Payment from a limited liability company formed through the transformation of a sole proprietorship, which originates from profits earned before the transformation, is tax-neutral. This ruling was reiterated by the Supreme Administrative Court in its judgment on October 12, 2023 (file reference II FSK 327/21). The judgment is crucial for many capital companies that were created as a result of transforming from a sole proprietorship.
Are payments from the company after the transformation subject to taxation?
This concerns the owners of sole proprietorships who, for various reasons, decided to transform into a limited liability company (LLC) and, before that, maintained accounting records due to their revenue levels and accumulated profits. These profits were not withdrawn for personal use but were retained within the company for business development. The profits not withdrawn increased the value of the equity (capital fund) in the company’s balance sheet. In the specific case considered by the court, the taxpayer indicated that a balance sheet for the company was prepared on the transformation date. The profits earned in the sole proprietorship were listed under the equity section on appropriate accounts, such as basic capital/fund and profit/loss from previous years. The taxpayer emphasized that these profits were not transferred to his personal account before the transformation. Now, there is a planned distribution of the profits earned in the previous business activities.
The taxpayer sought confirmation that the payment by the LLC to the transformed entrepreneur would be tax-neutral for him under personal income tax (PIT). This is because the funds to be distributed had already been subjected to taxation as income from the sole proprietorship. A sole proprietor pays personal income tax “as they go” from their profits, so the amounts to be paid by the LLC came from funds that had already been taxed. However, the tax authorities argued that making a payment by the LLC, formed through the transformation of the entrepreneur, as a shareholder, is a taxable event under Article 17(1)(4) of the PIT Act, subject to a 19% tax rate.
What did the Supreme Administrative Court decide?
According to the Supreme Administrative Court, there is no taxable income generated when distributing profits earned until the transformation date to the LLC. If it were deemed that the amount paid from the sole proprietorship LLC represents income from its profits, it would result in double taxation. This is not an isolated decision, as the Supreme Administrative Court, in a previous ruling with a different panel, confirmed the non-taxation of such historical profits of an LLC formed through the transformation of a sole proprietorship (judgment of August 30, 2023, file reference II FSK 252/21). Therefore, it is expected that the tax authorities will also consider the interpretation provided by the courts.