SETTLEMENT OF NEGATIVE EQUITY

The new Hungarian Civil Code regulates the requirements in connection with the equity. If companies do not comply with these requirements, the Registry Court may initiate a legality supervision procedure, which may even lead to compulsory liquidation. The new OBR system (Online Reporting and Form Filling System), due to its electronic schema, can inform the Registry Court about the companies with insufficient amount of equity. In order to prevent registry court proceedings, it is important to settle the equity capital, for which several solutions are possible.

Cases of lack of equity

According to the Act, a lack of equity arises in the following cases:

• in two consecutive financial years the equity is below the subscribed capital required for the company form,
• the equity capital is decreased to half (two thirds in case of a public limited company) of the subscribed capital.

Options for equity settlement

Shareholders have a choice of several options for the company's equity capital settlement. Several solutions is often necessary to be used at the same time.

Supplementary payment

One of the conditions of the supplementary payment is that the deed of company formation must contain the possibility of supplementary payment and its conditions. If the deed of association does not include the supplementary payment, the deed of association must be amended first, after which a decision on a supplementary payment can be taken. The regulation also allows the shareholders to cover losses by means other than a cash payment (e.g. provision of assets, which can be a contribution in kind, transfer of receivables). The amount of the supplementary payment and the method of payment must be determined by the general meeting of members and need not be registered with the Registry Court. The amount of the supplementary payment must be recorded as a tied-up reserve under the accounting rules, which is also a dividend payment limit. The amount of the supplementary payment must be returned to the members at a later date.

Reduction of subscribed capital

The subscribed capital can be reduced against the capital reserve or the retained reserve and entered in the accounts at the same time as it is registered with the Registry Court.

Capital increase by share premium

The owner can only transfer assets to capital reserves at the same time as an increase in subscribed capital. This is subject to the condition that the members have already fulfilled their previous contributions of assets. The capital increase can be made by a cash payment or by a contribution in kind (e.g. by transferring a claim of the owner), but this solution requires registration with the Registry Court.

Capital increase from dividends

There are two possible ways of raising capital from dividends. On the one hand, the members may waive their dividend claims, as a result of which the company declaring the dividend must recognise the amount of the dividend liability waived as an increase in the retained earnings. The equity problem can thus simply be solved. From a tax point of view, however, the member should be aware that if the dividend claim is waived in favour of an affiliated company, the member must increase its profit before taxation by the amount of the dividend claim waived. On the other hand, the approved dividend can also be used directly for a capital increase, but in case of individual members, personal income tax and social contribution tax up to an upper limit must be paid on the dividend as a general rule.

Waiver of liability

If the company has a debt to the owner arising from a member's loan or other liability, the owner may waive his claim against the company. The waived liability recognised by the company must be recorded as other income, which also increases equity through profit after tax. If the debt was waived by a private individual member, the company may be liable to pay gift duty.

Transfer of non-repayable assets

A transfer of non-repayable assets by a member is considered as other income which increases the profit after taxation the year and hence the amount of equity. However, it may lead to tax and duty payment liability.

Application of value adjustments

If the company has fixed assets which market value significantly exceeds their book value, the company can increase its revaluation reserve by accounting the value adjustment, which in parallel increases its equity. An audit is required to account for the value adjustment.

Transformation into another form of company

If the company cannot otherwise settle the equity deficit, it may decide to convert into a form of company that can meet the requirement of subscribed capital. In this case, however, it should be noted that, under the Act on Accounting, in the draft balance sheet of the successor company the elements of equity capital can be only positive. Thus, if the retained reserve of the predecessor company was negative, this must be settled.