Let’s start at the beginning! Concept of the equity
Equity shows the assets of the entity, that equals to the property contribution given by the owners at the time of the establishment of the company. Realized income through the operation of the company increases, while the loss decreases the equity of the company. Moreover, several other business events can occur in practice influencing the value of the equity e.g., dividend payment, capital increase or capital decrease.
Concept of the equity according to the Act C. of 2000. on Accounting:
“35. § (1) Equity instruments may be shown under owner’s equity only if made available to the company by its owner (shareholder), or which has been left by the owner (shareholder) with the company from the after-tax profit, in addition to what is contained in Section 36. The valuation reserve of adjustments and the fair value reserve shall also be directly included in equity.
(2) A company’s equity shall consist of subscribed capital (decreased by the amount which has not yet been paid up), capital reserve, retained earnings, tied-up reserves, valuation reserve, and the results after tax for the current year.”
The Act V. of 2013. on the Hungarian Civil Code (hereinafter: “new PTK”) states strict requirements relating to the minimum of the unpaid subscribed capital, that cannot be less than:
- in case of private limited liability company (i.e., Kft.) 3 million HUF,
- in case of the private limited company by shares (i.e., Zrt.) 5 million HUF,
- in case of the public limited company by shares (i.e., Nyrt.)10 million HUF,
Over the equity requirements, the equity/subscribed capital ratio is also regulated by law effected the companies with limited liabilities (Kft. and Rt. (Zrt. and Nyrt.)).
Sudden equity loss
The new PTK regulates the sudden equity loss differently given a Kft. or an Rt.
In case of a Kft. is a sudden equity loss, once:
- the equity decreases for half of the equity capital due to losses,
- the equity decreases for the minimum of the equity capital regulated by law,
- the company may experience insolvency,
- the assets of the company do not cover its debts.
In the event of the above-mentioned cases, the executive director is obliged to immediately arrange the board/general meeting or initiate the decision-making without any official personal board/general meeting. The members are obliged to decide about additional payment, ensuring the equity for reach the minimum level of equity capital or equity capital decrease. In lack of those decisions, the transformation, merger, division or termination without a successor of the company should be determined. In three months either decision would be executed. Conceding that after three months the cause of the board/general meeting arrangement circumstances still exists, the equity capital should be decreased.
In the case of Limited companies by shares (Rt.) the new PTK determines the following (3:270. § (1)-(3)):
“(1) The management board shall, with simultaneous notice to the supervisory board, call a general meeting within a period of eight days in order to provide for the necessary measures, or initiate a decision-making process without having to hold a meeting, whenever it comes to the notice of any member that:
- a) the limited company’s equity has dropped to two-thirds of the share capital due to losses;
- b) the limited company’s equity dropped below the amount limit defined by law;
- c) the limited company is on the brink of insolvency or has stopped making payments; or
- d) the limited company’s assets do not cover its debts.
(2) In the cases provided for in Subsection (1), shareholders are required to adopt decisions within or without a general meeting to determine the ways to eliminate the causes referred to in Subsection (1), or shall adopt decisions on the company’s transformation, merger or division, or in the absence of these, on its dissolution. The related resolutions of the general meeting shall be carried out within three months.
(3) If the reason referred to in Paragraph a) of Subsection (1), on account of which the general meeting was called is not eliminated within three months following the conclusion of the general meeting, the company’s share capital must be reduced.”
Slow equity loss
The new PTK regulates the slow equity loss equally in the case of a Kft. and an Rt.
“3:133.§. (2) If a business association’s equity is not sufficient to cover the subscribed capital prescribed for its specific corporate form over two consecutive financial years, and the members fail to provide for the necessary equity within a period of three months after approval of the annual account for the second year, the business association shall be required to adopt a decision within sixty days of this deadline for its transformation. Instead of transforming the business association may opt dissolution without succession or for the merger.”
