Capital Contributions in Malta

Capital contribution is a contribution of funds or property to a business by the shareholders of the company.  The contribution increases the shareholders’ equity interest in the business.  Although additional capital is introduced into the company, the shareholders do not take shares in return and they are neither creating debt.

Why it is done and difference between debt and equity

Apart from the company’s bank accounts, the shareholders of the company may finance the day to day operations of the company through debt or equity. 

Debt

The shareholders of the company may finance the company through a loan payable.  This is shown in the Balance Sheet section under liabilities and is generally done by a loan agreement.  The payment terms and interest terms may vary according to the agreement in place.

Equity

Alternatively, the shareholders may put further capital into the company without taking new shares.  This further capital injection is known as capital contribution and it is payable back to the shareholders when and if the company is deemed fit. This is shown in the Balance Sheet under equity and is shown as a separate line item headed ‘Capital Contribution’ or ‘Capital Contribution Reserve’.

Advantages and disadvantages of capital contribution

Advantages

• The company does not have a loan payable to the shareholder and only pays the capital contribution when and if it deems fit;
• If the business lacks creditworthiness through a poor credit history or lack of a financial track record, equity can be preferable and more suitable than debt financing.

Disadvantages

• Once contributed, the reserve becomes at the disposal of the company, and the original shareholder contributing the capital has no preference on the way the company decides on its distribution. Thus in cases of more than one shareholder, this may create issues;
• Given that the equity of the company shows a higher result than if the company entered into debt with the shareholders, the shareholders might expect higher returns.

Double entries of capital contribution and debt (loan payable)

Scenario

Funds contributed as further capital or funds lent to the company by its shareholders – EUR 50,000.

Capital contribution double entry

DR. Bank EUR 50,000

CR. Capital Contribution Reserve (under equity) EUR 50,000

Loan payable double entry

DR. Bank EUR 50,000

CR. Loan payable to the shareholder (under liabilities) EUR 50,000

Distribution of capital contribution

Accounting aspect

Article 192(3) of the Maltese Companies Act states the following:

“[…] a company’s profits available for distribution shall be its accumulated, realised profits, […]

Whereas share premium account or capital redemption reserve are considered as “undistributable reserves” (Article 193(3) of the Companies Act) and that there are rules in place when to be used or not, in the case of cash donation it is possible for this to be classified as a “distributable reserve” as long as the following conditions are met:

• Donation made by the shareholder to the Company has to be made in cash. If the donation made by the shareholder is not in cash e.g. donation of immovable property, then this would not be considered as “realised profits”, thus distributable.
• The source of cash that the shareholder is donating to the Company must be coming directly from the shareholder’s own funds. In other words, the source of funds cannot, whether directly or indirectly, emanate from the Company e.g. Company gave a loan to the shareholder and the shareholder is using the same money to donate it back to the Company.
• When the shareholder decides to donate the cash to the Company, it is important to document this in writing, and most importantly using the correct terminology (e.g. Mr X, qua shareholder of Company A, is donating the sum of EURO XXXX to the Company. Such sum is not repayable, in any way, to the shareholder). The wording used in such transactions is crucial as this determines whether the cash contribution made by the shareholder is classified as distributable reserve vs. non-distributable reserve.

As long as all of the above three factors are catered for, a donation of cash made by a shareholder to his Company would classify as “distributable reserve”.

One of the benefits of a capital contribution reserve is that a Company that has reported losses for a number of years - therefore cannot distribute a dividend – is now able to distribute a dividend because the cash donation exceeds the accumulated losses, and therefore provided that are profits allocated to the MTA/FIA of the Company, the shareholder is now in a position to claim a tax refund.