As part of their succession planning, parents often gift the company’s shares to their children while they are still active in ‘their’ company. To avoid tempting fate, such gifts are sometimes made well before retirement. Naturally, the parents still want to remain in charge of ‘their’ company for a while – at least until they retire. Moreover, in order to cover their personal financial needs, they often also want to retain the option of having dividends paid out to them from the company after making such a gift.
For these two reasons, shares are often gifted with reservation of usufruct, so that the children only acquire the bare ownership. This means that the parents, as the usufructuaries, will still be able to exercise the voting rights attached to the gifted shares at the general meeting (control), as well as retaining the right to the dividends paid out by the company (income).
As the usufructuaries, the parents are definitely entitled to dividend payments. But whether the usufructuary is also entitled to distributions from the liquidation reserve – either those already accumulated or those accumulated after the gift – is another matter.
Before we go into this in more detail, a quick reminder of the tax situation of the liquidation reserve may be helpful.
Dividend payments are in principle subject to a withholding tax of 30%. To mitigate this rate of tax to some extent, since assessment year 2015 SMEs have been allowed to reserve profits in a separate liability account, the liquidation reserve, instead of immediately paying them out as dividends. A one-off charge of 10% is deducted from this reserved amount. Withholding tax of 20% or 5% is due when payments are made from the balance of this reserved amount, depending on whether they take place with a period of five full financial years after the reservation or later; if the company is fully liquidated, the liquidation reserve is distributed free of any withholding tax. Based on the coalition agreement, the rates of tax and the waiting period may be changed in the near future.
To cut a long story short, the law does not specify this, there is no case law as yet and legal authorities hold differing views on the matter. This means that it is unclear whether the usufructuary is entitled to such distributions.
From a tax viewpoint, a distribution from a liquidation reserve is a dividend. Dividends are ‘fruits’ and therefore go to the ‘usufructuary’ (literally, the one who ‘enjoys the fruits’).
However, from a civil law perspective – and civil law takes precedence over tax law – there is no clear view on the matter. Technically, the profits have not been distributed as dividends, but added to the reserves for an undefined period. The question quickly arises as to whether transferring profit to a liquidation reserve is intended to keep resources within the company on a lasting basis, which would be to the advantage of the bare owner, or whether such a transfer is merely intended to extract the profit from the company in a more tax-favourable manner, in which case the distribution goes to the usufructuary.
The Civil Code makes a distinction between ‘fruits’ and ‘proceeds’. The distribution of ‘fruits’, such as a dividend, does not affect the capital value of the shares and goes to the usufructuary, whereas ‘proceeds’ will have a negative effect on the capital value of the gifted asset when they are distributed and therefore do not go to the usufructuary.
Given that the distribution of a liquidation reserve does eat into the capital value of the company’s shares, it might be concluded, on a strict (excessively strict?) reading of the law, that distributions from the liquidation reserve should go to the bare owner. However, several authors immediately point out that this strict view would have very unfair consequences for the usufructuary who, prior to making the gift, created a liquidation reserve purely for tax reasons but would have little or no claim to it after making the gift.
Attempts have therefore been made in legal doctrine to arrive at a more precise understanding, although ambiguity remains.
Some authors make a distinction depending on whether the distribution relates to a liquidation reserve that was created before or after the gift was made. At the time of gifting, the value of the gift is fixed. The liquidation reserves that have already been accumulated partly determine that value. If those reserves are subsequently distributed, this will reduce the capital value of the gifted shares. On this view, the distribution is therefore more likely to be regarded as ‘proceeds’, which works in favour of the bare owner. Of course, the distribution of liquidation reserves accumulated after the gift has been made will not affect the value of the gifted shares, so the holders of this view argue that the distribution should go to the usufructuary.
Some legal scholars, by contrast, have concluded that a distribution from a liquidation reserve is a fruit that accrues to the usufructuary, regardless of when the reserve was created.
In any case, in the event of a dispute both usufructuary and bare owner have legal grounds to support a claim to the distribution of the liquidation reserve.
This issue can also arise in the context of inheritance. Suppose the deceased has left a business to the surviving spouse and the children in which liquidation reserves have been formed. In principle, the surviving spouse inherits the usufruct and the children inherit bare ownership of the shares. Will these liquidation reserves then go to the surviving spouse (the usufructuary) and/or the children (bare owners) at the time of distribution? You guessed it: there is also debate in matrimonial property and inheritance law about who is entitled to the distributions if the company’s articles of association say nothing on the matter.
Fortunately, there are ways to deal with the legal uncertainty we have described.
First of all, our advisor will need to check carefully with the client who the liquidation reserves are supposed to go to – both those already formed and those that accumulate after the gift has been made.
Provided that the deed of gift and/or the company’s articles of association include a suitable clause, the distributions can be allocated to the intended party.
Even if stipulating what happens to the liquidation reserves was overlooked when the gift was made, a suitable legal solution can still be worked out after the event.
Don’t hesitate to contact us if you have any questions.