Possibilities for equity equalization
Possibilities for equity equalization are described below:
Based on the new PTK the deed of association can give the right to the board/general meeting to cover the losses with additional payment instruction in the name of the members. In lack of that clause first, the relevant section of the deed of association needs to be modified and afterwards, can the additional payment be instructed. The maximum amount and the frequency of the additional payment need to be defined. Fulfilment way, schedule and deadline of the additional payment must be defined in the decree of the board/general meeting. According to the new PTK the fulfilment of the additional payment through a non-payment contribution is also feasible. Thus, properties considering as a contribution-in-kind (“apport”) asset based on the new PTK rules can also be used as an additional payment by the owners.
The residual of the additional payments which is not needed for the loss coverage should be repaid to the owners.
Subscribed capital decrease in favor of the equity
The subscribed capital decrease can occur in favor of capital reserve or retained earnings based on the owner’s decision. It can be booked in the company’s accounts at the time of the entry of the Registry Court.
As long as the subscribed capital decrease is made in favor of the capital reserve with negative retained earnings (due to the lossmaking operation of the company), the negative retained earnings can be covered by the capital reserve based on the owner’s decision.
If the company has negative equity the above-mentioned option will not be suitable as the equity would be still negative. Therefore, another measure should be taken for the equalization of equity.
Subscribed capital increase by agio
During the capital increase by agio, the property contribution by the owners partly goes to the subscribed capital and partly (generally the significant portion) to the capital reserve aiming only the minimal increase of the subscribed capital ratio.
An important note is that the owner can only contribute property to the capital reserve simultaneously with the subscribed capital increase. Thus, if the owner will not increase the subscribed capital, property contribution to the capital reserve would not be possible. The subscribed capital increase can be booked in the company’s accounts at the time of the entry of the Registry Court.
Waiver of the owner’s liability
If the company shows liabilities against the owner (e.g., member loan, supplier liabilities…etc.) the owner can waive the related liability, thus the waived liability would be accounted as another income and through the loss/profit after taxes, the equity would be equalized. However, the corporate income tax and – given an individual owner – the gift fee liabilities should also be considered.
Final transfer of funds
The owner can equalize the status of the capital by permanent transfer of funds. The received funds – similarly with the waiver of the owner’s liability – would be accounted as another income and through the loss/profit after taxes, the equity would be equalized. However, the tax and duty liabilities should also be considered.
Applying value adjustment
The equity can be equalized – assuming the company owns fixed assets which market value are significantly higher than the booked value – with value adjustment as a valuation method. The valuation method can be used with the modification of the accounting policy. The valuation reserve is part of the equity and based on the capital protection rules defined in the new PTK the valuation reserve can be considered at the equity. However, if the audit is not compulsory at the company, then based on the Act on Accounting the valuation method should be reviewed by an auditor.
Transformation to another business form
If the company is not able/not willing to apply any above-mentioned options, it should transform to any business form under it would be able to fulfil the subscribed capital requirements.
As a further possibility, the owners can also terminate the company. The termination can occur with liquidation or elimination depending on whether the company is probably would be able to repay its liabilities or not.
Since the implementation of the Online Financial Statement Reporting System, the company’s financial statement data are available to the Registry Court which shows a clear picture about the position of the company’s equity.
Based on the notifications of the above system the Registry Court has the right to initiate an inspectorial procedure against the affected companies.
If the company is not willing to equalize its capital position despite the legal procedure, the Registry Court initiate a compulsory de-registration procedure effecting the termination of the company.
The consequences of the compulsory de-registration procedure are major and important for instances:
- the default penalty and the procedural penalty imposed by the Tax Authority shall be paid by the executive officer (Act CL. of 2017. on the Rules of Taxation, 12. §),
- the Registry Court shall disqualify the company’s executive officer, or a member with majority control in case of limited liability company registered at the time or at the year before of the opening of the involuntary de-registration procedure for a one-to-five-year period being an executive officer or a majority owner (Act V. of 2006. on Public Company Information, Company Registration and Winding-up Proceedings, 9/C. §).
Read more on our blog! Accounting & Taxation in Hungary