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When are capital gains on shares taxable for personal income tax purposes?

Thursday 20/05/2021
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Under which circumstances are capital gains on shares taxable for personal income tax purposes? This question still provokes a lot of discussion.

We would like to provide you with an overview of several interesting cases decided by a judge or the Ruling Commission. Timely availability of qualitative contracts and valuation reports can provide clarity.

What does taxation law stipulate about capital gains on shares?

Before focusing on actual situations, we will briefly summarise the applicable tax regulations. We are assuming that in each case the individual concerned does not trade in shares as a business activity.

Prudence versus speculation
  • In the private domain capital gains are tax free insofaras the underlying transaction amounts to 'prudent management of one's private assets'.
  • If it is a case of 'speculative capital gains', they are taxable at the 33% personal income taxrate. In such cases the individual concerned must declare these capital gains.

Speculation is all about facts

Whether or not capital gains are speculative has to be demonstrated on the basis of a thorough factual analysis. Traditional elements that point to speculative intentions include the fact that the natural person regularly buys and sells shares, exposure to irresponsible risks in order to acquire shares and making a quick profit, or a complex pattern of such facts.

For the sake of completeness, we also need to mention that when a natural person, and their family, own more than 25% of the shares in a Belgian company and they sell them to a buyer with fiscal residency outside the EEA, the capital gains are taxable at the 16.5% personal income tax rate and must be included in the tax return.

Practical application more complex than the rules

But as is so often the case, the proof of the pudding isin the eating! Practical experience and the cases outlined below show that the actual application of these tax rules is not always straightforward. Share transactions in the private domain often result in disputes with the tax authorities. It is of fundamental importance, therefore, to have qualitative contracts and valuation reports at hand in good time.

What about a Leveraged Buy-Out?

BelCo was acquired by a private equity group and its directors acquired a minority stake in the acquisition holding company (BE HoldCo). A few years later, BE HoldCo was acquired by a third party and the directors realised significant capital gains.

Ruling Commission’s point of view

Capital gains accrued on shares by the directors of a Belgian company within a Leveraged Buy-Out (LBO) context are tax free. The Ruling Commission decided that the directors had not realised a 'professional income' since they never structurally traded shares. Despite the complex facts, capital gains accrued on shares are not speculative income either. The main point is that the directors did not have controlling decision-making powers throughout the course of the transactions.

What about ‘Slicing Pie’ transactions?

Slicing Pie transactions imply that, once a year, the shareholders of BelCo evaluate their shareholding structure vis-à-vis the agreements made at the time of the company’s establishment. Depending on the actual annual contribution of each partner, adjustments to the share distribution and consequently share transactions between partners may be necessary.

Ruling Commission’s point of view

The Ruling Commission did not consider this professional or speculative income, as these share transactions are the consequence of each natural person’s shareholder status and not conducted in the pursuit of risky short-term profit.

What is a market-based share valuation?

BelCo was established by a natural person. Each share was valued at 10,000 euro. Soon after the BelCo shares were contributed to another company at 35,000 euro per share.

Judge's point of view

The tax authorities decided that the BelCo shares had been overvalued at the time of the contribution and wanted to tax the individual on a benefit in kind because they were also a director of the company to which the shares were contributed. According to the tax authorities, the valuation of 35,000 euro was based on budgets that were subsequently not realised.

However, the Court of Appeal in Ghent did not share this opinion. According to the court, valuation is not an exact science and the tax authorities have not demonstrated that the value of 35,000 euro does not correspond to an economic reality. BelCo was in a start-up phase and it is plausible, therefore, that budgets were taken into account.

What about exercising the right of first refusal?

Two brothers have been shareholders of BelCo since 1984. The shareholders' agreement stipulates that each brother has a right of first refusal and a piggy-back right on the other brother's BelCo shares. In 2015, the younger brother announced that he had received an attractive offer. The older brother exercised his right of first refusal and bought the BelCo shares from the younger brother because he had found another buyer prepared to pay an even higher price. The elder brother consequently accrued considerable capital gains.

Judge's point of view

The tax authorities ruled that the capital gains realised by the eldest brother on his own BelCo shares were tax-free. The capital gains on the purchased shares were considered speculative and were taxed at the 33% personal income tax rate. The tax authorities considered it uncommon for the eldest brother to negotiate the price of a share he did not yet own. The judge agreed with the tax authorities on this occasion.

What about an earn-out sale price?

An earn-out clause means that the acquisition price of shares partly depends upon the future results of the acquired company. Usually, the seller also remains active in that company for a number of years. The shareholders of BelCo sold their shares for 500,000 euro to a third party. This amount could be increased with a variable earn-out share up to a maximum of 1,500,000 euro. The sellers remained active in BelCo and had signed a non-competition clause.

Judge's point of view

The tax authorities considered this irregular and wanted to tax the variable part at the 33% personal income tax rate. The court ruled against the tax authorities because, among other things, an objective valuation report was available. According to the court, the tax authorities also failed to prove that the variable part was compensation for the non-competition clause.

Do you have questions concerning a specific situation or would you like further information? If so, our tax experts would be happy to assist. Please do not hesitate to contact them.

This article relates to Belgium, but if you are also active in France and Germany, you might like to know that the German exit tax on capital gains on shares has beentightened and that you will have to pay capital gains tax when selling shares in a French SCI.

 

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Kurt De Haen

Kurt De Haen

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