EU Taxation 9. Taxation of Mergers Arvind Ashta Introduction Short-Term Tax problems of mergers Long-term tax problems of mergers Transactions covered Main Features of Directive Qualifying companies Taxation of companies involved Taxation of the shareholder Contribution of a foreign branch Transactions not covered

Introduction Came out in 1990, applicable from 1992 Covers Mergers divisions transfer of assets exchange of shares Tax problems addressed if two or more Member States involved Only one-time short-term tax problems solved

Short-Term Tax problems of mergers ST problems of companies Capital Gains Tax-exempt reserves Carry forward losses lost ST problems of shareholders Capital gains

ST problems of companies: Capital Gains A transfers assets to B in return for shares, it has to pay for the capital gains on the sale of these assets. Since A has not received any cash (but only shares), it is difficult for it to pay the tax. This dissuades mergers. Example: Assets are bought at € 100 million. Cumulative depreciation is € 30 million. Net Assets are therefore € million. At time of transfer, if market value € 90 million. There is a capital gain of € million. If capital gains tax is 20% Capital Gains Tax amounts to € million If company A does not have € million, it may not agree to the transfer of assets.

ST problems of companies Tax-exempt reserves Against A's assets, there may be tax-exempt reserves. If A transfers the assets, it has to wind up such reserves and pay tax. Example: Investment in some less developed region € 100 million Investment Allowance @ 30 % Investment Allowance € million Earnings before Tax € 50 million Taxable Income (net of Inv. Allowance) € million Tax rate 40% Tax € million Tax reduction (due to Inv. Allowance) € million Capital reserves created € million If the assets of € 100 million are transferred before a certain time, say 8 years, tax of € million has to be paid.

ST problems of companies Carry forward losses lost Co. A may have carry-forward losses. These cannot be carried forward if Co A is merged into Co. B. The benefit of this therefore evaporates. Losses in 1999 - € 20 million Profit in 2000 + € 3 million Profit after set-off of losses Tax in 2000 @ 40% Carry forward of losses for 2001 - € million These accumulated losses of € million can be set off against profits of 2001 if company A makes profits. But if Co. A merges with Co. B and there is no longer any Co. A, these losses cannot be used to offset future profits.

ST problems of shareholders Capital gains The shareholder in Co. A received shares in Co. B for the transfer of his shares in Co. A. Having effectuated a transfer, he has to pay tax on capital gains, although he did not receive any cash income. Example: He bought 1000 shares of company A at € 110 Total paid € He now gets 500 shares of company b at € 300 Total value received € Capital gains € Tax on capital gains @ 20% € If he does not have cash, he is unlikely to agree to advantageous mergers.

Long-term tax problems of (share) mergers More administrative problems Examples Avoir fiscal replaced by withholding tax Dividend routed through parent company Merger Directive is not concerned with these issues

Transactions covered Legal Mergers Legal Divisions Asset Mergers Share Mergers 10% additional cash payout is allowed

Legal Mergers

Legal Divisions

Asset Mergers

Share Mergers

Main Features of Directive Member States to defer taxation of gains on companies Transferees to maintain old book values Member States to defer taxation of gains on shareholders Shareholders to maintain old asset values on new shares

Advantages to Qualifying companies Must be companies of a Member State Prescribed legal forms: see article 3 Prescribed fiscal status: see article 3 Advantages Tax deferrals Carry Forward of losses Transfer of reserves If activity continues in the same State

Taxation of the shareholder Deferral of capital gains tax Till he alienates the new substituted shares. Has to assign them the same book value as that of the old shares. If national law permits the shareholder the choice, and he opts to use a step-up tax value, obviously he pays tax now. Attached cash payment can be taxed now.

Contribution of a foreign branch Co A in State A to company B in State B transfers a branch in State C. State A not to tax on the transfer of the permanent establishment to company B. State A may recapture loss deductions granted to the State A activity due to losses of branch in State C.

Transactions not covered Assets transferred out of Member State Foreign branch transferred from one domestic company to another. Foreign State is free to tax the capital gains. Transfer of non-EC establishments of EC companies Transfer of EC establishments of non-EC companies. Individual assets not forming a branch of activity.