It often occurs in practice that, over the course of the year, the financial resources of companies are used on a regular basis by their shareholders for private purposes, and to such an extent that their reimbursement becomes impossible. This is executed by means of bank cards, transfers of funds or withdrawal of cash. Business accounts are used directly for personal or family purposes, similar services are provided for current needs, loans are given to family members or acquaintances without the issuing of the proper documentation, and a prospect of repayment. Often movable and immovable property (real estates and motor vehicles) are acquired directly with the financial funds of the company. These are the funds which, by their nature, do not constitute remuneration from a management contracts or for personally performed work of a shareholder, or dividends from profit reserves distributed through a resolution of the general meeting of shareholders after deduction of the corresponding dividend tax.
The Bulgarian Commercial Act provides a legal regulation of the dividends as an income from the shares of the shareholders in a joint stock company (Article 181 (1) of the Commercial Act). The Commercial Act doesn’t provide an explicit legal regulation with regard to the Limited Liability Company (Ltd or LLC). According to Art. 133, Para. 1 of the Commercial Act the partners are only entitled to receive part of the profit in proportion to the shares, which they own, unless otherwise agreed. Within the practise this is also known as a right of receiving dividend.
According to it. b, no. 5 of § 1 of the Additional Provisions of the Income Taxes on Natural Persons Act the document, proving the distribution of a dividend, is the protocol from the resolution of the general meeting of the shareholders of a LLC/ or the resolution of the sole shareholder of single-shareholder LLC. The adoption of a resolution of the general meeting of the shareholders of a LLC/resolution of the sole shareholder of a single-shareholder LLC could happen after the expiring of the fiscal year and the adoption of the annual financial reports and the balance sheets. I.e. such distribution is based on the retained profit from the previous financial years and is possible not only after the adoption of the annual financial reports, but also several times during the year, provided that retained profit and funds in the company are still available.
However, in case of no undistributed profit available, the shareholders often need to use company’s funds for private purposes. In that case, it is particularly important that the company is able to register a profit during the year and that the use of current resources for private purposes would not affect the payment of obligations to suppliers, creditors, etc., i.e. that there is no decapitalization of the company. In its nature, this payment represents a preliminary dividend distribution.
I.e. the shareholders receive funds based on predictions for realization of annual profit, which are included as an estimation at the end of the year in the company's current balance sheet. During the following year, by the general meeting of the shareholders adopts the annual financial statements for the previous year, decides on distribution of dividends, respectively on the payment of the dividend tax, as well as the estimation for the distribution of the advance profit (the provisional dividends) gets dissolved. The tax shall be paid until the end of the month following the quarter of the adoption of the resolution. Within the same period a tax declaration pursuant to Art. 55, Para. 1 of the Income Taxes on Natural Persons Act and Art. 201, Para. 1 of the Corporate Income Taxation Act shall also be submitted by the tax payer.
In this case, according to Art. 16, Para. 2, Item 3 of the Corporate Income Taxation Act, the National Revenue Agency in Bulgaria assumes that the distribution of the provisional dividends represent a short-term loan, granted by the company at the market interest rate within the meaning of item 32 from §1 of the Additional Provisions to the Corporate Income Taxation Act for the time period of the use of the "provisional" dividend until its dissolution from the estimation, i.e. this leads to undeclared interest income.
Unrecognised for tax purposes expenses (Art. 26 item 11 of the Corporate Income Taxation Act) or an estimation, which would not be reimbursed or would not be offset against other obligations of the company to the shareholders, are deemed as hidden distribution of profit, respectively as a dividend on the basis of item 5 (c) of § 1 of the Additional Provisions of the Corporate Income Taxation Act. For this reason, in accordance with Art. 38, Para.1 of the Income Taxation Act in conjunction with item 5 (c) of para. 1 of the Additional Provisions of the Corporate Income Taxation Act, a dividend tax of 5 % will be charged. In accordance with Art. 261 para.1 of the Corporate Income Taxation Act, a penalty in the amount of 20 % of the unrecognized expenses and/or the estimation shall be imposed.
Such penalty could be averted if within the year of the hidden distribution of the profit the amount is declared within Part VII – “Declaring of hidden distribution of the profit”, of the annual tax declaration according to Art. 92 of the Corporate Income Taxation Act for the corresponding year (Art. 267 Para. 2).
Is there a difference in case the owners declare the private withdrawal as a hidden distribution of profit?
For the hidden distribution of profit no resolution of the general meeting of the shareholders regarding the dividend distribution is required. There is no need for special documentation. The amounts are distributed on a quarterly basis and are accepted as dividends for tax purposes, in which case the tax payer deducts and pays the tax until the end of the month following the three-month-period, when the hidden distribution of profit took place (Art. 38, Para. 3 and Art. 65 Para. 3 of the Income Taxes on Natural Persons Act). The tax payer shall also submit a declaration under Art. 55, Para. 1 of the Income Taxes on Natural Persons Act and Art. 201 para. 1 of the Corporate Income Taxation Act for the amounts, used in the relevant quarter. At the end of the year, these private withdrawals are also declared in accordance with Art. 73 of the Income Taxes on Natural Persons Act, Ref. 814.
This serves as acknowledgment for hidden distribution of profit within the meaning of Point 5. Item “a” from § 1 of the Additional Provisions to the Corporate Income Taxation Act, in connection with It. 8 of § 1 of the Income Taxes on Natural Persons Act and is declared under Part VII – “Notification of a hidden distribution of the profit” within the annual tax declaration pursuant to Art. 92 Corporate Income Taxation Act for the corresponding year. In this case, when the hidden distribution of profit is declared within the annual tax declaration in accordance with Art. 92 of the Corporate Income Taxation Act, the amounts currently distributed between the shareholders are considered as advance hidden distribution of profit without legal penalties, they are not interest-bearing until the dissolution of the estimation and there is no penalty of 20% of the amounts. A problem arises only if, due to this hidden distribution of profit, the company is not able to meet its obligations to the public budget pursuant to Art. 19, Para. 2, Item 1 of the Tax-Insurance Procedural Code. But this liability also applies to all other cases of dividends distribution.
The accounting of money amounts as a hidden distribution of the profit could have very serious tax consequences such gets determined during a tax revision (the expenses would not be recognized for tax purposes, a dividend tax of 5% on the amount and a penalty payment of 20% of the distributed amounts would be imposed), provided that the loss of resources of the company is obscured in favour of the shareholders, accompanied by a non-declaring of income.
Finally, it can be stated that only for those companies which fulfil both criteria at the same time - actually achievable forecasted profit and strict compliance with the obligations to the public budget – it will be better to account private withdrawals on a quarter basis, as well to be paid a dividend tax in the amount of 5 % at the end of the month following the quarter of the amount deficit and their declaring within the annual tax declaration under Art. 92 of the section "Hidden Distribution of Profit".
For companies that have no real and uncontested reason to achieve the projected profit and to pay their public budget obligations, a distribution of an advance dividends by declaring them as hidden distribution of profit would be completely inappropriate.