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Tax obligations of LLC upon share investment of appraised property
Tax obligations of LLC upon share investment of appraised property
Independent auditor Altay Jafarov comments on the topic.
In practice, in many cases, we witness the creation of subsidiaries through the revaluation of property. In this case, the following transactions are allowed:
A Limited Liability Company (LLC), which is a taxpayer, creates a new LLC as the founder of another legal entity and contributes certain property to the formation of the charter of the newly created company. One of the important points is that the property contributed to the share is revalued before the contribution. Let's consider these points on an example.
Example: “AA” LLC formed the new “VV” LLC in September 2023, having a 100% share. That is, “AA” LLC is the parent company, and “VV” LLC is a subsidiary. The authorized capital of “VV” LLC is 200,000 manats, and the parent company decided to form it at the expense of its own property. The parent company has property with a residual value of 50,000 manat on its balance sheet. It revalued that property and contributed 200,000 manat to the formation of the authorized capital of the subsidiary.
Also, in June 2024, the parent company sold its share in “VV” LLC to another person for 200,000 manat. In this case, what amount should the parent company, “AA” LLC, reflect as income in its 2023 income tax return? Should income be recorded in the 2024 income tax return?
As can be seen, the property with a residual value of 50,000 manat on the balance sheet of the parent company was valued at 200,000 manat and contributed to the authorized capital of the subsidiary. The parent company can record this in two ways in its financial and tax accounting.
As the first method, initially, the property worth 50,000 manat can be revalued and subsequently recorded as a share investment. That is, the book value of the property should be recorded as 200,000 manat and the resulting amount of 150,000 manat should be recorded as revalued capital in capital reserves. Then, 200,000 manat should be recorded as investments in subsidiaries. As a result, no income is generated from both financial and tax accounting points of view. Thus, according to Article 13.2.12 of the Tax Code, income is considered to be the total value of transactions related to the provision of goods (works and services), as well as non-sales income. The time of receipt of income for taxation purposes is determined by Articles 132 and 135 of this Code. When residential and non-residential areas are allocated to the state from buildings constructed by persons engaged in building construction activities, turnover on the provision of residential and non-residential areas allocated to the state is not considered taxable income.
Non-sale income - income from participation as a shareholder in the activities of other enterprises, income from shares, bonds and other securities owned by the enterprise, as well as other income from operations not directly related to the production and sale of goods and services (work), including amounts received in the form of fines and damages, increased exchange rate differences on foreign currency transactions, amounts of creditor and depositor debts that have expired in accordance with the legislation.
It is also clear from the article that the difference arising from revaluation does not correspond to the provision of any goods, works, services or the concept of non-sale income. Therefore, the difference of 150,000 manat is not considered income.
As a second accounting method, the parent company “AA” LLC does not record any revaluation in its financial or tax accounting. The 50,000 manat invested as a share is recorded as a share investment in subsidiaries in its financial and tax accounting at the cost of the property. 200,000 manat will be recorded as a share investment in the subsidiary and as fixed assets, but the difference of 150,000 manat that arose during the consolidation should be taken into account both in fixed assets and in the share investment.
In these cases, it is recommended to give preference to the second method.
As a result: since there is no concept of income in this transaction in 2023, it will not be recorded in the income statement of “AA” LLC. However, in the income statement of 2024, the parent company will record the amount from the above transaction as income, since it sold the shares with a cost of 50,000 manat for 200,000 manat. Thus, regardless of whether it is recorded in both the first and second options, “AA” LLC will record the difference of 150,000 manat as income in the income statement.
Independent auditor Altay Jafarov comments on the topic.
In practice, in many cases, we witness the creation of subsidiaries through the revaluation of property. In this case, the following transactions are allowed:
A Limited Liability Company (LLC), which is a taxpayer, creates a new LLC as the founder of another legal entity and contributes certain property to the formation of the charter of the newly created company. One of the important points is that the property contributed to the share is revalued before the contribution. Let's consider these points on an example.
Example: “AA” LLC formed the new “VV” LLC in September 2023, having a 100% share. That is, “AA” LLC is the parent company, and “VV” LLC is a subsidiary. The authorized capital of “VV” LLC is 200,000 manats, and the parent company decided to form it at the expense of its own property. The parent company has property with a residual value of 50,000 manat on its balance sheet. It revalued that property and contributed 200,000 manat to the formation of the authorized capital of the subsidiary.
Also, in June 2024, the parent company sold its share in “VV” LLC to another person for 200,000 manat. In this case, what amount should the parent company, “AA” LLC, reflect as income in its 2023 income tax return? Should income be recorded in the 2024 income tax return?
As can be seen, the property with a residual value of 50,000 manat on the balance sheet of the parent company was valued at 200,000 manat and contributed to the authorized capital of the subsidiary. The parent company can record this in two ways in its financial and tax accounting.
As the first method, initially, the property worth 50,000 manat can be revalued and subsequently recorded as a share investment. That is, the book value of the property should be recorded as 200,000 manat and the resulting amount of 150,000 manat should be recorded as revalued capital in capital reserves. Then, 200,000 manat should be recorded as investments in subsidiaries. As a result, no income is generated from both financial and tax accounting points of view. Thus, according to Article 13.2.12 of the Tax Code, income is considered to be the total value of transactions related to the provision of goods (works and services), as well as non-sales income. The time of receipt of income for taxation purposes is determined by Articles 132 and 135 of this Code. When residential and non-residential areas are allocated to the state from buildings constructed by persons engaged in building construction activities, turnover on the provision of residential and non-residential areas allocated to the state is not considered taxable income.
Non-sale income - income from participation as a shareholder in the activities of other enterprises, income from shares, bonds and other securities owned by the enterprise, as well as other income from operations not directly related to the production and sale of goods and services (work), including amounts received in the form of fines and damages, increased exchange rate differences on foreign currency transactions, amounts of creditor and depositor debts that have expired in accordance with the legislation.
It is also clear from the article that the difference arising from revaluation does not correspond to the provision of any goods, works, services or the concept of non-sale income. Therefore, the difference of 150,000 manat is not considered income.
As a second accounting method, the parent company “AA” LLC does not record any revaluation in its financial or tax accounting. The 50,000 manat invested as a share is recorded as a share investment in subsidiaries in its financial and tax accounting at the cost of the property. 200,000 manat will be recorded as a share investment in the subsidiary and as fixed assets, but the difference of 150,000 manat that arose during the consolidation should be taken into account both in fixed assets and in the share investment.
In these cases, it is recommended to give preference to the second method.
As a result: since there is no concept of income in this transaction in 2023, it will not be recorded in the income statement of “AA” LLC. However, in the income statement of 2024, the parent company will record the amount from the above transaction as income, since it sold the shares with a cost of 50,000 manat for 200,000 manat. Thus, regardless of whether it is recorded in both the first and second options, “AA” LLC will record the difference of 150,000 manat as income in the income statement.