Negative Equity? Find Out What It Could Mean for Your Tax Bill

Why can negative equity lead to additional tax liabilities?

Under Section 4(2)(2)(c) of the Corporate Income Tax Law, the taxable base also includes excess interest payments calculated in accordance with Section 10 of the Law.

Section 10(1) provides that interest payments are included in the taxable base in proportion to the amount by which a company’s average debt obligations for the reporting year, on which interest is payable, exceed four times its equity as reported in the annual financial statements at the beginning of the reporting year. For this calculation, equity is reduced by the revaluation reserve for long-term investments and by any other reserves not arising from the distribution of profits.

Clause 77 of Cabinet Regulation No. 677 of 14 November 2017, Regulations on the Application of the Norms of the Corporate Income Tax Law, provides that where a company’s equity is negative, it is deemed to be zero for calculation purposes.

Accordingly, if a company has negative equity at the beginning of the reporting year, the permitted debt-to-equity ratio under Section 10(1) of the Corporate Income Tax Law is effectively zero. Unless a statutory exemption applies, all interest expense for the relevant reporting year may therefore have to be included in the taxable base. This applies to borrowings received by the company and the interest it pays, not to loans granted by the company.

However, negative equity does not automatically mean that CIT is payable on all interest. Section 10 of the Corporate Income Tax Law provides exemptions, including for certain loans from credit institutions and qualifying financial institutions, as well as for certain other forms of financing. Additional exemptions have applied since 2026 to certain financing arrangements and qualifying intra-group financing. Each borrowing must be assessed individually, including loans from related parties.

A second interest limitation rule must also be considered. If the difference between interest expense and interest income for the reporting year exceeds EUR 3 million, the 30% EBITDA limitation under Section 10 of the Corporate Income Tax Law must also be assessed. If both methods result in a taxable amount, the higher of the two calculated amounts applies, subject to the relevant exemptions.

Is loan capitalisation right for my business?

Loan capitalisation—converting a loan into a contribution to a company’s share capital—can be a practical way to strengthen equity before the start of the next financial year.

This option is expressly provided for under Section 201(2)(1) of the Commercial Law, which allows a claim against a company arising from a loan agreement for the payment of a specific sum of money to be contributed to the company’s share capital. Once the claim is transferred to the company, the corresponding obligation is extinguished through the merger of the claim and the obligation.

In practice, this means that a shareholder who has previously lent money to the company can contribute the claim to the company’s share capital in exchange for new equity interests.

Request advice on loan capitalisation

For CIT purposes, the timing of the capitalisation is crucial. The four-times-equity calculation uses the equity figure at the beginning of the reporting year. A capitalisation carried out during the year will therefore generally not change the opening equity figure for that same year or eliminate CIT consequences that have already arisen. For the strengthened equity position to be taken into account in the calculation for the next calendar reporting year, the share capital increase must be completed and properly recorded in the accounts by the end of the preceding year.

Grant Thornton Baltic’s legal and tax advisers recommend addressing the company’s equity position before the financial year-end. A timely assessment of potential tax liabilities and loan capitalisation may help address negative equity and reduce the risk of additional CIT liabilities in the next financial year.

Legal advisers provide end-to-end legal support for the loan capitalisation process, including preparing the documents required to capitalise the loan and register the share capital increase with the Register of Enterprises of the Republic of Latvia.

Tax advisers can assess the specific borrowing, any applicable exemptions under the Corporate Income Tax Law, the timing of the capitalisation and its projected tax impact, and advise on other potential solutions.