This article is written by Asmita Topdar, pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.
With the inception of globalization and privatization, the world has been witnessing an increase in cross border corporate restructuring and mergers and acquisition activities in recent years. The corporate business houses are constantly looking for merging and undergoing corporate restructuring not only with domestic companies but also with foreign ones. A cross-border merger involves coming together of two companies located in different territorial jurisdictions to merge and undertake their business operations. But anything cross border has its own complexities, and in the case of cross border mergers, it is the difference in tax imposition by the participating countries, which comes under the microscope while structuring the deal. This article revolves mainly around the tax issues in cross border mergers in Europe, the taxation aspect of the European Union and highlights the tax issues in the United Kingdom post-Brexit.
What are the types of cross border mergers?
Before going into depth about the tax issues in cross border mergers, it becomes pertinent to first understand the types of cross border mergers. Cross Border Mergers can be inbound, outbound, vertical, horizontal, market extension, product extension, reverse mergers, conglomerate and congeneric. Let us understand these concepts with respect to India as one of the participating countries in such cross-border transactions.
Here the resultant company will be in India after the Indian company acquires or merges with an overseas company.
Here the resultant company will be foreign-based after the foreign company acquires or merges with the Indian company.
When two companies at different levels of the supply chain get integrated, for instance, a merger between companies involved in manufacture and supply.
When two companies dealing in similar products and are at the same level of supply chain get their operations integrated.
Integration between completely unrelated companies having no similarity between them in respect to any services or products.
Mergers between companies with the objective to enter new markets. Here the companies deal with similar products but in different territorial markets.
Companies having the intention to expand their consumer base, the companies dealing with similar products operating in the same markets get their operations integrated.
Here the private company acquires the public company. The private company becomes public by acquiring shares or control without undergoing the lengthy process of initial public offerings (IPO).
Tax issues in cross border mergers in Europe
Cross border mergers often seem to be a simple transaction process however there are many restrictions to the cross-border restructuring activities due to the coordination of the legal and tax regime of several jurisdictions, which are distinct from each other. With the objective to remove fiscal difficulties in cross border reorganizations in Europe, the European Parliament and European Council had passed the European Merger Directive in the year 2005 to provide for a uniform legal mechanism for cross border mergers across European Union and the same became effective from December 15, 2005. The member states were later required to adapt the directive in their respective national legislations until December 2007. The EU Merger Directive intended to allow for the merger of corporations that were established pursuant to the laws of an EU member state having their registered office, their administrative office, or their principal place of business in the European Community. However, certain tax issues emerged when the UK exited the European Union in 2016 (officially on January 31, 2020). Consequently, the UK is no longer governed by the EU merger directive and cannot avail the benefits of tax reliefs. This has resulted in various tax issues emerging in the UK and European countries.
This article will first lay down the tax benefits provided within the EU merger directive applicable to the EU member states followed by the various tax issues arising in the UK post-Brexit in 2021.
Taxation aspects in European Union
A uniform tax regulation for all European Union (EU) member states in the form of Council Directive was first introduced in 1992 and was improved in 2006. All the Council Directives including the 2006 directive, consolidating all the tax provisions, were later incorporated in Council Directive 2009/133/EC. The main objective of the regulation is to remove fiscal difficulties arising among the EU members while undertaking any kind of cross border mergers. It also aims to provide for safeguarding member states’ taxing rights along with provision for deferred taxation on income, capital gains and profits arising from the cross-border mergers. Some of the major taxation aspects and the tax reliefs provided by the 2013 Council Directive 2013/13/EU, which is currently in force, are enlisted hereinbelow:
- A merger, division or partial division shall not give rise to any taxation of capital gains calculated by reference to the difference between the real values of the assets and liabilities transferred and their values for tax purposes.
- Any gains accruing to the receiving company on the cancellation of its holding shall not be liable to any taxation, where the receiving company has a holding in the capital of the transferring company. The minimum holding percentage required to attract this provision is 10% on or after January 01, 2009.
- Any shares or securities representing the capital of the acquiring company, which is allotted to the shareholders of the target company as a consideration in exchange of target company’s shares pursuant to any merger, exchange, or division of shares, shall not attract any tax on capital gains, income, or profits. This provision is applicable only when the shareholders receive securities that attract a higher tax value than the value of the exchanged shares calculated on the date immediately before the merger, exchange, or division of shares.
