What kind(s) of income may a shareholder derive from their limited liability company? Oftentimes, one and the same individual dons the hat of a shareholder and of a managing director, but also e.g. of an employee (or even, as a freelancer, a contractual partner) of the company.
Shareholder’s income from dependent work
The shareholder of a limited liability company may work for their company in a labor-law relationship (i.e., doing dependent work). According to Sec. 2 of the Labor Code (Act No. 262/2006 Coll.), dependent work is understood to mean activities carried out on behalf of the employer within the relationship of a superior (the employer) and a subordinate (the employee), whereas the employee shall personally carry out the work themselves. As per Sec. 3 of the Labor Code, dependent work may only be performed within a labor-law relationship (i.e., regular employment or an agreement on the performance of work outside regular employment, which in the Czech Republic comes in two types known by their abbreviated designations as DPČ or DPP).
The salary which the shareholder draws from their employment is subject to wage tax under Sec. 6 of the Income Tax Act and, subject to the statutory conditions, to withholdings toward social security, the state employment policy, and general health insurance premiums.
If the shareholder of a limited liability company is at the same time also its managing director, they may moreover draw compensation under a manager agreement. Such compensation, too, qualifies as income from dependent work within the meaning of Sec. 6 of the Income Tax Act.
The shareholder’s income from dependent work is taxed like the regular salary of workers in an employment relationship, i.e., at a rate of 15% (or, as the case may be, 23%).
Income from independent work
A shareholder who pursues business as a self-employed individual (OSVČ) may be in a commercial relationship with their own limited liability company, i.e., by supplying the company with materials, products, goods, or services as a part of their business activities. They may derive income for such activities from the limited liability company based on invoicing. For tax purposes, such income on the part of (a natural person who is) a shareholder qualifies as income from independent work within the meaning of Sec. 7 of the Income Tax Act (unless it is found to be income from dependent work within the meaning of Sec. 6 (1) (b) or (d) of the Income Tax Act).
In order to arrive at the proper assessment of whether the income derives from independent or from dependent work, it is important to examine whether the shareholder pursues this business independent from the company, whether they do so also for other entities, whether the shareholder covers its own costs and expenses associated with their business, and whether they use their own work aids and tools for the activity in question.
If the shareholder or managing director personally engages in work for the company and the character of such work is in line with the company’s registered scope of business, then the income from such work must be considered income from dependent work within the meaning of Sec. 6 (1) (b) of the Income Tax Act.
Shareholder income in the form of rent from asset leases
- In addition, the shareholder may decide to let their assets to the company. On the part of the shareholder (as a natural person), the income from such a lease may qualify as:
income from rent within the meaning of Sec. 9 of the Income Tax Act (this being the case if the rental assets do not form a part of the shareholder’s business assets), or - income from independent work within the meaning of Sec. 7 of the Income Tax Act (if the rental assets are included among the shareholder’s business assets), in which case the rental income is subject also to social security payments and payments toward the state employment policy and health insurance.
For the purposes of income tax, the shareholder and their limited liability company are affiliated persons within the meaning of Sec. 23 (7) of the Income Tax Act, and rent must therefore be agreed in a customary amount, at fair market value.
Distribution of the share in profit
The most straightforward way in which a shareholder may draw financial rewards is in the form of a profit share (dividend). The income of the shareholder from the profit share associated with their participation in the limited liability company is subject to a special 15% withholding tax pursuant to Sec. 36 (2) (b) of the Income Tax Act (if the beneficiary is a natural person and Czech tax resident).
This means that double taxation occurs: Firstly, the earnings of the limited liability company are taxed at 21% (corporate income tax), and secondly, the taxed earnings, if paid out in the form of profit, are taxed again at 15%.
The withholding tax is final, and the beneficiary therefore does not have to account for the dividend elsewhere. No social security or health insurance payments apply to dividends.
Conclusion
One and the same individual often appears in the role of shareholder and managing director, or also in that of an employee (or a self-employed supplier). With respect to each of these roles, one must consider the specifics of taxation.
Source:
Income Tax Act (Act No. 586/1992 Coll.)