Stay alert to tax risks with capital increases
IS THERE any tax risk associated with a capital increase? Many people understand that cash from a capital increase is a company’s equity, and so is not the income of the company.
Also, shareholders generally view that all their investments, including capital increases, should be regarded as their costs of investment when computing realised gain or loss from that investment. And if the investment results in a loss, that loss should be allowed as a deductible expense because it’s a real cash investment that they’ve made while running the business, and that loss could happen because of market circumstances.
However, the understanding outlined above may not be unconditionally applied to all cases.
In Supreme Court judgments, there have been cases where a capital increase was ruled a concealed transaction, with shareholders disguising their true intention to provide subsidies, financial support or debt forgiveness. If this is the case, both the company that received the capital increase and the shareholders who made the additional capital investment could be exposed to the risk of a tax assessment.
Normally, a business entrepreneur makes an investment decision in order to get profits and dividends from that investment. So, when the funds from a capital increase aren’t used to expand the business or make a new investment, but instead used to repay outstanding debts and improve liquidity, this is likely to make the true intention of the capital increase unclear and can trigger tax risk.
When the taxpayer is unable to provide sufficient evidence to prove it intends to run and obtain profits from the business, cash that the company receives from a capital increase would be assessed as a subsidy which the company should include as its taxable income.
This happened in Supreme Court case no 5812/2557, where the capital was increased with a premium before the company dissolved the business and the capital used to repay bank loans.
In that case, the court was unconvinced that the capital was increased to carry on the business and obtain profits, and ruled that the capital increase was actually a concealed transaction for the shareholders to give a subsidy to the company.
Moreover, when the capital increase is attacked as a concealed transaction, the shareholders are not allowed to include capital increase as its cost of investment (cost per share). So, the gain or loss from the disposal of those shares would be reassessed as if the capital increase had not taken place. This kind of assessment actually occurred in Supreme Court case no 9144/2560.
Several issues and evidence were brought into the analysis before the court finally concluded that the capital increase was actually a concealed transaction. This should not be misinterpreted as meaning that capital increase for improving liquidity and repaying outstanding debts would be regarded as a taxable item, but rather the management should view the above cases as an alert to the potential tax risks and be more prudent when undertaking its transactions.
Sometimes a capital increase for repaying outstanding debts may be driven by commercial reasons. One example is to prevent the company from going bankrupt and to improve liquidity and increase working capital while new business opportunities are being sought. In this scenario, supporting evidence will play an important role to help manage tax risk.
Both shareholders and the company should have evidence to show and support the reason for the capital increase that is raised to run the business and look for profits. So documents, such as a new market analysis, the business plan, etc, should be properly maintained. Lastly, the company’s actual actions are also equally important because they |must be consistent with the business plan.
This article was submitted by ORAWAN FONGASIRA, partner and NOPAJAREE WATTANA-NUKIT, director, PwC Tax & Legal, Thailand.