- In the case of partial division, the shareholders of the target company, who receive shares of the acquirer company as consideration of the partial division of the target company, shall not be liable to pay any tax on capital gains, income, or profits. This provision is applicable only when the sum of shares received by the shareholders along with the shares held by him in the target company, attracts a higher tax value than the value of the exchanged shares calculated on the date immediately before partial division.
- Where a Member State considers a shareholder as fiscally transparent on the basis of that Member State’s assessment of the legal characteristics of that shareholder arising from the law under which it is constituted and therefore taxes those persons having an interest in the shareholder on their share of the profits of the shareholder as and when those profits arise, that Member State shall not tax those persons on income, profits or capital gains from the allotment of securities representing the capital of the receiving or acquiring company to the shareholder. This provision is applicable only when the shareholders receive securities that attract a higher tax value than the value of the exchanged shares calculated on the date immediately before the merger, exchange, or division of shares. The additional condition imposed in this tax relief is that this provision is applicable only when the sum of shares received by the shareholders along with the shares held by him in the target company, attracts a higher tax value than the value of the exchanged shares calculated on the date immediately before partial division.
- In case of transfer of assets including permanent establishment of the target company in a merger, division or partial division which is situated in a member state other than the state of the target company, then the member state of the target company shall renounce any right to tax that permanent establishment.
What are the tax issues in cross-border mergers in the UK post Brexit?
Although the EU Council directive, providing the above-mentioned tax reliefs, are still applicable to the European Union member states, however companies in the UK are no longer eligible to participate in EU cross border mergers and cannot avail the benefits of tax reliefs provided therein. After completion of the transition period, the UK stands separated from the EU as of December 31, 2020. Post-Brexit, the UK and EU have entered into the Post-Brexit Trade and Cooperation Agreement which has come into effect from January 01, 2021. Presently, the UK and EU have become two distinct legal, regulatory, customs and tax territories. The following are the possible tax implications associated with cross border restructuring which can arise post Brexit:
Transfer of UK business
According to the notice to stakeholders issued by European Commission, the EU merger directive and the Takeover regulations of the EU will cease to apply to the UK post-Brexit. Previously by virtue of the UK’s implementation of the UK merger directive, transfer of the business of UK companies to any EU entity would be at no gain, no loss basis. However, after Brexit, although the provisions of merger directive provisions are enacted into UK law, the UK will cease to be an EU Member State and the UK will no longer avail the benefits of tax reliefs. This will potentially give rise to many tax charges on the assets involved in the transactions.
Transfer of non-UK business by UK company
Similar issues will arise when a UK company would look to transfer a non-UK business to a company situated in any EU member state. Since references to “EU Member States” in the legislation of other EU members will cease to include the UK, any mergers involving assets in the other Member States will, most likely, no longer benefit from tax relief under the existing framework in that Member State following Brexit.
Tax consequences in the transfer of business/goods
Previously any sale or transfer of goods, taking place on a B2B basis, used to be treated as zero-rated intra-EU acquisitions. Now post Brexit, since the UK is now considered as a ‘Third Party’ such exemptions cease to exist and all B2B transfers of goods between EU member states and the UK will attract the standard rate of import, export along with import VAT.
Corporate migration is when any company intends to shift its business and relocate to a place outside the UK. Following Brexit, for any such relocation, UK Tax rules on corporate migration will get applicable. For instance, a company that ceases to be resident in the UK is deemed to have disposed of and reacquired all its assets at market value immediately before ceasing to be a UK tax resident. This may result in a chargeable gain arising, which would be subject to UK tax post-Brexit. Previously exemption was provided wherein companies could postpone the payment of such taxes if the company relocated in any European Economic Area (EEA) member states. However, with changing times after Brexit, the emergence of tax consequences related to corporate migration in future becomes inevitable.
Mergers and acquisition is a complex and lengthy process involving different legal and tax regimes. However, such transactions become more complex when either of the participating companies is foreign-based. Cross-border mergers involve laws of a different jurisdiction and thus it becomes inevitable to understand the legal regimes of participating companies and structuring the deal in compliance with laws of the land. Any company looking to merge with European countries are required to understand both legal and tax regimes applicable in Europe. European Union provides for uniform and common merger directions which have been incorporated by member states in their domestic laws. The EU merger directive provides various tax reliefs to the member states. However, because of Brexit, the EU merger directive is no longer applicable to UK companies and thus cannot avail its tax reliefs. Tax issues are bound to arise for companies situated in EU member states looking to merge with UK companies or any UK company looking to transfer non-UK business to any other EU member countries. Corporate migration of any company outside the UK will also result in levying of taxes.
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