Comparison of the transfer of an ownership interest in an LLC to an individual and a legal entity

Legal and accounting-tax perspective

Imagine the following model situation:  

You have a limited liability company and want to transfer, for example, your 100% ownership interest to another person. Your reasons may vary –  selling the company to a larger player, tax optimization, or generational succession.

LEGAL PERSPECTIVE

A 100% ownership interest in a limited liability company (the “ownership interest”) is a so-called majority ownership interest, which the Commercial Code currently associates with the obligation to submit the tax administrator’s consent when transferring it to a third party, and makes the effectiveness of the transfer conditional on registering the change in the owner’s (shareholder’s) details in the Commercial Register.

However, this bureaucratic burden will cease to apply as of 17 July 2022. For the purposes of this article, we will model the sequence of steps without including the obligation to submit the tax administrator’s consent.

From a legal perspective, it is not decisive for the transfer of an ownership interest whether the transferee is an individual or a legal entity.  What is important is verifying the facts to which the Commercial Code links the impossibility of transferring an ownership interest and ensuring that the steps are properly carried out in the legally prescribed order.

What are the basic steps for transferring an ownership interest to a third party (an individual or legal entity)?

1. REVIEW OF THE ARTICLES OF ASSOCIATION AND ANY AMENDMENTS – the lawyer will check whether the deed of incorporation (articles of association) permits the transfer of the ownership interest to a third party. If the transfer of the ownership interest is excluded, decisions must first be adopted to amend the relevant provisions of the deed of incorporation so that the transfer of the ownership interest is no longer excluded.
2. ADOPTION OF A DECISION ON THE TRANSFER – The sole shareholder, acting in the capacity of the general meeting, adopts a decision granting consent to the transfer of the ownership interest (in the case of points 1 and 2, these are formalistic steps, since in our model example the company has only one 100% owner, but for reasons of legal prudence it is necessary to proceed in accordance with the rules of the Commercial Code).
3. AGREEMENT – The sole shareholder and the transferee enter into an agreement on the transfer of the ownership interest (containing all the particulars and declarations required under the Commercial Code). The transfer agreement must be delivered to the company (the time at which the transfer becomes effective is linked to its delivery). The authenticity of the signatures must be certified.
4. APPLICATION FOR REGISTRATION OF CHANGES IN THE COMMERCIAL REGISTER – The company prepares an application for registration of changes to the registered details in the Commercial Register of the Slovak Republic, covering the changes to the details recorded in the Commercial Register (changes in shareholders, including all legally required details).
5. REGISTRATION OF CHANGES – The company submits the application for registration of changes to the registered details in the Commercial Register of the Slovak Republic electronically, together with all legally required attachments, including the application for changes concerning the ultimate beneficial owner.

What must be considered before the transfer process?

1. Verify the (non-)existence of facts to which the Commercial Code links the impossibility of transferring/acquiring an ownership interest – is the shareholder or transferee listed as an obliged party in the register of issued authorizations for enforcement proceedings? In that case, they may not transfer/acquire an ownership interest in an LLC.
2. Are there obstacles to the transfer under Section 115(3), first sentence, of the Commercial Code? – A shareholder may not transfer their ownership interest to another person if proceedings for the company’s dissolution are pending, if the company has been dissolved by a court or pursuant to a court decision, or if the effects of a declaration of bankruptcy or authorization of restructuring apply to the company.
3. Are you an individual and does your ownership interest fall within the marital community property regime? Obtain your spouse’s consent in advance for all steps, and in particular all actions, that you plan to take to ensure the transfer of the ownership interest.
4. Chain ownership – A company with one shareholder may not be the sole founder or sole shareholder of another company. An individual may be the sole shareholder of no more than three companies.
5. Check whether the LLC has all details required under the Commercial Register Act registered in the Commercial Register of the Slovak Republic – in particular, details that had to be added subsequently, such as the shareholders’ birth numbers. Why? Because the Commercial Register of the Slovak Republic will not register other changes (i.e., changes in the shareholder) until the details required by law have been registered in the Commercial Register.

