Reduction of share capital is sometimes a risky sport…

1. What was the issue?

The dispute concerned a personal income tax of EUR 412,013.66 established for tax year 2018 on several taxpayers.

The taxpayers had created a holding company and contributed the shares of their operating company as share capital.

This share capital consisted mainly of a contribution of existing retained earnings and cash.

The shareholders of the holding company then carried out a share capital decrease of EUR 1,250,000 without cancelling the shares. This amount was largely accounted for as a current account receivable in their favor.

Then, an amount of EUR 834,643.72 was transferred from the taxpayers’ current account to the current account of the operating company.

As a result, the holding company’s debt to the taxpayers decreased by EUR 834,643.72 and a new debt of an equivalent amount arose vis-à-vis the operating company.

Within the operating company, a claim equal to EUR 834,643.72 was recorded, which was offset by the operating company’s outstanding claims against the taxpayers, up to the same amount.

A nice current account settlement, therefore, without any tax.

The tax authorities claimed that these various transactions constituted a construction that had only been put in place to avoid withholding tax on dividends and therefore applied the anti-abuse regulations. The argument was that the legal acts as a whole had a single ultimate objective, namely to give taxpayers the opportunity to settle their personal debts in the operating company, by setting up a complex operation itself divided into several acts.

2. The taxpayers’ position

The taxpayers argued that the capital reduction was a legitimate operation and did not constitute a breach of the tax legislation.
In their view, no tax had been evaded, given that share capital reductions are not taxable in themselves.
They maintained that the holding structure had been set up for family reasons, including the possible takeover of another company and estate planning.
Their argument was therefore that in this case there was no question of an artificial construction.

3. The position of the tax authorities

According to the tax authorities, the transactions constituted a set of legal acts, the sole objective of which was to enable the shareholders to receive existing liquidities in the operational company free of tax.
The share capital reduction had been financed by the operating company itself via a complex flow of money, which revealed that the corporate structure was merely a tax optimization instrument.
According to the tax administration, these transactions therefore fell perfectly within the scope of the definition of tax abuse.

4. Position of the Court of Appeal

The Court of Appeal also considers that all the legal acts constitute a coherent construction, which was set up entirely to evade taxation, and confirms the disputed assessment.

4.1. Objective element: a transaction contrary to the objectives of the law

First of all, the Court notes that the sequence of operations – the creation of the holding company, the contribution of shares, the share capital reduction and the allocation of debts – had only one purpose: to avoid the tax on dividends.
The operating company had accumulated significant retained earnings and liquid assets over the years, which would normally be taxed through a distribution of dividends.
The creation of the holding company introduced an intermediate stage, which allowed these retained earnings to return to  the shareholders without paying withholding tax through a capital reduction.
Ultimately, the share capital reduction was financed by the operating company itself, which demonstrates that the operating company bore the final burden.
There was neither an economic activity within the holding company nor any substantial reason for the legal acts other than tax avoidance.
The Court therefore concluded that these transactions were opposed tothe objectives of the tax law, which provides that corporate profits are normally taxed through a dividend distribution.

4.2. A subjective element: intention to evade tax

To prove tax abuse, it is necessary to demonstrate, in addition to the objective breach of the tax law, that the taxpayer acted with the sole or decisive aim of avoiding tax.
The Court of Appeal found that this was indeed the case.
The holding company had no autonomous economic activity and only served as an intermediary for tax optimization.
The share capital reduction had no other substantial objective than the tax-exempt disposal of cash. The share capital reduction could ultimately only be fully financed via a complex flow of money, in order to achieve the end result of a tax-exempt distribution of dividends.
The taxpayers were unable to provide proof of a genuine operational motive behind the structure put in place. The reference to a possible takeover of another company is not supported by documents.
Similarly, the argument of family wealth planning is rejected by the Court, given that the taxpayers retained full control over the companies.
The Court of Appeal therefore considers that no evidence to the contrary has been provided and that the legal construction was only motivated by fiscal reasons.

4.3. Tax increase: legitimacy and proportionality

The taxpayers also contested the 10% tax increase for incorrect declaration.
The Court of Appeal considers in this respect that the application of a 10% tax increase for making an incorrect tax declaration without the intention of evading tax, the first offense, is proportionate in this case in relation to the offense committed.
In its opinion, any further reduction of the tax increase is not possible since it is established that the incorrect tax declaration is not due to circumstances beyond the taxpayers’ control, in which case no tax increase would be applied.

5. Conclusion

We can therefore only recommend that those who intend to set up such operations and the professionals who assist them to implement act with the utmost caution and make sure that such operation is justified  on the basis of solid non-tax reasons supported by objective and conclusive documents.

Should you have any questions on this subject, please do not hesitate to contact the specialists of the Andersen Tax department: info@be.Andersen.com or +32 2 747 40 07.