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;
- Financial funds of the companies used by their owners for personal needs, purchases of personal belongings for the owner or third persons directly from company accounts.
- 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
There are certain situations where it might be necessary to use personal funds of the owners despite the absence of retained earnings from previous years. In these cases, it is above all crucial whether the company has the certainty that it will make a profit during the year and the utilization of current personal funds will not disrupt the payment of obligations to suppliers, creditors and others, i.e. the company will not be decapitalized. By its nature, this payment is the receipt of an advance dividend.
For instance - sums are received from the owners on the occasion of the estimated annual profit and are shown as an estimate at the end of the year in the current balance sheet of the company. In the following year, following the decision of the General Assembly on the adoption of the annual financial report for the previous year and distribution of dividend, respective withholding and payment of dividend tax, calculations of sums absorbed in advance /advance dividend/ are closed. The tax is paid by the end of the month following the quarter in which the decision was made. In the same period, a declaration under Art. 55, Section 1 of the Income Tax Act and Art. 201, Section 1 of the Corporate Income Taxation Act is to be submitted by the payer of the income.
In this case, the NRA accepts that according to Article 16 Section 2 pt. 3 of the Corporate Income Taxation Act, the received advance dividends represent a short-term loan granted by the company, for which interest is due based on the market interest rate in the sense of pt. 32 of § 1 of the additional provisions of the Corporate Income Taxation Act, for the period of using the "advance" dividend until it is closed as a settlement. Thus, this results in unreported interest income.
In another case, when there is a hidden distribution of profit, i.e. expenses which are not recognized for tax purposes (Art. 26, pt. 11 of the Corporate Income Taxation Act) or there is an estimate that will not be reimbursed or deducted from other obligations of the company to the owner, then the expense and the estimate are treated as a hidden distribution of the profit and from here as a dividend on the basis of pt. 5, letter "c" of § 1 of the additional provisions of the Personal Income Taxes Act. Therefore, a 5 percent dividend tax would be charged on these amounts in accordance with Art. 38, section 3 of the Income Tax Act in connection with pt. 5, letter “c” of § 1 of the additional provisions of the Personal Income Taxes Act. A pecuniary sanction would also be imposed in accordance with Art. 267, section 1 of the Corporate Income Taxation Act in the amount of 20 percent of the reported expense or estimate.
It is not due only if in the year of hidden distribution of profit the amount is declared in Part VII - Declaration of hidden distribution of profit of the annual tax declaration under Art. 92 of the Corporate Income Taxation Act for the relevant year, Art. 267, section 2 of the Corporate Income Taxation Act.
In the case of hidden distribution of profit, no Protocol - Decision of the General Assembly on dividend distribution has to be drawn up. No special paperwork is required. The accrued amounts are divided by quarter and are accepted for dividend tax purposes, and the tax is withheld and paid by the company - payer of the income, within a period until the end of the month following the quarter in which the hidden distribution of the profit was made (Art. 38 , section 3 and Article 65, section 3 of the Income Tax Act.) The payer of the income shall also submit the Declaration under Article 55, Section 1 of the Income Tax Act and Art. 201, Section 1 of the Corporate Income Taxation Act for the amounts used for the quarter. At the end of the year, these sums for personal use are also declared in the Reference under Article 73 of the Income Tax Act code 814.
This is a recognition of the presence of a hidden profit distribution in the sense of pt. 5, letter "a" from § 1 of the additional provisions of the Corporate Income Taxation Act in connection with pt. 8 of § 1 of the Personal Income Taxes Act. And it is reflected in Part VII - Declaration of hidden distribution of the profit of the annual tax declaration under Art. 92 of the Corporate Income Taxation Act for the relevant year, i.e. if a hidden profit distribution is declared in the annual tax declaration under Art. 92 of the Corporate Income Taxation Act - in practice, the amounts currently used by owners are treated as an advance distributed dividend without any legislative sanctions, there is no interest until the final settlement of the accounts, and there is no 20 percent sanction on these amounts. The only problem is only when a hidden profit distribution prevents the company from repaying its public obligations according to Art. 19, Section 2, item 1 of the Tax-insurance Procedure Code. But this responsibility is also present in all other cases of dividend distribution.