The subject of the hidden distribution of profit according to the Bulgarian tax law is of significant importance for the regulation of the financial relations, especially with regard to the relations between related persons and for the needs of the tax optimization. Recently, this matter is particularly actual, since the Bulgarian Revenue Agency significantly increased the number of the tax inspections on companies that have declared a large amount of cash in their recent tax declarations, which could be considered as an indication of a hidden distribution of profit. Following the above, in this article we will try to illustrate the most common conditions concerning the hidden distribution of the profit.
Nature of the hidden distribution of the profit
According to §. 1, it.5 of the Additional provisions of the Bulgarian Corporate Income Taxation Act the following is considered as a hidden distribution of the profit in Bulgaria:
1. Amounts not related to the carried by the taxable person activity or exceeding the usual market levels, accounted, paid or distributed in any form in favor of the shareholders, or parties related thereto, except the dividends.
This includes two types of amounts:
- Amounts, which are not related the business activity of the company. Within this group usually fall the personal expenses in favor of shareholders and persons, related thereto. Further specific examples therefor are listed below:
- travel and accommodation costs, whose relation to the business activity cannot be proved;
- costs for the usage of external assets, which are not obtained on the basis of a rental contract;
- assets costs, which assets are not available in the company, but it is established, that they serve the personal needs of the shareholders, stockholders and persons related thereto;
- costs for unaccomplished deliveries;
- other costs;
- Amounts, which are related to the business activities of the company, but they exceed the usual market levels. In Bulgaria only this part, which exceeds the market price, is deemed as hidden distribution of profit. The comparison of the commercial and financial relations between two independent companies to comparable conditions is considered for a common market price.
It should be noted, that in Bulgaria not only the sums, which are billed as costs, are deemed as a hidden distribution of profit, but also:
- Cash payments;
- Withdrawn cash through a company bank card;
- Prepayments, whose connection with the business activity cannot be proved;
The following is not deemed as a hidden distribution of the profit:
- Payments to persons, who are not shareholders or persons related thereto. In this case the tax non-recognition of the expenses would be considered as the only negative consequence.
- Payments to shareholders or persons related thereto, which payments do not represent a loan, however, but get recovered to the company immediately.
2. The calculated interest costs (except the cases for which the conditions of the loan have been negotiated in accordance with the legal provisions) for loans, which fulfill at least three out of four conditions, listed below:
- the loan exceeds the value of the payer’s equity up to 31st of December the previous year;
- the repayment of the loan or the interests thereto is not time-barred;
- the repayment of the loan, the interests or the value of the interests depends on the availability or the amount of the income of the payer of the income.
- The repayment of the loan depends on the satisfaction of other creditors’ claims or the distribution of dividends according to the Corporate Income Taxation Act.
This case concerns a loan, given to the company from a shareholder or a person related thereto, or a hidden shareholder, who generates interest costs. Thus, such loan conceals the real capital increase, after which the obtained profit shall be distributed as dividends, which accordingly have to be taxed. The difference between both cases lies in the fact that the interest costs are tax-recognized and reduce the annual tax result, however the dividends are not recognized for tax purposes.
It is important to be noted, that only the above listed requirements represent the criteria for treatment of the loans as a hidden distribution of profit in Bulgaria, regardless of the fact whether it is granted by a shareholder or a person related thereto.
Tax treatment and consequences in case of identification of hidden distribution of profit
The tax treatment depends on the fact whether the hidden distribution of profit in Bulgaria has been accounted as a cost or not.
In case the hidden distribution of profit is accounted as a cost, this cost is not recognized for the purposes of the Corporate Income Taxation Act (Art. 26, para. 11 of the Corporate Income Taxation Act) and is pointed out as an increase of the financial result on line 8 of the annual tax declaration according to Art. 92 of the Corporate Income Taxation Act for 2015.
Regardless of the fact whether the hidden distribution of the profit is accounted as a cost or not:
-a penalty in the amount of 20 % of the accounted costs (Art.267 of the Corporate Income Taxation Act) is imposed. This penalty concerns only the corporate tax-obligated persons. The latter could be averted if the tax-obligated person declares the costs in Part VII “Notification of a hidden distribution of the profit” in the annual tax declaration according to Art.92 of the Corporate Tax Act for the year of the distribution. In case of declaring of the hidden distribution of the profit in the annual tax declaration an additional tax inspection of the company could be expected.
-a dividend tax in the amount of 5 % (Art.194 of the Corporate Tax Act), calculated over the amount of the hidden distribution of the profit gets charged. This sanction applies only for persons who are legally obliged to pay such tax.