Asymmetrical allocation from liquidation reserve accepted for the first time

The liquidation reserve in a nutshell

The usual way for a company to distribute profits to its shareholders is by paying dividends. A few years ago, dividend payments became subject to the standard 30% withholding tax rate. As this represented a substantial increase in the rate, some regimes were introduced to distribute profits at reduced rates, subject to certain conditions of course.

One option is that small companies can reserve their profits in a so-called liquidation reserve.

When such a reserve is created, it is subject to an anticipatory levy of 10%. That tax is payable by the company.

When a previously created liquidation reserve is distributed, withholding tax is levied at the following reduced rates:

• 20% if distributed within five years (and created from assessment year 2018, before that 17%);
• 5% if distributed after five years;
• 0% if the distribution takes place as a result of the liquidation of the company (regardless of whether the reserve has existed for more or less than five years).
   

Loss of anticipatory levy of 10%

A shareholder-natural person who receives a dividend from a liquidation reserve need not add it to his or her taxable income once 5% withholding tax has been deducted. The withholding tax discharges from further tax liability. So this category of shareholders receives a dividend through an allocation of created liquidation reserves at 13.64%: 10% anticipatory levy on the gross amount of the reserve to be created and 5% withholding tax on the amount paid out.

For a shareholder-company, the dividends it receives are taxable profits for corporate income tax purposes. The withholding tax deducted can be set off against the corporate income tax, but the anticipatory levy of 10% deducted upon creation of the liquidation reserve cannot be set off.

In ordinary distribution circumstances, without that 10% liquidation reserve, a combination of the dividends received deduction (DRD) and the withholding tax exemption allows many companies to exempt their dividend income. When there is a liquidation reserve with a 10% anticipatory levy, these are unnecessary costs.

In other words, a shareholder-company cannot recover the 10% anticipatory tax, nor can it be offset. Whereas the reduced withholding tax was precisely meant to improve access to finance for SMEs by stimulating shareholder investment.
 

The road to an asymmetrical dividend policy

A possible solution to optimise the liquidation reserve technique from a tax point of view is an asymmetrical allocation.

• Allocation from the liquidation reserves is made preferentially to the shareholders-natural persons.
• The shareholders-companies preferentially receive dividends from the other reserves.

In 2015, this option was presented to the relevant minister, who dismissed it. He pointed out that shareholders have identical dividend rights.

A negative ruling followed in 2016. The Advance Ruling Service in Tax Matters (Ruling Commission) characterised an asymmetrical allocation from the liquidation reserve to shareholders-natural persons only as a form of tax abuse. The main argument was that this was a violation of the articles of association. And also that shareholders of the same class of shares are treated differently according to whether they are a natural person or a company.

In 2019, the new Companies and Associations Code (WVV) brought a lot more flexibility in terms of voting and dividend rights. There are now more possibilities to provide in the articles of association for an unequal distribution of dividend rights between different classes of shares.
 

First positive ruling

Now that the theoretical possibility for the asymmetrical creation of a liquidation reserve exists, the question remains whether such a creation also passes the tax test. The answer came recently with a first positive ruling (Advance Ruling 2021.0601 of 17 August 2021) in which the Ruling Commission recognises the use of the asymmetrical technique.

The articles of association provided for different classes of shares:

• Class A shares (natural persons): when dividends are distributed, the company's liquidation reserves are drawn from first.
• Class B shares (legal entities): when dividends are distributed, the company's ordinary reserves are drawn from first.

The Ruling Commission confirms that there is no question of tax abuse. The amendment of the articles of association and the creation of different classes of shares do not conflict with the tax purpose of the liquidation reserves.

In addition, the Ruling Commission also focuses on the economic motives. In particular, applying the benefit of the reduced withholding tax to shareholders-natural persons, if there are also shareholders-companies.

Even the fact that the liquidation reserves had been created before the amendment to the articles of association was not a problem. What is important is that there is no disadvantage between the different types of shareholders.

If you have any questions about this, or if you would like advice about your specific situation, we will be happy to discuss this with you.