The traditional manner in which a company raises its own funds generally takes the form of share capital and loans. For the purposes of this article the loans will refer to shareholders’ loans. Both sources of company financing are regulated by law and are usually covered in the company’s Memorandum and Articles of Association.
The share capital route is seen at the incorporation stage of a company with further increases subject to the corporate mechanisms for allotments found in the Companies Act 1 and Articles of Association. While not problematic and straightforward, this requires the consideration of a certain time frame for all requirements, including filings at the Registry, to be met.
A loan made to the company on the other hand, needs to abide by the clauses of the Civil Code and creates a liability for the company on its balance sheet.
Another means that can be considered beyond the more traditional avenues is that of a capital contribution understood as a gratuitous transfer of funds, or receivables, from the shareholder to the company, without a corresponding issue of shares or creation of a shareholders’ loan. This form of financing is also considered by the provisions of Article 1740B of the Civil Code 2.
Article 1740B of the Civil Code
1740B(c) provides that, “Any transfer which is… a gratuitous assignment, transfer or contribution of capital, cash or any other assets by an undertaking to another undertaking where both undertakings are either controlled or beneficially owned, directly or indirectly, to the extent of more than 50 per cent by the same persons: shall not be governed by the provisions of this Title [Title XIV, of donation] and in particular shall not be subject to the formalities required by article 1753… provided that such assignment, transfer or contribution shall on the pain of nullity be expressed in writing…”
For a donation to be validly executed this must be made by a public deed.
Therefore, under the terms of Article 1740B, a capital contribution by a parent undertaking to a subsidiary in which it owns directly or indirectly more than 50 per cent, which is expressed by means of a written agreement, will not fall under the requirements of donations found under the Civil Code.
Requirements
In practice, a suggested route to effect a capital contribution would require:
1. A capital contribution agreement in writing between the contributor and the contributee (understood respectively as the shareholder and the subsidiary whether direct or indirect);
2. A board resolution by the contributor and contributee to enter into the agreement;
Capital contributions are clearly not receipts subject to capital gains
3. The allocation in the accounts of the contributee of an amount equal to the value of the contribution to the ‘Capital Contribution Reserve’ or equivalent account; and
4. From the side of the contributor, the inclusion of the capital contribution as an addition to the cost of investment in the subsidiary.
The capital contribution agreement would need to specify the amount contributed, the form of the contribution (cash/receivables) and reference to the exclusion to the rules of donation found under Article 1740B of the Civil Code.
Accounting treatment
The double entry of the contribution for the contributee would be:
DR Bank; and
CR Capital Contribution Reserve.
The double entry of the contribution for the contributor would be:
DR Investment in subsidiary; and
CR Bank/Receivables.
Tax implications
Generally, Malta charges tax on certain Income and certain capital gains. Article 4 of the Income Tax Act3 (the ‘ITA’) establishes what types of income are taxable, whereas articles 5 and 5A establish what types of capital gains are taxable.
Keeping in mind that that:
the provisions of article 4(1)(g) serves as a catch-all clause to tax any income which is not dealt with under sub-articles (a) to (e) of article 4(1) (sub-article (f) was repealed); and the ITA does not tax Capital.
we would need to distinguish receipts of an income nature (therefore taxed under article 4), capital gains (therefore taxed under articles 5 and 5A) and receipts of a capital nature which would not be taxed by elimination.
Capital contributions are clearly not receipts subject to capital gains, therefore the remaining distinction needs to be made between an income and capital nature. This distinction is drawn from case law, which establishes that income is recurrent whereas capital is static. Maltese tax cases contain numerous pronouncements on such distinctions. Such pronouncements use the principle of Badges of Trade to make such a distinction.
With this in mind, the sum received by the contributee would not be deemed to have originated from trade or any other sub-article of article 4(1), and would therefore not constitute income. As a consequence, such contributions would be classified as Capital Sums, and therefore not part of chargeable income as defined in the ITA.
A capital contribution therefore can definitely present another means of corporate financing for private companies to be considered by the board of directors. What about the impact of capital contributions on the capital requirements and own funds calculations of certain regulated entities, among others? How about foreign jurisdictions? Does this form of financing exist? Is it recognised and possibly legislated upon? Both topics would merit further discussion and analysis.
Chris Cachia is a senior manager within Alter Domus Malta’s company secretarial and legal team, focusing on legal and secretarial work for local and international companies. He is a lawyer and chartered accountant.