Once again on the Lithuanian taxation of shares
Amended provisions of the Law on Personal Income Tax of the Republic of Lithuania became applicable to the personal income from 1st January, 2014. For the purposes of this article only the amendments related with the taxation of the sales income of the securities will be discussed.
Changes to the taxation of sales income of securities
According to the provisions, applicable until 1st January, 2014, the sales income of securities is deemed as non-taxable, if the securities are sold or otherwise transferred into ownership not earlier than 366 days after the date of their acquisition and the individual did not hold more than 10% of the shares (interests, member shares) of the entity whose securities are sold or otherwise transferred for 3 years preceding the end of the tax period in which those securities were sold or otherwise transferred into ownership. From 1st January, 2014 the said tax relief is not applicable to the personal income.
Personal income from the sale or other transfer into ownership of securities acquired before 1 January 1999 was deemed as non-taxable income until 1st January, 2014. This tax relief is also not applicable from 1st January, 2014.
From 1st January, 2014, the income from the sale or other transfer into ownership of financial instruments or from realization of derivatives, not exceeding 10 000 litas during the taxable period, is deemed as non-taxable income.
Taking into account the above mentioned amendments, the income tax on the sale of shares in case of incorporation of a holding company is worth remembering.
Holding companies in Lithuania are usually established by setting up a new private limited company with a minimum share capital and increasing the share capital of a newly established company with the shares of a long-acting company being held. By increasing the authorized capital with a non-monetary contribution, it must be assessed by an independent property valuer in accordance with the laws governing property valuation. Value of the shares issued by a holding company depends on the value of the shares of the long-acting company.
Personal income tax after having set up a holding company
Article 19 (5) of the Law on Income Tax of Individuals provides that When an individual sells or otherwise transfers into ownership the shares received in the cases specified in Article 2 (14) (7) and (8) of this Law in exchange for the shares of the acquired entity, the acquisition price of the shares sold or otherwise transferred into ownership shall be equal to the acquisition price of the shares held in the acquired entity. In short, in this case of the sales of the shares of a holding company to an individual, the purchase price of the shares used as a non-monetary contribution for increasing the share capital of the holding is considered as their purchase price (i.e., the purchase price of a long-acting company’s shares).Article 2 (14) of the Law on Income Tax of Individuals determines what is considered to be personal income. It is established in part 8 of the said section, that the personal income shall not include the difference of the value of the property of the entities, referred to in Article 41 (1) (1) of the Law on Corporate Income Tax, formed during operations carried out during reorganisation and transfer established in Article 41 (2) of the Law on Corporate Income Tax when the shares of the acquiring entity received by a member of the entity are being acquired in exchange for the shares held in the entity being acquired, and there is no payment in cash for the difference in the prices of the shares. Simply put, the resident’s income does not include the difference of values of the shares contributed to the holding company’s share capital and the shares of the holding company received in exchange. Article 41 (2) (7) of the Law on Corporate Income Tax provides that one of the situations of transfer or reorganization is when an entity (i.e. a holding company) in order to acquire complete control of the other entity by acquiring a majority of votes (i.e. to have more than 1/2 of shares with voting rights in the company) is transferring its shares to be issued to members of the entity being acquired in exchange for their shares held in the entity being acquired.
In view of the foregoing, it follows that the acquisition price of shares of a holding company would be considered the purchase price of the shares the old, long-acting company and the date of purchase would be the date of the establishment of a holding company and registration of the increase of the share capital thereof.
Income tax applicable to a holding company
As it was already mentioned, the increase of the holding company’s share capital by a contribution in kind corresponds the case referred to in Article 41 (2) (7) of the Law on Corporate Income Tax in this case. Article 42 (1) of Law on Corporate Income Tax has established that in cases defined in Article 41 of the said Law where the shares held in an entity are received by members of the entity in exchange for shares in another entity, the increase of the value of the property is not considered to be the income of the members who have received the new shares in exchange. According to the commentary on Article 42 of the Law on Corporate Income Tax provided by the State Tax Inspectorate, in case of exchange of the shares in the case defined in Article 41 (2) (7) of the Law on Corporate Income Tax, that is, when a Lithuanian entity, for the purpose of acquiring control of another Lithuanian or foreign entity, acquires the shares of that other entity from its member in exchange for its newly issued shares, issue price of its shares shall be considered the purchase price of the shares of the Lithuanian entity thereby received in exchange (including direct costs associated with the acquisition of the shares received in exchange). It should be noted that under the Law on Corporate Income Tax, the said provisions apply only when the entity or its members, having received shares (stock, interests) in exchange, do not sell them or otherwise assign ownership to them in three years.
In view of the foregoing, it follows that after the establishment of a holding company and increase of its share capital by a non-cash contribution in a long-acting company’s shares, the issue price of the shares being transferred to the holding company, i.e. the value of the shares transferred to the holding company under a property valuation report, shall be considered the purchase price of the long-acting company’s shares. For this reason, in case of selling a company’s shares to a holding company, income from the sale of such shares would be significantly lower than in case of the sale of the shares without having established a holding company.
As it was already mentioned, amendments to the Law on Income Tax of Individuals of the Republic of Lithuania will come in force on 1 January 2014, abolishing the personal income tax relief applicable to the income from the sale of the shares. For the purposes of this article, a relief should be noted regarding the inclusion of the income from sales of shares in the income statement for the year 2013 – by 1 January 2014, income from the sale or other transfer to the ownership of securities, purchased before 1 January 1999, is considered non-taxable income. It is likely that for entrepreneurs, who have launched their business quite a long time ago and have plans to sell it in the future, the sale of the company will be charged an extremely high personal income tax, because the value of the company from its incorporation until its sale is usually significantly higher, i.e. the difference between the acquisition price and the sale price of the company’s shares is extremely high. It was advised to such individuals to transfer their shares acquired before 1st of January 1999, however not every shareholder is willing and/or is able to do that before the end of the year, because the sale of large and long-acting companies is usually a time-consuming process. In this case, if one has no intentions of selling its business in the near future, a possibility of establishing a holding company is worth attention, especially considering the fact that the holding companies are eligible to certain income tax benefits associated with dividends. Given the fact that the tax treatment of dividends is not the subject of this article, it will not be analysed further.