The determination of retained earnings and their distribution is one of the fundamental rights of shareholders, acquired based on their initial investment in the company. Besides shareholders, third parties can also participate in the distribution of profit. This article provides a detailed overview of the decision-making process regarding the realized profit of a company, the tax implications for the company distributing the profit, and the method of taxation for the recipient.
Legal Basis
The legal basis for determining profit and its distribution is primarily regulated by the Companies Act (ZGD-1). The introductory provisions of this Act foresee that companies operate to achieve profit in the market. Not only does the company benefit from the profit, but shareholders are also entitled to it. The right to participate in the profit is part of their property right acquired upon obtaining a share in the company. In addition to shareholders, other persons may also participate in the distribution of profit.
The Companies Act mentions the distribution of profit in Chapter 8. This chapter provides a detailed definition of retained earnings, the method of their formation, and their accounting presentation. It also sets the rules for profit distribution in individual companies.
Regarding the distribution of profit among shareholders of a limited liability company, the Companies Act stipulates that:
- Shareholders have the right to decide on the use of retained earnings (decision-making at the general meeting and adoption of an appropriate resolution),
- Shareholders are entitled to a share in the retained earnings as determined in the annual balance sheet unless the articles of association state otherwise, and
- The profit is generally distributed in proportion to the amount of business shares unless otherwise provided by the articles of association.
Since these provisions are dispositive, they can be modified through the articles of association based on the Companies Act.
Profit is distributed based on a resolution adopted at the general meeting regarding profit distribution, which must include all necessary components. Exceptionally, profit can be distributed even before it is determined.
Distribution of Profit to Third Parties
The distribution of company profit to third parties (e.g., employees, other companies, foundations) is possible but only based on a suitable legal basis. Since the provisions of ZGD-1 regarding profit distribution are dispositive, profit can be distributed to third parties. This is possible if the articles of association provide for it and the shareholders adopt a resolution on the distribution accordingly.
Profit can also be distributed to employees based on the Employee Participation in Profit Act (ZUDDob). Other entities (legal or natural persons, foundations, etc.) can participate in the distribution of a company’s profit. This participation is based on an appropriate contract between the distributor (the company) and the profit recipient. The Companies Act allows the management of a particular distributing company to conclude a special agreement on the transfer of profit or other types of business contracts. This type of agreement is valid only if the general meeting gives its consent.
The distribution of profit in the case of company dissolution is not considered a dividend payout under the Personal Income Tax Act but as capital gains. Upon the dissolution of a company and the distribution of profit to its shareholders, this payment is made. It represents a reduction of the shareholder’s ownership share.
Tax Treatment
The taxation of profit distribution depends on the status of the distributor and the recipient. This means whether the recipient is a natural or legal person and whether they are a Slovenian or foreign tax resident.
When employees who are not shareholders are involved in profit distribution, this income is not treated as profit distribution (dividends). Instead, it is typically taxed as employment income, which is fully included in the tax base. Social security contributions are calculated and paid on the entire income.
If the income (profit distribution) has its source in Slovenia under tax legislation, the Corporate Income Tax Act (ZDDPO-2) and the Personal Income Tax Act (ZDoh-2) generally apply for the taxation of both the distributor and the recipient. In the case of residency uncertainty, international conventions on avoiding double taxation apply. These conventions determine where taxation takes place and what withholding tax rate is considered. According to ZDDPO-2, dividend payouts are subject to a 15% withholding tax. However, specific conventions on avoiding double taxation often provide for a lower rate. A profit distribution to a foreign company based in an EU member state may also be exempt from tax if the conditions under ZDDPO-2 are met.
Profit represents the excess of income over expenses, paid to shareholders or members in connection with participation in the distributor’s profit. The taxable subject and the circumstances and facts essential for taxation must always be assessed based on their economic substance. Thus, ZDDPO-2 also treats income similar to dividends as dividends (Article 74 of ZDDPO-2).
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