Holding companies and the various methods of establishing holding structures have recently become an increasingly common topic of both professional and public discussion. One such method is the contribution of a share in an existing company to a holding company by way of a non-cash contribution.
Recent articles in the public domain have discussed this approach primarily in connection with the tax implications of a subsequent repayment of such a contribution. At the same time, they have, to some extent, portrayed it as a questionable practice inherently driven by improper motives. Such an assessment, however, overlooks both the nature of a non-cash contribution and its legitimate purposes. We therefore consider it appropriate to explain this legal mechanism in greater detail and outline the possibilities for its practical use.
A contribution outside the registered capital is a standard legal mechanism through which a shareholder may strengthen the capital position of a company.
An obligation to make such a contribution must be provided for in the company's constitutional document. By contrast, a voluntary contribution is made at the shareholder's discretion, subject to the consent of the company's managing director. In the case of a joint-stock company, consent is granted by the board of directors or the administrative board.
A shareholder may make a voluntary contribution either in cash or in kind. For this purpose, the shareholder enters into a contribution agreement with the company. The requirements of the agreement depend on the nature of the asset being contributed.
For example, where real estate is contributed, the agreement must be made in writing and the parties' signatures must be officially authenticated.
Ownership of a share, as with other assets, may generally be transferred in two principal ways. The first is a standard transfer for consideration or without consideration. The second is a transfer of ownership resulting from the contribution of the share to a company by its shareholder.
Such a contribution may be made as a non-cash contribution to the company's registered capital upon its incorporation or in connection with an increase in its registered capital, thereby satisfying the relevant contribution obligation. Alternatively, it may be made by way of a voluntary non-cash contribution outside the company's registered capital.
The main difference between these methods lies in the fact that, in the case of a transfer for consideration, the company incurs a debt payable to the shareholder. Where the share being transferred has a substantial value, such debt may represent a significant burden for the holding company.
By contrast, where the share is contributed by way of a voluntary non-cash contribution outside the registered capital, no debt of the holding company arises. In substance, the transaction therefore results "only" in a strengthening of the holding company's capital position. The amount of this capital increase corresponds to the value of the share as determined by an expert valuation, which must be prepared for the purposes of the non-cash contribution.
Upon completion of the contribution, the holding company becomes a shareholder of the relevant company. Through its governing body, the holding company exercises the rights and performs the obligations attached to the share.
Following the contribution, the general meeting may subsequently resolve to repay the contribution, in whole or in part. In doing so, the company must comply with the applicable conditions governing distributions from its own resources.
The contribution may only be repaid to the extent that it exceeds the company's losses. Any repayment is made to the current holder of the share to which the contribution relates. Accordingly, the recipient need not be the person who originally made the contribution to the company.
At the same time, a decision to repay the contribution should be supported by relevant factual reasons. Such a reason may be the purpose for which the shareholder originally made the contribution was ultimately not pursued.
As a general rule, a non-cash contribution is repaid by the company through a cash payment corresponding to the value of the contribution, or the relevant part thereof. This approach follows from the statutory rules governing distributions of profits and other resources of the company.
However, the company's constitutional document or articles of association may allow the contribution to be repaid by returning the asset originally contributed. The same approach may also be approved by all shareholders.
When repaying the contribution, the company's governing body must act with due managerial care. It must also assess whether the repayment of the contribution to the shareholder satisfies the applicable statutory tests.
The contribution of a share to a holding company by way of a voluntary non-cash contribution outside its registered capital constitutes a lawful and legitimate method of structuring the ownership of a company through a holding structure. Its use may also prevent the holding company from incurring significant debt.
If the contribution is subsequently repaid, the company must comply with all applicable statutory requirements. At the same time, there should be sufficient factual grounds for such repayment that can, where necessary, be substantiated.
