Changing a Company’s Legal Form

Risks of tax complications

Since a change of legal form does not involve a transfer of assets and liabilities to another entity, the risks associated with breaching tax neutrality do not, in practice, arise here. From a tax perspective, the company smoothly continues depreciating assets from the original acquisition costs and continues to apply any tax losses from prior years.

Taxation and VAT complications could arise only where the transformation is not carried out as a simple change of legal form, but as a more complex merger (for example, by merging an s.r.o. into another a.s.). The practical impacts and the most common mistakes in monitoring tax neutrality in reorganisations are discussed in more detail in the article Tax implications of mergers and demergers: How to comply with the rules on tax neutrality when reorganising corporate structures. In such a case, an asset transfer would already occur and the boundaries of tax neutrality would have to be monitored strictly.

VAT risks in a transformation: Change of form vs. merger

From the perspective of value added tax (VAT), it is crucial which legal route the transformation follows. If it is a pure change of legal form from an s.r.o. to an a.s., the legal entity does not cease to exist and its estate does not pass to any successor. From a VAT perspective, this process is neutral and does not constitute a taxable supply, as the company retains its original VAT ID (DIČ).

The situation is entirely different if you handle the transformation through a merger (e.g., by merging an s.r.o. into an existing a.s.). In that case, the company ceases to exist and its estate passes to the successor company. Although the Czech VAT Act does not treat a transfer of a business as a supply of goods or services, strict conditions must be met; otherwise, additional assessments may be imposed. For mergers and business transfers, it is worth involving tax law already at the stage of designing the transaction structure to avoid additional assessments and related penalties.

VAT risk in mergers arises in particular where the condition of a transfer of an organised part of a business is not met and only isolated assets are transferred. Problems also arise where the transformation is carried out in non-standard stages, or where the successor company is not a VAT payer at all and fails to meet the necessary formal and registration obligations.

In mergers, the solution is critical: the process must take place as an immediate and complete succession. All assets and liabilities must be transferred from the dissolving s.r.o. to the successor a.s. in a single legal act, without any transitional periods, splitting of assets outside the framework of the business transfer, or provisional leases.

The legal transformation process – phases and typical mistakes

The transformation of a business company is governed by the Czech Transformations Act (ZPMOT) and the Business Corporations Act (ZOK). In practice, however, companies often make mistakes because they confuse a pure change of legal form with a more complex merger. The entire process has several key phases.

The managing directors first prepare the transformation project and an explanatory report. Guidance on how to set the next steps after completing the project (including follow-up corporate changes) and avoid dead ends can also be found in the text The life cycle of an SPV: How to safely carry out a merger or liquidation of an SPV after selling out a residential project. However, these documents do not address any transfer of assets and liabilities, because nothing is transferred anywhere. The project specifies the new form (a.s.), the draft articles of association, and the rules under which shareholders will receive shares.

In a change into an a.s., no audit of the project is carried out, but the law strictly requires valuation of the estate by an independent expert. The expert must confirm that the company’s value safely covers the registered capital of the future joint-stock company. All documents must then be published one month in advance.

The shareholders must then approve the transformation at the general meeting by at least three quarters of the votes present. A notarial deed must be drawn up for this decision. Creditors must be informed of the change and may, where applicable, request security for their claims.

As regards registration in the Commercial Register, a common misconception is the belief that the original s.r.o. ceases to exist at this final step. By registration in the register, the company neither ceases to exist nor is a new one created. It is still the same existing legal entity, which only from that moment officially begins to operate under the rules applicable to an a.s.

The most common legal mistakes – and their impacts

Formal defects in resolutions are among the most common mistakes. This includes failure to meet the formal requirements for a notarial deed, incorrect convening of the general meeting, or an insufficient quorum for approval. The consequence is harsh: the registration court will reject the application, causing significant delays to the entire process and unnecessary additional costs.

