Making contributions to cover the share capital of a limited liability company constitutes a fundamental obligation of a shareholder. The contribution may take the form of a cash contribution or an in-kind (non-cash) contribution.
The value of the in-kind contribution can be allocated in full to the ‘share capital’ or in part. In the latter case, the surplus is allocated to the company’s ‘supplementary capital’. The contribution’s value allocated to the ‘share capital’ corresponds to the nominal value of the shares issued to a shareholder in exchange for the contribution.
The object of an in-kind contribution can be the ownership of things (e.g. car, real estate, computer), transferable rights (e.g. copyrights, shares), as well as an enterprise or its organized part.
This article relates to the taxation of the contribution of assets other than an enterprise/its organized part and shares in another company, which under certain conditions can be tax neutral. Except for them, in-kind contributions are subject to taxation with income tax, tax on civil law transactions and in certain cases also with VAT.
Making an in-kind contribution to a limited liability company generates taxable revenue on the part of a shareholder. This revenue is equivalent to the market value of the contributed assets - generally the contribution's value indicated in the articles of association. For the purpose of PIT/CIT taxation, it is not therefore relevant what part of the in-kind contribution is allocated to the ‘share capital’ and what part to the ‘supplementary capital’ of the company. The entire value of the in-kind contribution is treated as revenue. The above revenue can be reduced before taxation by expenses related to the purchase or production of the contributed assets.
The shareholder’s income resulting from making the in-kind contribution is treated as ‘capital gains’ and it is not aggregated with income from other sources (e.g. employment or business activity income). The tax rate applicable to this income amounts to 19% PIT or CIT (depending on the status of a shareholder).
It should be noted however that the tax treatment of the in-kind contribution may be different if such contribution is made by a foreign tax resident. Applicable double taxation treaty should be then taken into consideration.
As regards the company receiving the in-kind contribution, such transaction does not result in tax liability on its part.
Tax on civil law transactions
Making an in-kind contribution to a limited liability company entails the company’s obligation to pay tax on civil law transactions.
This tax amounts to 0,5% of the nominal value of the shares issued by the company, i.e., the value of the contributions allocated to the company’s ‘share capital’. The tax base, unlike under income taxes, does not include the value of the in-kind contributions allocated to the ‘supplementary capital’.
Making an in-kind contribution may be also subject to VAT taxation. It generally takes place when the contributed asset is related to the business activity of a shareholder (determining the VAT status of a shareholder often creates problems, it should be noted that the lack of VAT registration does not preclude such qualification).
According to the current practice of the tax authorities, the VAT tax base amounts to the nominal value of the shares issued to a shareholder in exchange for the contribution.
VAT rate and other VAT rules applicable to the in-kind contribution depend on the type of contributed assets.
What to watch out for?
Before making the in-kind contribution to a limited liability company it is worth considering whether / or what part of the value of this contribution should be allocated to the ‘supplementary capital’ of the company. This decision may affect the amount of tax costs that the company will be able to recognize in a possible subsequent sale of the contributed asset (there is a risk of tax authorities allowing to deduct only the nominal value of the issued shares).
It should also be taken into consideration that making the in-kind contribution may prevent the company from benefiting from the reduced 9% CIT rate and from switching to the so-called ‘estonian CIT’ for two tax years.
In certain cases, it may turn out to be more beneficial to equip the company with the necessary assets by making a cash contribution or granting a loan and then purchasing the assets.