed by the shareholders by way of entering into a shareholders agreement.
II. ACCOUNTING ASPECT
In accordance with the Russian accounting standards, contributions to property of the Russian companies shall be registered as "additional capital" (account 83). This position has been confirmed by the clarifications issued by the Russian Ministry of Finance3. From IFRS perspective, there is no specific guidance with respect to contributions to property. They should appear in the "equity" section (i.e. in the line "additional paid-in capital").
III. TAX ASPECT
As from 2018, contributions to property made in accordance with the procedures provided for by the Russian civil legislation (described above) shall be exempt from profit tax for the Russia-based recipient companies.
Indeed, according to art. 251 p.1 it. 3.7 of the Russian Tax Code, shall not be included in the profit tax base an income in the form of property (including money and other things), property rights or non-property rights in the amount of their monetary value, which are received as a contribution to property of a company in accordance with the civil legislation of Russia.
This profit tax exemption applies irrespective of the share held by the contributing shareholder (whether an entity or an individual) in the authorized capital of the recipient company. Resolutions of the general meeting of shareholders and agreements on contribution to property, as the case may be, shall be kept by the company as a documentary proof of compliance with the civil law requirements.
Before 2019 contributions to property were considered a form of non-returnable financing. Indeed, Russian civil legislation does not contain any provisions concerning the possibility to return the contribution to property to the shareholder that initially made it. At the same time, there is no express legal restriction in this respect. Considering that for tax purposes such transfer would have been assimilated to payment of dividends and assessed to profit tax accordingly, there was no particular practical interest in investigating this option.
However, the situation changed in 2019 when the Russian Tax Code was added with art. 251 p.1 it. 11.1 stating that the money received by an entity on a free of charge basis from a commercial company or partnership, in which such an entity is a shareholder, within the limits of the amount of this entity's previous contribution (contributions) to property made in the monetary form shall be exempt from profit tax. The entities (their successors) shall keep the documents confirming the amount of the corresponding contributions to property and the amount of funds received free of charge.
According to the comments of the Russian Ministry of Finance, the operation indicated in art. 251 p.1 it. 11.1 of the Russian Tax Code is the reverse of the operation of receiving money as a contribution to the property according to the Russian civil legislation, which is exempt from taxation by virtue of art. 251 p.1 it. 3.7 of the Russian Tax Code.
Nevertheless, it should be noted that the tax exemption with respect to money transferred on a free of charge basis back to the shareholder that previously made a contribution to property of a Russian company has a narrower scope of application as compared to tax treatment of an operation of receiving the contribution to property.
Indeed, new tax exemption applies to:
- legal entities (whether Russia-based or foreign) having a share in the Russian company that initially acted as the recipient of contribution to property. The money returned to an individual having contributed to the company's property will be assessed to profit tax;
- Contribution(s) to property shall be made and returned in the form of money only. In case of contributions of another categories of property or property rights, reverse transfer of money will be beyond the scope of this provision. This should exclude mala fide actions associated with disproportionate initial investment and the method of its tax-free return.
Profit tax exemption applies to the free of charge transfers of money that take place after January 01, 2019. The date of initial contributions to property is not important for enjoying the tax benefit in question and can precede the said date. This opinion was supported by the Russian Ministry of Finance4.
Even though the said provision is beneficial for promoting contributions to property as an instrument of investing into and financing the Russian subsidiaries, it creates some practical legal issues connected with the formalization and documentation of the operation of returning money to the shareholders.
Indeed, the legislators did not introduce respective amendments to the civil legislation that would expressly state the companies' right to return the contributions to property to their shareholders and the procedure to be followed (i.e. decision of the general meeting and/or agreement, required majority of votes etc.). In the absence of such provisions, the legal perimeter of this operation remains unclear, especially in a presence of a legal restriction on gifts exceeding 3 thousand rubles between legal entities5. For instance, the shareholders cannot claim the return of their contributions to property from the company. Thus, the return of contributions to property would be possible in case of mutual agreement of the shareholders only. Should the amount repaid to the corporate shareholder exceed the amount of his contribution(s) to property, the excess would be subject to withholding tax as dividends. The same treatment should be applicable to repayments in case of non-monetary initial contributions to property. However, until and unless the civil legislation is brought in line with new tax opportunities, we would recommend to avoid any cases of contribution to property returns other than specifically mentioned in the tax legislation.
Starting from January 01, 2021, further amendments regarding taxation of contributions to property came into force.
From now on, corporate taxpayers (whether Russia-based or foreign entities) selling shares in Russian companies are allowed to reduce their taxable base by the amounts of monetary contributions made to the company's property (art. 268 p.1 it. 2.1 and art. 280 p. 3 of the Russian Tax Code). The amount of the deductible contribution to the company's property is determined in proportion to the number of shares subject to sale in the total number of shares belonging to the shareholder.
Previously, only contributions to charter capital were deductible, including those made at a premium.
Similar provisions will apply in the case of property distribution when the Russian subsidiary is liquidated or when shareholders or participants exit the subsidiary (art. 277 p. 2 and art. 250 p. 1 of the Russian Tax Code).
New rules do not impose any limitation as to the date when contributions to property were made. These amendments will apply to both Russian and foreign shareholders.
Considering the foregoing, we can conclude that the changes in the tax legislation introduced the last years created necessary prerequisites for turning contributions to property into an alternative to interest-free loans and a versatile instrument of investing into and financing the activities of Russian subsidiaries.
This novelties should increase the investment attractiveness of the Russian companies since they will guarantee to the investor that all investments (not only contributions to authorized capital) will be taken into account in the event of exit from the business project.
1. Contribution to property not increasing the authorized capital: legal research. Laletina A.S., Kosyakin I.A.
2. Art. 66.1 p. 1 of the Civil Code
3. Accounting regulation "Income of the company" 9/99 approved by the Order of the Ministry of Finance dated 06.05.1999 No. 32n, Letter of the Ministry of Finance of Russia dated 29.01.2008 No. 07-05-06/18
4. Letters of the Ministry of Finance dated 12.07.2019 No. 03-08-05/51772, dated 03.10.2019 No. 03-08-05/75878
5. Art. 575 p. 1 it. 4 of the Civil Code
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