Conversion with losses: share capital, insolvency and tax losses

Losses in the balance sheet do not in themselves prevent converting a small partnership (mažoji bendrija, MB) into a private limited company (UAB). But the UAB’s share capital must be no less than the statutory minimum, and if the MB’s assets are not enough or its liabilities exceed the value of its assets, the members have the right to make additional contributions. A UAB that is insolvent cannot be converted. Tax losses carry forward after conversion only if the owners do not change as a result of the conversion and the converted entity continues the same activity for 3 years.

Two different meanings of “losses”

The question “do losses block a conversion” has two parts. The first is a company-law question: can an entity with losses in its balance sheet or negative equity change its legal form. The second is a tax question: can tax losses still be carried forward after conversion and used to reduce taxable profit. Different laws answer them.

An MB with losses converted into a UAB

An MB is converted into a UAB under the provisions of the Law on Companies on converting a legal entity of another form into a company (Article 29(8) of the Law on Small Partnerships of the Republic of Lithuania (MBĮ)). The assets for which UAB shares are issued must be valued by an independent valuer (Article 72(12) of the Law on Companies of the Republic of Lithuania (ABĮ)).

The UAB’s share capital must be no less than the minimum capital set in ABĮ Article 2 (ABĮ Article 72(15); ABĮ Article 2(4)). If the MB’s assets are not enough to form the minimum share capital, or its liabilities exceed the value of its assets, the participants of the entity being converted have the right to make additional contributions (ABĮ Article 72(15)). So the law itself foresees the case where an MB’s liabilities exceed the value of its assets and names the way to fix it.

Do members have to pay in money? The law frames additional contributions as a right (ABĮ Article 72(15)). If, after valuation, the MB’s assets are enough for the share capital, no new money is needed. If they are not, the UAB’s share capital would not be formed without additional contributions, so the conversion depends on them.

Can an insolvent MB be converted into a UAB? The ABĮ ban on converting an insolvent company (ABĮ Article 72(4)) applies to a company, that is, an entity whose share capital is divided into shares (ABĮ Article 2(1)). MBĮ Article 29, which governs the conversion of an MB (MBĮ Article 29(1)), contains no such ban, while the MBĮ forbids the members’ meeting to decide to liquidate an insolvent MB (MBĮ Article 30(3)). We found no case law on whether an insolvent MB can be converted into a UAB, so if an MB’s liabilities exceed the value of its assets, the safest course is to restore its equity through additional contributions before the decision.

A UAB with losses converted into an MB

An insolvent company cannot be converted (ABĮ Article 72(4)). Insolvency is the state in which a legal entity cannot meet its property obligations on time or its liabilities exceed the value of its assets (Article 2(7) of the Law on Insolvency of Legal Entities of the Republic of Lithuania (JANĮ)). So a UAB whose liabilities exceed the value of its assets must first restore its solvency.

If a UAB’s reserves and share premium are not enough to cover its losses, the shareholders may cover them with their own contributions and restore equity to at least 1/2 of the share capital stated in the articles of association (ABĮ Article 59(10)). If there is no such decision or the equity is not restored, the general meeting must consider reducing the share capital, converting into a legal entity provided for in ABĮ Article 72, or liquidation (ABĮ Article 59(11)). An MB is one of those forms (ABĮ Article 72(24)), but only while the UAB is not insolvent.

While losses are recorded in the balance sheet, share capital can be increased only from the revaluation reserve (ABĮ Article 51(3)).

Do tax losses carry forward

Tax losses for a tax period are carried forward to later tax years under Article 30 of the Law on Corporate Income Tax (Article 30(1) of the Law on Corporate Income Tax of the Republic of Lithuania (PMĮ)). A special rule applies to conversion: if an entity is converted during a tax period, tax losses of earlier tax periods are carried forward only where the entity’s owners do not change as a result of the conversion and the converted entity continues the same activity as before the conversion for 3 years (PMĮ Article 43(5)).

So two conditions must be met together:

• the same owners: the MB’s members become the UAB’s shareholders, or the UAB’s shareholders become the MB’s members, and no new participants appear;
• the same activity for 3 years after the conversion.

The carry-forward then continues under the PMĮ Article 30 procedure (PMĮ Article 43(7)). Under it, the carry-forward stops if the entity no longer continues the activity that gave rise to the losses, unless it stopped for reasons beyond its control, and the amount of losses carried forward in a tax period is capped (PMĮ Article 30(4)).

PMĮ Article 43(5) does not directly say whether the owners count as unchanged when the same persons hold different stakes after the conversion than before it, and we found no case law, so in that case change the proportions only after assessing the tax consequences in advance.

What to check before the decision

Before taking the conversion decision, check:

• the latest balance sheet: whether liabilities exceed the value of the assets;
• the valuation result, if an MB is being converted into a UAB: whether the assets are enough for the share capital;
• whether the members are ready to make additional contributions if the assets are not enough;
• the corporate income tax returns: how much tax loss is carried forward and from which activity it arose;
• whether the participants and the activity will stay the same after the conversion.

The decision to convert an MB is taken by the members’ meeting by a majority of at least 2/3 of all members’ votes (MBĮ Article 18(1)), and the decision to convert a UAB by the general meeting of shareholders (ABĮ Article 72(5)).

More on conversion

• Converting an MB into a UAB: decision, capital, creditors, timing
• Reducing the share capital of a UAB
• Converting an individual enterprise into a UAB or MB

How to start

Send us the latest balance sheet, the profit and loss statement, the latest corporate income tax return and the list of participants. We will assess whether the conversion needs additional contributions and whether the tax losses will be kept, and prepare the conversion documents.

Phone +370 5 212 1506, email info@linden.lt

More about this service: Changing the legal form of a legal entity.