After many years in which the Net Asset of an entity registered in Romania has become an indicator closely monitored by the state authorities, it seems that a shift of perspective has occurred recently. In the context of the current crisis generated by the Covid-19 pandemic, the representatives of the Ministry of Public Finance decided that the entities should be encouraged to improve their financial position, because the previous version under which in case of non-compliance they would be dissolved on request of the National Agency for Fiscal Administration was not going to be a viable version in Romania in 2020.
Although in 2019 there were information on the existence of some draft legislation that was going to introduce the possibility for the MPF, through NAFA, to request the dissolution of the companies that fail to comply with the net asset requirements, this draft legislation have not been published in the Official Gazette so far. On the contrary, in September 2020 it was adopted the GEO 153/2020 setting incentives meant to increase the equity interests of the Romanian entities by granting tax reductions.
The Net Asset, a key indicator in assessing a business
The Net Asset is an indicator frequently used in the financial analysis, because based on it an estimate value of a company is determined. It is not the equivalent of a company’s market value but represents the value of the equity interests of an entity, namely the difference between the value of the assets and the value of the liabilities recorded by the entity. In practice, the Net Asset represents the amount that the associates/shareholders/partners of a company would receive in case of liquidation of the company, after the capitalisation of the assets and satisfaction of the debts registered by the entity.
A low level of the Net Asset indicates that the entity is not financially able to develop with its own resources, is highly indebted and therefore cannot pay its creditors, suppliers, taxes, employees, partners etc. Such situation raises the doubt on the business continuity of the respective company.
Which are the obligations currently correlated to the Net Asset
There is currently the obligation to adjust the Net Asset in case its value is below half of the value of the Share Capital. The respective entity must settle this issue by the end of the year that follows the one in which the non compliance of the requirement is acknowledged.
Such obligation is laid down by the Companies Law (Law 31/1990), the prospective consequence in case of non compliance is that any interested party may apply for the dissolution of the relevant entity.
Although this legally binding approach exists for quite a while now, in practice we are not aware of many cases in which the dissolution of an entity was claimed based on this ground. However, fiscal inspections were conducted by NAFA over time where explanations were requested on this issue and measures were provided with regard the remediation of this issue.
What is changed in 2020
In the context in which many of the companies deal with liquidity shortage, the authorities reviewed the previous proposals and it seems that the conclusions were different with respect to the ones in the past: the entities are strengthened to remedy these issues, receiving tax reductions in this respect.
By the GEO 153/2020 reductions were introduced which apply for the period 2021-2025 and related to the taxes due by the companies in the form of corporation tax, income tax on micro-enterprises or the tax specific to certain activities such as:
1) 2% for a positive equity value and the value of the Net Asset equal to or exceeding 50% of the value of the Share Capital;
2) between 5% and 10% according to the level of the adjusted annual increase in the equity value for the year in which the tax is due in relation to the adjusted equity value of the preceding year, also complying with the conditions provided at point 1);
3) 3% beginning with 2022 if the level of the annual increase in the adjusted equity value for the year in which the tax is due in relation to the adjusted equity value of 2020 exceeds a minimum level set out for each year (5% in 2022, up to 20% in 2025), also complying with the conditions provided at point 1).
If 2 or 3 of these conditions are met, the reduction percentages of the tax are cumulative.
Why is the end of the year important from the perspective of the Net Asset
Both from a legal perspective and from a financial one recently the indicators Net Asset and Share Capital are significant at the end of the year because:
a) legally - there is the obligation to remedy the issue of the Net Asset by the end of the following year if it decreases below 50% of the Share Capital;
b) fiscally - in the period 2021-2025 tax reductions will be granted according to the indicators presented in the annual statements.
The end of 2020 plays an even more important role while being a benchmark year in obtaining tax reductions for 2021-2015.
How to adjust the Net Asset
Although the fiscal cuts will only be applied beginning with 2021, the end of 2020 may be considered an important one given that satisfying the requirements for the increase in equity values may require a long period to detect the funding sources, while not disregarding the legal obligation to remedy the Net Asset by 31.12.2020 if its value decreased below 50% of the Share Capital until 31.12.2019.
Several options can be taken into account to remedy the Net Asset, but the applicability of each one is determined according to the level of the Net Asset/ assets and/or liabilities of the entity, the current value of the share capital, the retained earnings of the company etc.
The first step is to establish the type of Net Asset recorded by the company:
1. Positive Net Asset but below 50% of the Share Capital:
Scenario 1: Decrease the Share Capital by covering the accounting losses
In most cases, the existence of a low value Net Asset is due to accounting losses recorded in the previous years. Based on these losses and the value of the Share Capital, the company may decide to decrease the Share Capital by covering the recorded losses. A high importance should also be given to the fiscal impact in the light of the value of the Share Capital in the future, i.e. not to be under RON 45,000, in which case the entity is liable to pay corporation tax by option.
Scenario 2: Share Capital increase with issued share premiums
Another way in which the failure to comply with the Net Asset proportion in relation to the value of the Share Capital may be settled is to increase the Share Capital by issuing share premiums, a higher percentage of the increase value being allocated to the Share Premiums. The entity is thus able to increase the Net Asset value and to also maintain a low value of the Share Capital.
2. Negative Net Asset
Scenario 1: Share Capital increase by contribution in cash/assets
If the Net Asset turns to be negative, the first option to take into consideration is that which enables the Share Capital increase by new contribution in cash or in assets. If the option of the contribution in cash may be deemed simple and without major implications, the option of the contribution in assets may be deemed more complicated because it requires the assessment of the assets brought as contribution giving rise to prospective fiscal implications.
It can also be conducted an analysis of the assets and/or liabilities of the entity depending on the official situation, the following options may be considered:
Scenario 2: Asset assessment
If the company owns assets such as real estate, if an increase in the market value thereof is projected it will be possible to assess the assets. From an accounting point of view, the increase in the recorded value for the relevant real estate generates Revaluation Reserve which is included in the value of the Net Asset. Nevertheless we point out that this approach should be compliant with the accounting policies used by the company.
Scenario 3: Share Capital increase by converting the debts towards the shareholders
If the company incurs debts towards the shareholders, an option whereby the Net Asset can be sort out is that in which the respective debts are converted in Share Capital.
Such increase must be validated by all the company’s shareholders and recorded in the Shareholders General Meeting which will form the basis of this process together with an accounting expert’s report prepared by a chartered accountant. The chartered accountant will review all the documents and accounting records existing in connection with the respective debts and will conclude based on them if the debt is certain, of a fixed amount and due at the time of the projected share capital increase. At BDO, we frequently assist clients in preparing this accounting expert’s report in order to adjust the Net Asset value.
Such an increase may also be achieved by converting some of the interests due for the loans received from shareholders, giving greater importance to the fiscal treatment from the perspective of the tax on incomes obtained by non-residents when the beneficiary of the interests is a non-resident.
In conclusion, we can identify several ways to remedy the value of the Net Asset for the purpose of obtaining a positive value and/or satisfying the condition provided by Law 31/1990, but not all of them are generally applicable.
Our team can support you in an analysis to be made for the financial status of the company, correlated to the estimates for the future and an assessment of the accounting, fiscal and legal implications, necessary in this case with the purpose of finding the best solution for your company.