When reducing capital, will the capital proceeds be taxed?

Generally, a capital reduction is a return of an investment (not income) to the investor with no increase in value. However, if shareholders receive capital proceeds from an investment, they have to pay tax, because the payment has come from the company’s accumulated retained earnings, legal and other reserves set aside from profits. 

Under the Civil and Commercial Code (CCC), a capital-reduction scheme requires the approval of a special resolution at a shareholders’ meeting, which must be passed by at least three-quarters of the votes of the shareholders who attend the meeting and have the right to vote, unless the Articles of Association provide otherwise. 

There is no restriction under the CCC of the number of times that the number of shares or the amount of the capital can be reduced. The code only provides that the amount of capital to be reduced will depend on the approval of the shareholders, but the amount reduced must not be more than 75 per cent at any one time.

The first time shareholders receive capital proceeds on their investment, to the extent that the company has retained earnings and has set aside reserves from profits, the amount of capital reduction will be subject to tax. The term “sum of profits and reserves” refers to retained earnings (both appropriated and unappropriated), which include the legal reserve.

If the company wants to reduce its capital more than once, are the capital proceeds returned to shareholders subject to tax? Under Thai tax law, although a legal reserve is already subject to tax, the shareholders may be subject to further tax on the amount that doesn’t exceed the sum of profits and reserves when capital is reduced for a second time. This means that the same amount of legal reserve could be taxed again and again if the capital is reduced on multiple occasions. 

However, the Revenue Department ruled recently that where a company reduces its capital many times and if the legal reserve was already subject to tax, the amount returned to the shareholders on subsequent occasions (including the legal reserve that has already been taxed) would not be subject to tax again. This approach seems to be rational, since the same amount of legal reserve should not be subject to tax more than once. 

Furthermore, on a cross-border payment, if the capital proceeds are remitted to a non-resident shareholders, the amount of the distribution that is equal to the sum of profits and reserves is generally subject to Thai withholding tax at the rate of 15 per cent. Relief may be granted if there is a double-tax agreement between Thailand and the country in which the shareholders are tax residents. 

It should be noted that the distribution of capital proceeds is not always subject to withholding tax when the shareholders receive a return on their investment in the form of capital reduction (if the payment doesn’t exceed the sum of profits or reserves). It may be reduced to 10 per cent (if the capital proceeds represents profits and reserves) are classified as dividends. So which Thai withholding-tax rate applies depends on the relevant double-tax agreements of shareholders having tax residence. 

Shareholders who wish to extract excess cash out of their companies should consider all possible methods, not just the simplest. It may be wise to talk with your tax adviser first on how to manage your tax liability when extracting cash.

 

Orawan Phanitpojjamarnis, the author, is a tax director at PricewaterhouseCoopers Legal & Tax Consultants.