Dispute Resolution Directorate decision – Capitalisation of debt and subsequent sale of resulting shares at a loss amounts to an artificial arrangement.
The Dispute Resolution Directorate (the “DRD”) of the Independent Authority for Public Revenue (the “IAPR”) in its decision No. 4450/2021 held that where a creditor to a company capitalised the debts and then immediately sold the shares under their par value, the resulting loss is not tax deductible.
The Facts of the Case
The company under tax audit (the Creditor), had claims against Company A (Debtor A) and Company B (Debtor B). Both Debtors held a share capital increase, in which the Creditor participated and acquired shares valued at approximately 99% (of Debtor A) and 98% (of Debtor B) of its overall claims against them. In exchange, the Creditor proceeded to an equivalent reduction of its claims against each of the Debtors. Subsequently, it sold all shares acquired under the share capital increases at a price lower than their par value. The sale resulted in a loss for the Creditor of approximately 73% (regarding Debtor A) and 45% (regarding Debtor B) of the value of the shares. The seller suffered a loss in excess of €3,000,000, which the tax auditors found should not have been treated as tax deductible.
Petition before the DRD
In an administrative recourse before the DRD, the Creditor claimed that this arrangement was genuine and inescapable as 1. the participation in a share capital increase at a price lower than the par value of the existing ones is prohibited, 2. it would have lost the entirety of its investment if the debtors declared bankruptcy or had their operating license revoked, 3. its purpose was not to obtain a tax advantage but was indicated by the Bank financing it (the Creditor), which would have terminated the loans provided to the Creditor, and 4. if the debtors had declared bankruptcy, the deductible tax loss resulting from the uncollected claims would have been greater.
The decision of the DRD
The DRD held that the sale of the shares under their par value was not justified by valid commercial reasons and did not reflect ordinary transactional behaviour. The DRD found that what the Creditor did was in essence to write-off bad debts. If the Creditor had done this directly, the resulting loss would have had been tax deductible only if the write-off had been preceded by specific steps aimed at collection. The implication was that the Creditor attempted in this case to treat the entire loss as tax deductible, without first having taken the required steps under law to collect the debt.
Implications of the decision of the DRD
The question that remains open is how the transaction would be treated by the tax authorities as regards the debtor, Companies A and B in this case. It should be noted in this context that under the Greek Income Tax Code an agreement to write off debt between two parties in a business relationship results in taxable income for the debtor of an amount equal to the amount of the debt forgiven. No income is generated, however, where the debt is capitalised. Restructuring of debts via capitalisation is a longstanding practice in Greece. It is often the case that companies in need of such restructuring would not be financially able to pay income tax over their extinguished debts, had the latter been written off. It is also important, in our view, that capitalisation of debts is not something that the debtor company has a say over, i.e. it is something that may be resolved upon exclusively by its shareholders.
Authors:
Katerina Stathakarou, Trainee Lawyer
Eleonora Ligoutsikou, Senior Associate
Georgios Minoudis, Partner
