Clients approached us – two owners of two different legal entities. Both companies had the same ownership structure, consisting only of the two aforementioned individuals.

In one company (A), an interest-free liability towards one of the shareholders amounting to CZK X million was recorded.

The owners wanted to transfer the debt from one company to the other. At the same time, they planned to change the ownership structure in both companies and proceed differently in their future development than before.

Part of the assignment for the Jaspar office was that there should be no transfer of funds, demerger of the companies, or changes in share capital between the firms.

 

How did we resolve this situation?

1) The indebted company (A) transferred its interest-free liability towards the shareholder to the debt-free company (B). Company B assumed the debt from company A according to Section 1888 et seq. of the Civil Code (debt assumption).

For this step to be possible, the creditor’s consent (in this case, the shareholder’s) to the assumption of the debt by the new debtor is always required. Without this consent, the transaction would not be possible. In such a case, only the so-called assumption of performance (according to Section 1887 of the Civil Code) would be possible, where company B would undertake to company A to pay the debt on its behalf.

2) As consideration for the debt assumption by company B, a new relationship arose between the companies: company A incurred a liability towards company B in the amount of the assumed debt. Company B thus became the creditor of company A. In the debt assumption agreement, both parties defined that company A would pay company B market interest on the liability towards it.

Accounting:

• At Company A: The liability towards the shareholder ceased to exist, and a new liability towards company B arose.
• At Company B: A liability towards the shareholder arose, and simultaneously a receivable from company A was created.

 

3) Company B became a debtor towards the creditor – the shareholder.

4) After several months, the companies agreed that company A would not repay the liability towards company B. Based on this agreement, company B’s receivable from company A ceased to exist through forgiveness. As a result, company A effectively got rid of its debt.

 

What was the impact on costs/revenues and tax liabilities?

After the debt transfer from company A to company B:

• Company A, in accordance with the agreement and accounting regulations (on an accrual basis), accounted for interest expense. This interest (paid to company B) became its expense. Generally, for company A, this should be a tax-deductible expense if it met the conditions for tax deductibility (Section 24(1) of the Income Tax Act – ZDP) and specific conditions for interest.
• Company B accounted for interest income (in the same period as company A accounted for the expense). This interest was thus its (taxable) income.

 

After the debt forgiveness between companies A and B:

• At the moment the debt towards company B ceased to exist free of charge (by agreement not to pay/forgiveness), company A generated taxable income equal to the amount of the unpaid debt (Section 23(3)(a)(11) ZDP), increasing the corporate income tax base. However, company A had losses from previous years exceeding this taxable income. Consequently, the debt forgiveness had no impact on company A’s tax liability.
• Company B accounted for the write-off of the receivable from company A as an expense (reducing its own profit/loss). This expense from the receivable write-off was tax-non-deductible because the receivable ceased to exist based on an agreement between related parties and the legal conditions for tax-deductible write-off of receivables were not met (Section 24(2)(y) ZDP). Company B could therefore not reduce its tax base by the value of the written-off receivable.

 

What was the impact on the assets/liabilities of both companies?

After the debt transfer from company A to company B:

• At Company A: Only the structure of liabilities changed. The liability towards the shareholder ceased, and a new liability towards company B arose. The total amount of liabilities at company A did not change in this step.
• At Company B: There were changes in both assets and liabilities. A new liability towards the shareholder arose (external funds – long-term liabilities). Simultaneously, a (long-term) receivable from company A was created (fixed assets – long-term receivables).

 

After the debt forgiveness between companies A and B:

• At Company A: The liability towards company B ceased (external funds – long-term liabilities), and at the same time, equity increased (through the profit/loss account, where the income from debt forgiveness was entered). The total balance sheet remains balanced. There were no changes in assets at all; only the structure of liabilities changed.
• At Company B: There were changes in both assets and liabilities. The receivable from company A ceases to exist in assets (it is written off). The write-off of the receivable is reflected (via reduced profit/loss) in a decrease in equity.

 

Outcome of the entire operation

• The debt was transferred from one company to the other without the need to transfer funds.
• Tax liabilities in this specific case were minimal.
• The costs associated with this operation consisted of the interest paid by company A to company B until the agreement on debt forgiveness was reached.

 

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We will relieve you of most of the worries associated with similar operations and ensure that they are carried out in accordance with the law and correctly according to accounting and tax rules. If necessary, contact us.