Ruling on tax on reserves for capital reduction

A shareholder that is a foreign company not operating a business in Thailand would be subject to withholding tax of 10 per cent on any dividends received. 

However, when shareholders receive a return on their investment in the form of a capital reduction, to the extent that the company has retained earnings and has set aside reserves from profits, the amount of capital reduction would be subject to tax. In a cross-border payment, the tax is collected as a 15-per-cent final withholding tax. Section 40(4)(d) of the Revenue Code includes in the definition of “assessable income” a payment received as a result of the reduction of capital of a company insofar as the payment does not exceed the “sum of profits and reserves” of the company. 

In this context, the term “sum of profits and reserves” should refer to retained earnings, either appropriated or unappropriated, and would include the legal reserve. As its name implies, the legal reserve is required to be set aside by law. 

Under the Civil and Commercial Code, each time a company pays a dividend, it must set aside an amount equal to 5 per cent of the profit for accumulation as its legal reserve until such time as the reserve reaches 10 per cent of the capital of the company or such other amount as may be required by its articles of incorporation. 

It is intended to ensure that the company has a strong financial position for the protection of its creditors. 

It is clear that if a company reduces its capital at a time when it has profits and reserves in its latest financial statements, shareholders will be subject to tax on the amount that does not exceed the “sum of profits and reserves”. 

It is important to note that the amount of legal reserve that is required to be maintained at all times cannot disappear or be distributed to shareholders until the company is dissolved and liquidated. 

Since this legal reserve has already been subject to Thai tax, shareholders could face double taxation if registered capital were reduced on multiple occasions. 

If, at the time of the capital reduction, the company has retained losses but has set up a legal reserve when distributing dividends in the past, would the shareholders be subject to tax on the proceeds derived from the capital reduction? 

This question was the subject of a Revenue Department ruling issued earlier this year. 

The ruling implied that a legal reserve could not be set off against retained losses and therefore represented taxable income. 

Suppose a company has capital of Bt1,000, retained losses of Bt900 and a legal reserve of Bt100. 

The return of capital in the amount of, say, Bt750 would be distributed to shareholders who would be subject to Thai tax on the amount equal to the reserve, or Bt100, while the remaining Bt650 would not be subject to Thai tax as it is considered as a return of the original cost of investment. 

This interpretation could have an impact on all companies with retained losses that plan to pay out cash in a capital reduction.

However, if the company planning a capital reduction is a limited public company, the Public Company Act allows such a company that has retained losses to first write-off its legal reserve against available retained losses. 

It can then undertake a capital reduction for cash whereby no more tax has to be paid by shareholders. 

Given the ruling, it may be seen that private companies could face concerns if they have no cash on hand and need to borrow money to pay the tax upon receipt of the proceeds of the capital reduction.

 

Orawan Phanitpojjamarn is a tax director at PricewaterhouseCoopers Legal & Tax Consultants.