When two or more people join together to operate a business, they often choose a limited partnership as their legal structure. While it is fairly simple process to start a limited partnership, provisions regarding liability can sometimes pose major challenges to shareholders. Whoever enters into a limited partnership doesn’t just take over a part of the management duties, they also become...
In some situations, a company may need a small financial injection that doesn’t necessarily need to come from a bank or external investor. When it comes to their own business, many business owners are willing to sacrifice their personal savings for success. In these instances, they are making what is known as a capital contribution: They are putting their personal assets into the company without receiving direct compensation. This is known as a capital contribution.
What counts as a capital contribution?
A capital contribution is the financing of a company (individual or partnership) by the business owner themselves, or by the company’s shareholders from their personal assets. There are no direct advantages for the depositors. The company’s equity increases, but the transfer is still considered to be non-profit-neutral, i.e. the company’s profit is not increased by the capital contribution.
A capital contribution is a business owner putting their own financial resources or material into their company in order to increase equity capital and improve liquidity. The same applies to partnerships: Each shareholder has the option of making their own assets available to the company. A crucial point: The capital contribution does not increase the company’s profit, only its equity capital. After all, the additional assets did not arise from business operations, but external funds.
The counterpart to capital contributions are capital withdrawals.
Different types of capital contribution
Business owners and shareholders can put both money and benefits in kind into a company.
Cash deposits: The cash deposit is probably the most common type of capital contribution. This is simply money being made directly available to the company. This can be done through a bank transfer or a cash deposit, for example.
Contributions in kind: When it comes to contributions in kind, the business owner makes certain means of production available to the business. This could be real estate or land, machines and tools, or even vehicles. In addition to these tangible assets, intangible assets are also among the possible contributions in kind: Securities, patents, and licenses can be transferred to a company as private deposits. If you transfer previously used objects into the company, this must be done through a clear action – a change of location, for example.
Transfer of use: In situations of standard contributions in kind, the assets are transferred to the company and remain privately owned at the time of use. Only use for operational purposes is allowed. Use is free of charge, while the amount of the deposit is valued with a fictional rental payment.
Service: In the case of a partnership, shareholders can make their labor available and begin working privately within the company. An example of this would be if management is provided without an open call to external applicants.
Contributions in kind must have an operational benefit. The capital contribution should not only be made for tax purposes, but must be directly related to the company.
Capital contributions in sole proprietorship or partnership
Capital contributions can be made to sole proprietorships and partnerships through their private accounts. A private account is kept in the accounting department for each partner in a partnership.
Capital contributions in a limited company and other corporations
Corporations and publicly traded companies have no privacy and therefore no private accounts. Due to this, private deposits are not really possible with limited liability companies and corporations. In the case of a corporation, a payment to the company from a private source always leads to greater shares for the shareholders. The shareholders exchange cash, or non-cash contributions for shares.
Find out how to book private deposits and withdrawals correctly in our article on the topic.
Do I have to pay tax on capital contributions?
Tax laws like Section 118 deal with private deposits in terms of defining the concept of a profit. As a business owner, you generally tax your company profits, not its assets. Capital contributions are considered performance neutral, since there is no profit or loss generated by the payment. This means you can increase your operating assets with a capital contribution, without affecting your business’s tax status. A profit or loss with a tax impact would only arise if you sell an item that was previously transferred to the company as a capital contribution. The profit or loss is the difference between the item’s sale value and its value at the time of deposit.
However, it is crucial that you record the deposit’s value correctly. Valuing a cash deposit is easy, but things can become more difficult when accurately trying to quantify a contribution in kind. If the item is previously used, then the original purchase price no longer counts, since the item has decreased in value since the time of purchase.
In U.S. Generally Accepted Accounting Principles (GAAP), the fair value measurement of a deposit liability is described as the amount payable on demand as of the reporting date. Items that you have inherited and then put into your company are also valued using this method. However, the decisive factor for the valuation is not the date you inherited, but the date that the deceased acquired the item.
A special feature of private deposits is deductible input tax: Let’s say you buy a car as a private individual, which you then contribute to your company after one year. When you bought the car, let’s say you paid 19 percent sales tax (this number will vary from state to state) on the purchase price. However, as soon as the car is transferred to your company as a capital transfer, you are entitled to recover the sales from the amortized acquisition costs from the state tax authorities. This also applies to any other items subject to sales that you purchase privately and then contribute to your company.
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