Tax implications of establishing a private limited company and increasing share capital

The establishment of a limited company or public limited company and the subsequent increase in share capital raise several tax issues, both for the company and the shareholders. This is particularly important when the shareholder contributes assets other than cash. In this article, we closely examine the tax consequences for both shareholders and the company in such transactions.

Main Forms of Capital Contribution

The default rule in company law is that capital contributions (share capital and share premium) are made in cash (Norwegian kroner). However, the law also permits contributions in the form of other assets, known as in-kind contributions. These can include real estate, business operations, intangible rights, or currency.

For an asset to be used as an in-kind contribution, it must be capable of being recorded on the company’s balance sheet. Therefore, an obligation to perform work or services for the company cannot be used as a share contribution. In capital increases, share contributions can also be settled by set-off, or through a bonus issue (transfer of other equity in the company to share capital).

Tax Consequences for the Shareholder

Contributions in the form of cash

The establishment of a company or capital increase where the shareholder contributes cash generally does not raise any specific tax issues for the shareholder at the time of contribution. The shareholder's acquisition cost and tax-paid capital correspond to the share contribution, i.e., share capital and any share premium.

It is possible that the subscription price (especially in capital increases) is higher or lower than the actual value of the shares issued. If the share subscription occurs in the same proportion as the shareholders' existing ownership, there is no tax liability or deduction right for any discount or premium.

Contributions in the form of assets (in-kind contributions)

When contributions are made in the form of assets, this is considered a realization of the assets in exchange for compensation in shares. The contributor must therefore calculate a gain or loss for each of the assets contributed, and the question of tax liability/deduction right is regulated by the general rules.

This also applies when the shareholder owns or becomes the owner of all shares in the company, as the shareholder and the company are considered separate tax entities. This principle was established in the Supreme Court ruling Rt. 1925 p. 624 (Oscar Larsen).

In calculating gain or loss, the exit value of the asset is set to the market value of the shares at the timing of the contribution. Normally, this also corresponds to the market value of the assets contributed. When several assets are contributed, the compensation must be allocated among the assets in the same proportion as the market value of each asset.

The gain or loss is timed according to the realization principle, based on when the contributor acquires an unconditional right to the shares. In practice, this is normally when the asset is considered delivered to the company, often at the time of the auditor's statement that the contribution has been received.

Set-off against a claim

A claim against the company in which shares are subscribed cannot be used as an in-kind contribution but can be used for set-off of a contribution obligation. Set-off is considered a realization of the claim, and a gain and loss settlement must be conducted for the creditor (the subscriber) if the realization of the claim is taxable.

In calculating gain and loss, the exit value is normally the value of the shares issued. In practice, it is assumed that the exit value of the claim should be set to the real value of the shares, especially in refinancing of companies in economic trouble where the real value of the claim is often lower than its nominal value.

Tax Acquisition Cost and Paid Capital

The shareholder’s tax acquisition cost for shares is primarily what the taxpayer has paid for the shares, plus any acquisition costs. In the case of in-kind contributions, the acquisition cost of the shares and tax-paid capital is generally set to the market value of the transferred assets at the time of transfer.

In a bonus issue, the shareholder’s acquisition cost is spread over a larger number of shares without any payment. The acquisition cost of a bonus share is set to a proportional part of the acquisition cost of the shares to which the bonus share is related. However, the tax position of paid capital is not distributed in the same way, since, in principle, no capital is paid on the bonus shares.

Choice Between Issuing New Shares or Increasing Par Value

In a capital increase, one can choose between issuing new shares or increasing the par value of existing shares. This choice can have tax consequences.

When issuing new shares, the acquisition cost is allocated to the new shares. When increasing the par value, the acquisition cost is added to the shareholder's previous acquisition cost of the existing shares. This also applies to the tax position of paid capital.

Since shielding is determined separately for each share, a capital increase by issuing new shares may result in the shareholder having different basis amounts for their original and newly issued shares. This may also lead to different taxation of dividends and gains on the shareholder’s shares. In most cases, it is therefore advantageous to perform a capital increase by increasing the par value rather than issuing new shares.

Deduction Right for Costs

The shareholder does not have a direct right to deduct the establishment costs in cases where the shareholder incurs these costs, but must capitalize them on the shares. For shareholders covered by the shareholder model, the costs are deducted through gain calculation upon realization of the shares. The costs also enter into the basis for shielding for the shareholders.

Tax Consequences for the Company

Contributions are Not Taxable Income

Contributions to a limited company (share capital and share premium) in connection with establishment or capital increase are not considered taxable income for the company. This applies regardless of whether the subscription price deviates from underlying values. The principle was established by the Supreme Court as early as Rt. 1917 p. 627 (Tromsø Privatbank).

When Does Tax Liability for the Company Arise?

A limited company is considered established when all founders have signed the founding document. In practice, tax law has been interpreted such that the subjective tax liability arises at this time, even though the company may later acquire rights and incur obligations towards third parties.

Allocation of Result Between Contributor and Company

Upon the transfer of assets or business as an in-kind contribution, each party must be taxed for the income that according to timing rules falls within their ownership period. This principle was established in Rt. 1966 p. 1470 (Tomren). In practice, January 1st of the transfer year is often used as the effective date for practical reasons.

Tax Acquisition Cost of the Assets

The Supreme Court in Rt. 1995 p. 1674 (Viking Supply) established that the company's acquisition cost of contributed assets should correspond to the market value of the objects being contributed, and not the value of the shares issued. This may lead to a lack of tax continuity between the contributor's exit value and the company's acquisition cost.

Deduction Right for Costs

It is generally accepted in practice and theory that expenses for establishment and capital increase are deductible if the company itself covers the expenses. The company can choose between expensing the costs immediately or deducting them gradually as income permits.

If the expenses are part of a larger transaction/acquisition, it is necessary to distinguish between costs related to the establishment or capital increase, and those related to the transaction/acquisition. Transaction costs for the acquisition of shares must be capitalized as part of the company’s acquisition cost of the shares.

Special Cases and Exceptions

Tax-Free Transformation and Merger/Demerger

Upon transformation of a sole proprietorship or partnership into a limited company, or during merger and demerger, it can be carried out with tax continuity under certain conditions. This also applies to tax positions such as deficits, positive gain and loss account, and negative balance.

Deduction Right for Share Contributions in Start-Up Companies

Individual taxpayers are entitled to a deduction of up to NOK 500,000 for share contributions at the establishment or capital increase in start-up companies under certain conditions. The criteria for obtaining such a deduction are quite detailed and impose several restrictions on which companies are eligible for the scheme.

Summary

The establishment of a limited company and increase in share capital raises several tax issues that must be carefully considered. This is particularly relevant when the share contribution is made with assets other than cash. A thorough understanding of the tax consequences is important for both the company and the shareholders and may influence the choice between different methods of capital contribution.