Conversion of a partnership into a capital company, i.e. a limited liability company or joint-stock company, is connected with certain tax consequences. How is the transformation of a company defined? Is the distribution of profits taxable? What is worth knowing when deciding on such a transformation? We discuss below
Table of Contents
- What is transformation?
- Loss of single taxation possibility
- A partnership after transformation into a company – profit distribution
What is transformation?
The transformation of a company changes its legal status. At the same time, it preserves its existence and previous identity. This does not entail dissolving the existing company and creating a new one. The business entity undergoing transformation remains unchanged. After the transformation, the company continues operation under the same company name. The transformed entity inherits tax identification number (NIP) and statistical number (REGON). The rights and obligations resulting from its previous agreements are continued. There is no need to sign any annexes. After the transformation, partners of the transformed company are jointly liable for the obligations of this entity.
Loss of single taxation possibility
Transformation of a partnership into a limited liability company, a joint-stock company, or a limited partnership results in the loss of its main benefit, which is single taxation. Capital companies lack tax transparency. Their profits are subject to double taxation. Firstly, the current profits of the company are taxed with CIT. Then, the dividend payout to the partners is also taxed.
The transparency rule and the distribution rule result in a lack of neutrality for companies in terms of taxation. As for companies without legal personality, their income is taxed once. Namely, at the level of partners. In the case of capital companies, income divided among shareholders is subject to double taxation.
The taxation of both types of companies differs also when it comes to the allocation of profits. In a company without legal personality, partners can keep a part or even the entire profit for investments. These decisions do not affect company’s taxable income and its taxation. It means that from a civil law perspective, the non-distributed profit increases the company’s assets. However, is completely ignored for tax purposes. The situation is different for capital companies. In this case, as long as the profit is kept within the company and allocated to investments or funds for future developmental purposes, there is no taxation on the shareholders. The tax burden stays at the level of the corporate income tax paid by the company. Furthermore, the increase in the company’s assets is neutral for the shareholders. Unless they decide to sell their shares. This entails the obligation to value these shares on the basis of their market value.
A partnership after transformation into a company – profit distribution
Profits from a partnership transformed into a capital company will not always be taxed when distributed.
In practice, companies do not distribute immediately all generated profits to shareholders. Instead, they keep the profits within the company for future payouts. Shareholders may also allocate them to increase the reserve capital. As a result, there may be a situation where, during transformation into an LLC, there are undisbursed profits. They can be paid after transformation – already as part of a limited liability company. However, such a payment could be considered as the partners’ income from their share in the profits of a legal entity. Just like in the case of dividends. This would require withholding of a flat-rate tax at a 19% PIT or CIT rate. This means an actual double taxation of distributed profits generated by general partnership.
Tax authorities also present this view in many individual interpretations. According to them, the key factor in classifying profit distribution is which company makes the payment. Which company actually generated those profits is of lesser importance.
When planning the transformation of a general partnership (transparent in terms of taxation) into an LLC, it is worth considering adopting a resolution on the distribution of profits before the transformation, and leaving them at the disposal of shareholders. Acting in this way, the profit accumulated in the company becomes a liability towards the shareholders. One may not treat this payment as a dividend even if it is an LLC that makes the payment.
In summary, transforming a partnership into a capital company has significant tax implications. Therefore, it is advisable to seek the support of specialists. They will help you understand tax consequences and prepare you for the transformation.
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