Advance payment of profit shares
By the end of 2013, payments of profit distributions in three- and multi-level holding structures had become a two-year process, at the very least, before the generated profits were received by its rightful owner. A positive change for entrepreneurs has come in the form of the new Act on Business Corporations, effective January 1st 2014, which allows for a so-called advance payment of profit shares (hereinafter “profit share”).
What are the notable conditions for this advance payment? The deposit can be paid only if it does not cause the bankruptcy of the company. Advance payments can be made only on the basis of interim financial statements showing the company has sufficient funding and available resources to consider payment of profit distributions. By available resources we essentially mean the sum of the profit/loss of the current year, retained earnings, and other funds from profit reduced by accumulated losses, a mandatory allocation to the reserve fund (if its creation is given by the agreement) and other assigned resources.
Let us use a simplified, illustrative example to demonstrate how an advance payment works in practice. Consider a group, ABC, consisting of three companies.
By June 30, 2014 Company B, as a 100% shareholder, decided to pay profit shares to company C in the amount of 10 mil. CZK.
Under the old legislation, Company B would have to report a revenue from business shares for the year 2014 in the amount of 10 mil. CZK, and company A could gain this 10 mil. CZK, in the form of an accepted profit share in 2015 on the basis of approved financial statements from company B for the year 2014.
The new legislation allows company A to gain the profit share of 10 mil. CZK a year earlier in the form of an advance payment. On the basis of the interim report drawn up on 30 June, 2014, Company B reports a profit in the amount of 10 mil. CZK (revenue from its share of company C). This 10 mil. CZK can be paid in favour of company A as an advance payment of profit shares. The Act on Business Corporations does not require approval of the Board of Directors at its annual meetings for the advance payment of profit shares, but, due to a lack of case law, we can only recommend doing so.
We have outlined the legal solution for profit-share payments above. What does the accounting solution look like? This is an advance payment of a future profit share, i.e. at the moment of acceptance / dispensing of financial means to a bank account, the advance payment is accounted for as follows:
The amount of equity capital or the profit/loss of the current year of both participating companies will not be affected at the date of the advance payment, as it is an advance payment that is refundable if the available resources, according to the annual financial statements for the year 2014, do not reach the amount paid. The resulting receivables from partner/ payables to partner in the next year are booked against the decision of the Board of Directors at its annual meetings / sole partner on the payment of profit shares.
If you remain uncertain as to whether, and in what amount, you can pay an advance payment of profit shares in during 2014, we will gladly advise you.
Author: Eva Šmahová