A major risk is an incorrect contract analysis. Although a change of legal form does not involve a transfer of rights and obligations to another entity, some contracts contain clauses that directly prohibit a change of legal form without the counterparty’s consent. Overlooking these clauses may lead to termination of key contracts or financial penalties.

A breach of information obligations towards creditors is another threat. The law requires proper publication of the project and notifying creditors of their rights. While failure to comply with this obligation will no longer invalidate the transformation once it has been registered, creditors may seek additional security for debts or damages through the courts.

Rules relating to employees and revaluation are also often applied incorrectly. Companies mistakenly proceed as if in a merger, inform employees about a non-existent “transfer” to a new employer, and attempt to revalue assets for tax purposes. This creates confusion within the company and risks unnecessary disputes with authorities, because the company’s identity continues in a change of legal form.

The attorneys from ARROWS, a Prague-based law firm, navigate the pitfalls of corporate transformations with confidence. We will guide you through the entire process to identify hidden contractual risks in time and ensure that all steps are carried out correctly in both form and substance, in strict compliance with current Czech legislation.

Accounting revaluation and its hidden risks

In this area, the biggest myth keeps recurring in practice. As we have already mentioned, in a pure change of legal form from an s.r.o. to an a.s., there is no transfer of assets and liabilities. Although the assets are valued by an expert report for the purposes of the registration court, they are not revalued to fair value in the accounting records.

It logically follows that a change of legal form cannot result in an accounting valuation difference or goodwill. Assets and liabilities continue to retain their historical values in the accounting books. Any attempt to “inflate” the balance sheet through artificial revaluation is illegal here and contrary to accounting regulations.

In this area, the biggest myth keeps recurring in practice. As we have already mentioned, in a pure change of legal form from an s.r.o. to an a.s., there is no transfer of assets and liabilities. Although the assets are valued by an expert report for the purposes of the registration court, they are not revalued to fair value in the accounting records.

It logically follows that a change of legal form cannot result in an accounting valuation difference or goodwill. Assets and liabilities continue to retain their historical values in the accounting books. Any attempt to “inflate” the balance sheet through artificial revaluation is illegal here and contrary to accounting regulations.

When is there a risk of overvaluation of intangible assets and goodwill?

Accounting revaluation to fair value and the recognition of goodwill occur only in more complex transformations, typically in mergers (e.g., the absorption of an s.r.o. into an existing a.s.). In such cases, assets are actually transferred to another entity and must be revalued for accounting purposes.

In these merger cases, we often encounter a tendency to overvalue “hidden” assets—intangible assets such as know-how, customer databases, or internal processes. They are often concealed under the term goodwill. The aim is usually to artificially increase equity to improve the company’s image with banks or investors.

Where is the problem and what are the consequences?

• Tax implications: Non-objective and excessive valuation of intangible assets in mergers immediately attracts the attention of the authorities. If the tax authority suspects circumvention of the law or a purpose-driven arrangement, the company may face strict audits and potential additional tax assessments.
• Non-deductibility of goodwill for tax purposes: You gain nothing for tax purposes from inflating goodwill in the accounts. Goodwill arising in a merger is generally non-deductible for tax purposes. Its accounting amortisation therefore has no effect whatsoever on reducing the corporate income tax base.
• Audit perspective: An auditor of merging joint-stock companies will require detailed substantiation of the valuation. Unjustified overvaluation leads to qualifications in the audit report. Moreover, banks can easily see through an “inflated” balance sheet, which will reduce their willingness to finance the company.

Best practice with ARROWS, a Prague-based law firm

In mergers, valuation should always be objective, conservative, and strictly supported by an independent expert report. If the valuation of intangible assets is not 100% credible, it is better not to revalue them.

Experts from ARROWS, a Prague-based law firm, will help you choose the right type of transformation and avoid dangerous distortions in your accounting. We will ensure that all steps are carried out in full compliance with legal, tax, and accounting regulations.