What are the tax consequences of new shareholders/financiers joining a loss-making company?
If a company does not (yet) bring what its original shareholders/financiers expected of it or if even more money is needed to run the company successfully, new shareholders and financiers may be needed. This often leads to tough negotiations, as the old shareholders feel that they are at the root of a potentially profitable business and thus believe that some of the future value should accrue to them.
Often they will have problems with it if their interest is diluted too much. But if that has already been agreed upon, the next challenge arises; what are the tax consequences of changing shareholders/financiers? Below are the main areas of concern.
Loss compensation
This is actually a relatively straightforward issue; as long as it is clear that the company will continue to exist, the loss compensation can remain intact (but see at waiver!). If there is a holding company structure and there is a fiscal unity for corporate tax purposes, it is even possible to pass along the losses that are actually with the holding company for tax purposes to the operating company.
Waiver of receivables
If debts are forgiven, then that results in a profit for the company whose debts are forgiven. But that forgiveness profit is untaxed. However, it does reduce the loss compensation present.
In the case of the remitting company, losses on remitting loans are deductible if they are loans that a third party, not also a shareholder, would have provided on the same terms. Incidentally, the tax authorities are not very easily convinced of this and take the position that there is an "impractical loan" in almost all cases.
Waiver of shareholder claims
If a shareholder has a receivable from a company, there is an additional issue, namely that (among other things!) when the receivable is cancelled, profits must in principle be taken for tax purposes (however, probably not if there was an imprudent loan!). Incidentally, profit-taking in connection with forgiveness on a truly arm's length loan can be deferred by forming a "revaluation reserve." However, that revaluation reserve must be added to profits when the business returns to value.
Summary
When refinancing a company, a good analysis of the situation of the various equity holders must be made. Important factors include:
- The extent of loss compensation;
- The value of the loans;
- Whether the loans qualify as "imprudent" loans.
Asset owners and the company in question would therefore do well to analyze what their tax position is before participating in a refinancing operation involving a company in which they are participating.
