Reinvestment reserve release in anticipation of dissolution of tax entity

Entrepreneurs when divesting themselves of operating assets have the option of deferring the levying of tax on the book profit thus realised by creating a reinvestment reserve. The creation and preservation of such a reserve is contingent upon the entrepreneur’s reinvest­ment intention, the onus of proof in connection with (the existence of) which rests with the entrepreneur.

Where the business venture is carried on under a private limited-liability company format, negotiations on the topic of the divestment of the shares in the company in question do not as such warrant the conclusion that the reinvestment intention has been ditched, as the exis­tence of such an intention has to be assessed from the perspective of the company rather than that of the shareholder. It is important, however, that a significant change in the participat­ing interest in a private limited-liability company that has a reinvestment reserve on its books will result in the reserve in question being released to the profit in immediate anticipa­tion of the relevant change. It follows that the reserve has to be used ahead of the moment the shares in the company’s capital transfer in order to stop such a release happen­ing. It should be noted in this context that a reinvestment reserve must be charged to the pur­chase or production costs of other operating assets, the entry into a contract of sale as such not being enough as long as no actual transfer of title or payment has taken place.

The subsidiary company forming part of a corporation tax entity sold one of its operating assets and created a reinvestment reserve to accommodate the book profit from the divest­ment. Just under two years later the subsidiary company’s articles of association were amended and a contract of sale was concluded for a number of immoveable properties in which it was stipulated that the transfer of the risk associated with the properties in question was to be deferred until such time as the notarial closing instrument had been executed. The shares in the private limited-liability company were transferred before closing had taken place, which caused the tax entity to dissolve. The Tax and Customs Administration adjusted the tax return the (former) tax entity had submitted by releasing the reinvestment reserve. The District Court ruled that the adjustment had been rightly applied as a change in the ulti­mate (share) holding in the private limited liability company had occurred which in turn had prompted the mandatory release of the reinvestment reserve just ahead of the moment of dissolution of the tax entity, and the release of the reinvestment reserve therefore had to be considered as having gone towards the (subsequently dissolved) tax entity’s profit.