The Czech National Accounting Council has approved the new interpretation I-46 (“the Interpretation”) on the accounting treatment of free business and settlement shares in companies with limited liability and a settlement share in associations, i.e. in a case when a partner leaves the company (e.g. on the basis of an agreement on the termination of participation or due to death).
It should be noted that the National Accounting Council’s interpretations are not legally binding. However, they express a professional opinion of an expert group, which definitely represents a relevant source of information mainly when the given issue is not directly covered by the accounting regulations. Accounting issues when a business share becomes free have not been clearly addressed by the Czech Act on Accounting or any related legislation.
In the course of operation of a limited liability company (“LLC”), several situations may arise that result in a partner leaving the company. Their equity investment is often sold, however, if there is no one interested in the purchase of the investment, the company itself takes on the active role and decides on the release of the partner. In other words, if an equity investment becomes free with no legal successor, the company has to settle the investment according to the applicable legislation or the company’s Articles of Association. The situation gets even more complicated by the fact that the free business share legally remains in the ownership of the leaving (former) partner, who can no longer exercise the related rights and obligations. At the same time, the right to settlement or the so-called settlement share arises.
This very complex legal situation should therefore be reflected in the accounting records, ideally in a true and fair view. Due to the lack of legislation in this area, the Interpretation offers a solution to the issue of the free business and settlement share in specific situations (e.g. settlement through the satisfaction from proceeds from the sale of the free business share, settlement without the sale of the free business share, transfer of the free business share after the settlement share payment, termination of the share, etc.).
What does the Interpretation recommend in these cases?
- Broadly speaking, it proposes certain accounting methods that, in our experience, have already been used in practice.
- It also offers some simplification of accounting and defines the moment at which the legal title to the recognition of the settlement share debt arises.
- It concludes that the termination of the free business share, respectively the creation of the settlement share is not to be reported as an expense in the current period by the paying LLC (according to the Interpretation, it is an equity payment).
When terminating the participation in an LLC, it is worth keeping in mind the related tax impacts. In general, the settlement share claim is subject to a withholding tax, whereas the income may, under certain conditions and rules, be depreciated by the acquisition value of the share in the LLC. In this context, please note that the withholding tax falls within the competence and responsibility of the LLC as a taxpayer. Therefore, the respective transactions have to be not only correctly recognised from the company’s perspective but also correctly reflected in taxation.
The above-mentioned clearly demonstrates that dealing with a free business share is a complex issue from the legal, accounting as well as tax perspectives. It is not easy to choose the most convenient way for the leaving partner, the company and the current partners and meet all relevant rules and obligations concurrently. Should you deal with the issue of a free business and settlement share in an LLC or an association, we recommend referring to the National Accounting Council’s interpretation I-46.