ACCOUNTING AND TAX PERSPECTIVE

The fundamental aspect of the transfer of an ownership interest that is important for every entrepreneur is addressing the question: how is income from the transfer of an ownership interest treated from an accounting and tax perspective?

Income from the transfer of an ownership interest

Income from the transfer of an ownership interest in a company acquired  after 01/01/2004 is subject to income tax(Section 8(1)(f) of the Income Tax Act).  This is so-called  other income.

Income from the transfer of an ownership interest acquired after 01/01/2011 is  exempt from income tax,  if, after deducting expenses, it  does not exceed EUR 500 in the tax period.

Accounting and tax obligations depend on the status of the transferor and transferee of the ownership interest.

If the transferor is  (former shareholder):

• a private individual or a self-employed individual who does not include the ownership interest in their business assets  – they tax the tax base  (at a rate of 19% or 25%),  which is the difference between the amount of the contribution or acquisition price of the interest and the price for which the ownership interest was sold. The sale of an ownership interest cannot result in a loss (i.e., a situation where the amount of income was lower than the amount of the contribution or the acquisition price of the interest). If the interest was acquired by inheritance, the expense is the value determined by a notary or stated in the certificate or resolution of inheritance. In the case of a gifted ownership interest, the value of the interest is determined by a court-appointed expert. In addition to income tax, income from the sale is also subject to health insurance contributions at a rate of 14% (of the tax base). The amount is calculated by the health insurance company as part of the annual reconciliation based on the submitted tax return.
• a self-employed individual who includes the ownership interest in their business assets (e.g., a sole trader) –  accounts for the ownership interest throughout the entire holding period, including changes in its fair value or its sale  (in the book of long-term financial assets as an acquisition at acquisition cost or the sale of the interest; in the cash journal as an expense not included in the tax base, and upon sale as income included in the tax base, etc.).  The tax base for income from business activities or other self-employment is the difference between the income from the sale and the amount of the contribution or acquisition price of the ownership interest  (up to a maximum of the income from the sale).  The tax rate is 15% or 19%.
• legal entity (e.g. a limited liability company) –  accounts for the ownership interest throughout the entire holding period, including changes in its fair value or its sale  (as long-term financial assets in the accounts of account group 06x).  The corporate income tax base is the difference between the income from the sale and the amount of the contribution or the acquisition cost of the business interest. The acquisition cost includes, for example, fees and commissions related to its acquisition. The sale of the business interest is recorded in profit and loss accounts  (expense and revenue accounts)  with an impact on the tax base. The tax rate is 15% or 21%.

Example of calculating the tax base:  A shareholder  (individual)  bought a business interest for €3,000, the sale price was €6,500, and the tax base is €3,500  (6 500 € – 3 000 €). The resulting tax at a rate of 19% would be €665. If the tax base were lower than EUR 500, income from the transfer of the business interest would be fully exempt from tax.

Notice:  If the transferor is a VAT payer, the sale of the business interest is  exempt from tax.

If the transferee is  (the new shareholder):

• a private individual or a self-employed individual who does not include the ownership interest in their business assets – has no tax or accounting obligations,
• an individual entrepreneur who has the business interest classified as business property  (e.g. a sole trader) – accounts for the business interest throughout the entire holding period, including changes in fair value or its sale. The price paid for the business interest is not included in the tax base. The income is included in the tax base only at the time of its sale.
• a legal entity  (e.g. a limited liability company) – accounts for the business interest throughout the entire holding period, including changes in fair value or its sale. The price paid for the business interest is not included in the tax base. The income is taxed only at the time of sale of the business interest.

Notice:  If the original shareholder  (the transferor)  enters into a business interest transfer agreement with the new shareholder  (the transferee),  the transfer has no effect on the tax base of the relevant company whose business interest is the subject of the agreement. Only accounting entities are required to record the acquisition or sale of a business interest in their accounts  (e.g. a limited liability company, a sole trader keeping single-entry accounts, a joint-stock company, etc.).

Do you need to know more? Do not hesitate to contact us.

This article was prepared for you by SKYLEX Attorneys in cooperation with ATP Services

JUDr. Zuzana Skýpalová, attorney (skypalova@skylex.sk) a Ing. Sarah Šipkovská (sarah@atpservices.sk)