A corporation (AG) is a legal form in which so‑called shareholders provide capital so that a company can be established, expanded, and transformed. In return, the investors receive shares that make them co‑owners of the company. If the company generates profit, there is a possibility that shareholders will also benefit from it. However, there are a number of conditions that must be observed before profits can be distributed. This article is dedicated to these.
Entitlement to profit distribution
Art. 660 para. 1 of the Swiss Code of Obligations (CO) states that shareholders are entitled to a proportionate share of the profit. However, overriding this is creditor protection and, in particular, the protection of equity, which serves as security for creditors. Profits therefore cannot be fully distributed as long as there are no corresponding reserves.
Appropriation of profits
The resolution on how retained earnings are used and the determination of dividends, subject to the statutory provisions, lies with the general meeting in the case of a corporation. Before we look at the specific options for using retained earnings, it is important to know that there are different categories depending on whether the profit remains in the company or is distributed. In general, the following options are available for retained earnings:
Distributed profit that remains in the company
Distributed profit that remains in the company can, for example, be statutory or voluntary profit reserves.
Statutory profit reserves (Art. 672 CO):
The law requires that part of the profit may not be distributed to shareholders but must be retained in the form of statutory profit reserves (ordinary profit reserves). Ordinary profit reserves may only be used or released to cover losses.
Voluntary profit reserves (Art. 673 CO):
Based on Art. 673 of the Swiss CO, the corporation can stipulate in its articles of association (statutory allocation) or by resolution of the general meeting (voluntary reserves) that additional profit reserves are to be formed. These additional voluntary allocations are rarely formed in Switzerland. Their aim is to prepare and protect the corporation for economically unstable times. The general meeting may dissolve voluntary reserves at any time.
Distributed profit that flows out of the company
Distributed profit can be:
- Dividends – Dividends are the share of the company’s profit that is paid out to shareholders. The term superdividends is used when the dividend payment exceeds 5% of the paid‑in participation and share capital.
- Profit‑sharing bonuses – Profit‑sharing bonuses are performance‑based remuneration that is usually paid, in addition to fixed compensation, to members of the board of directors.
An example: A shareholder receives a dividend based on their stake in the company, while a member of the board of directors receives a profit‑sharing bonus for their special contributions to the company.
Dividends and profit‑sharing bonuses may only be distributed once all allocations to statutory and voluntary reserves have been made. Both dividends and profit‑sharing bonuses of a corporation (or an LLC) are subject to double taxation. This means that both the legal entities (AG or GmbH) and the private individuals pay taxes. For legal entities this tax is called income (profit) tax, and for private individuals (i.e. owners) it is called income tax.
Undistributed profit
Examples of undistributed profits are retained earnings and loss carryforwards.
- Retained earnings – Retained earnings are the accumulated profits from previous years that have not been allocated to reserves or distributed as dividends. With retained earnings, part of the profit is carried forward to the following financial year.
- Loss carryforward – In contrast, with a loss carryforward, losses are offset against profits expected in the future.
Allocation to statutory profit reserves (Art. 672 para. 1 CO)
The company is obliged to retain 5% of its annual profit each year for statutory profit reserves until half of the share capital entered in the commercial register has been reached. Retained earnings do not have to be taken into account, while a loss carryforward may be deducted from the annual profit in advance.
Profit distribution plan
Since Art. 671 CO stipulates that statutory and voluntary provisions must be formed (provided that the required reserve levels have not yet been reached), retained earnings cannot be fully distributed. A similar procedure is also used in budget planning. The so‑called profit distribution plan (also called appropriation of profits statement, profit appropriation plan or proposal on the use of retained earnings) shows how much money is available for allocation and how it is distributed. It therefore provides information on the following points:
- Amount of retained earnings (in accordance with the resolution of the general meeting)
- Portion of the profit that remains in the company as reserves
- Portion of the profit that is distributed
- Balance that is carried forward to the new year
Preparing a profit appropriation plan
To distribute profits optimally, the following steps can be carried out:
- Determine the amount to be distributed (addition of retained earnings or loss carryforwards from prior‑year balance sheets to the profit of the current year)
- Formation of statutory reserves (depending on the level of statutory reserves already in place)
- Decision on the profit distribution at the general meeting
- Second allocation to general reserves (depending on the amount of dividends and profit‑sharing bonuses)
- Formation of voluntary reserves (if provided for in the articles of association or by resolution)
- New retained earnings / loss carryforward
The profit appropriation plan provides a good overview because it shows how much liquidity is actually available for distributions of any kind.
Excursus: Payment of dividends
Art. 660 para. 1 CO lays down a basic principle for corporations, according to which shareholders are entitled to payment of retained earnings. These are recorded differently in the accounts of subsidiaries and parent companies. As a rule, dividends are paid per share certificate, i.e. per share acquired and thus per capital invested. The share is therefore measured according to the nominal paid‑in share capital – unless otherwise provided for in the articles of association.
Asymmetric dividends
If this is not the case and dividends are paid out in deviation from the equity participation ratio, this is referred to as an asymmetric dividend. Such a case would exist, for example, if 100% of a resolved dividend were paid to a single shareholder, even though this person does not hold 100% of the shares. Asymmetric dividends are not viewed equally positively throughout Switzerland.
While some cantons only permit them if they are anchored in the articles of association (e.g. Aargau, Zurich), other cantons (e.g. Nidwalden, Zug) also accept them without this requirement.
From a tax perspective, asymmetric dividends are often viewed critically. The question arises as to why the distribution of profits did not take place proportionately. One example of a tax pitfall that can occur in practice in this context is reclassification as salary.
Reclassification as salary
If a shareholder is also an employee, an asymmetric dividend can be understood as salary for additional performance. However, this raises questions (e.g. Has a market‑based salary already been paid from a business perspective?). In addition, there is a tax difference as to whether dividends are paid to shareholders (income from dependent employment) or to employees (expense reducing taxable profit).