Taxation of disproportionate profit share distributions
The Coordination Committee of the General Financial Directorate and the Chamber of Tax Advisors recently dealt with the taxation of profit distribution under the Corporations Act in situations where members of a limited liability company or shareholders of a joint-stock company receive shares in profit disproportionate to their shares in the registered capital.
The Corporations Act allows for flexibility in determining the amount of profit shares. Usually, members of limited liability companies receive profit shares equalling their shares in the registered capital, unless the memorandum of association provides otherwise. The same applies to shareholders of joint-stock companies, who are generally entitled to profit shares proportionate to their shares in the registered capital, unless the articles of association provide otherwise for a specific class of shares.
The Coordination Committee’s discussion aimed to clarify whether the payment of a share in profit disproportionate to the share in the registered capital between Czech tax residents is subject to a regular tax regime, i.e. a 15% withholding tax with potential exemption from tax upon the payment of profit shares to the parent company. The Committee also had to decide whether such a share in profit may lead to the generation of other taxable income by the entity receiving the profit share.
The discussion paper dealt with various alternatives of disproportionate profit share distributions, one of which was the payment of profit shares specified by the memorandum of association as fixed amounts different from the relevant shares in the registered capital. Another alternative involved the annual change of the articles of association of a joint-stock company when each shareholder is annually paid a different profit share amount while maintaining the same shareholders’ structure. The last alternative was the possibility to determine a profit share depending on the amount of profit for distribution (e.g. profit of up to CZK 10 million is distributed among members proportionately to their shares in the registered capital and profit exceeding this amount is distributed in another proportion). All the above changes in the allocation of profit shares must have good economic reasons and may not be aimed at generating income tax savings or gaining other tax advantages.
The discussion paper submitters and the GFD arrived at the same conclusion: the distribution of a share in profit disproportionate to the relevant share in the registered capital of a corporation performed in compliance with the Corporations Act is subject to the standard tax regime, i.e. a 15% withholding tax. The exemption of profit share distribution paid out to the parent company may also be applied. In addition, the Coordination Committee confirmed that members or shareholders who receive shares in profit higher than their respective shares in the registered capital do not generate other taxable income.