Considering the tax impact of keeping or integrating companies in the acquiring company
Keeping companies and transferring results within the group
The management of a group poses specific problems associated with the existence of companies which, in legal terms, are independent. Contrary to economic reality which recognises the whole as forming a single entity, the law does not acknowledge (or hardly acknowledges) the notion of a group.
This is the case with tax law which considers each company in a group to be an independent company that must have 'normal' relations (as with third parties) with the group’s sister and parent companies. Under tax law the different group entities must each generate a profit separately.
A consolidated profit system exists, but its scope for application is restrictive and it is barely used.
The legal structuring of groups into parent company, subsidiaries and sub-subsidiaries proves to be particularly ill-suited when some companies start to generate losses. The losses of one or more subsidiaries cannot be used to offset the taxable results of other companies in the group.
And yet, it is a group’s responsibility to optimise its tax management so as to minimise the overall tax burden and/or delay the date of payment thereof.
For the purpose of efficient tax planning, groups may be encouraged to transfer the results from one company to another. Different techniques may be used to do this while exercising caution so as not to abuse the law.
Modification of the contractual relations between companies in the group
Leasing or renting
One way of transferring the results of one company to another is for one company to purchase equipment or buildings and lease them to another company in the group. This method has several advantages:
- it allows any reducing balance depreciation and borrowing expenses to be allocated to a profit-making company in a group, while the rental payments invoiced to a loss-making company will be lower at the start of the lease (provided, however, that the market price is respected in order to avoid an adjustment in the taxable profit) – hence a temporary transfer of results. This transfer can be substantial in the case of a property investment for which, over numerous years, the rental payments may not cover the depreciation and the borrowings;
- the separation of ownership and use allows a group to bring foreign shareholders into the investing company who would only be interested in long-term profitability and sometimes in the possibility of offsetting the deficit of the initial years against their profits.
The limits concerning simple renting are laid down by law and leasing is included in the regulated activities. This system can therefore only be applied to simple renting unless the group owns a company authorised to carry a leasing activity.
Another technique consists of debt write-offs between the profit-making companies and the loss-making companies in the group. For the operation to be fully effective, the write-off must be considered as deductible for the company that grants it.
A debt write-off is a debt cancellation granted by the creditor to the debtor. This is generally an extraordinary operation because business logic does not easily accommodate such actions. A distinction must be made between:
- debt write-offs of a business nature: if granted in the business interests of the creditor company, the write-off will be deductible.
- debt write-offs of a financial nature: debt write-offs granted not for business reasons but because of a partnership agreement (example: the parent company writes off a debt due by its subsidiary). In principle this debt write-off is not deductible; it represents an additional investment on the part of the creditor and increases the acquisition cost of its holding.
Use of transparent subsidiaries
Tax transparency means that taxation takes place at the level of the partners who include the income and losses made by their transparent subsidiaries in their tax results, in proportion to their holding in those companies. Through this transparency, a de facto consolidation is achieved, allowing the subsidiaries’ losses to be offset against the parent company’s profit or the temporary non-taxation of the subsidiaries’ profits in the event of parent company losses.
In practice, the groups might have been set up at a time when all the subsidiaries were making profits. As a result, the advantages of tax transparency might not have been apparent and so the subsidiaries were set up in the form of opaque capital companies, where the partners benefit from limited liability. As the tax consequences of a transformation from a capital company to a transparent company can prove particularly costly, the use of this technique for transferring results must be analysed very carefully.
Another solution for transferring results within a group can be for a company to place its business assets under lease management for a limited period. In this scenario, the company that places its business assets under lease management will not be considered as ceasing its activity. It will receive rental payments which will be offset against previous deficits. The operating losses of the business assets will reduce the results of the company that manages them.
Limits to the use of these different techniques
It would be tempting to believe that transferring the results of one company to another is easy and therefore that the tax rules which do not acknowledge the notion of a group can easily be bypassed.
The right to skilful legal planning and to the choice of the most tax-efficient option does, however, have certain limits. The tax authorities do in fact have a weapon which is the repression of the abuse of the forms and possibilities of civil law structures: in the case of abuse, the taxes are collected as they would have been as per the legal conditions applicable to the economic operations.
In practice, decisions concerning techniques for transferring results between group companies must therefore take economic, commercial and strategic considerations into account. Tax optimisation can validly back up these decisions. However, taking only the tax factor into account could be dangerous.
The regime for parent and subsidiary companies allows for the tax-exempt circulation of dividends within groups; however, strictly speaking, it does not provide for specific group taxation.
The advantage of such a consolidation regime is to allow, where applicable, the losses made by the subsidiaries to be offset against the parent company’s profits (and vice versa). This is why Luxembourg introduced the consolidated profit regime. Tax consolidation is a tax regime whereby the subsidiary of a parent company is regarded as a single permanent establishment so that the profits and losses recorded by the two companies can be offset against each other, even where they are two different taxpayers.
Scope of application
The relevant companies must be capital companies.
The consolidating company must in principle be a Luxembourg company, often itself a subsidiary of a foreign parent company. Tax consolidation has also been available to the permanent establishments of non-resident capital companies since 1 January 2002. In this case, the non-resident capital companies must be subject to a tax equivalent to Luxembourg corporate income tax.
The companies whose results are to be consolidated must be opaque companies fully liable for Luxembourg corporate income tax. International tax consolidation is therefore not possible. As transparent companies do not exist from a tax point of view, the indirect holding of a participating interest in an opaque company through a transparent company is deemed equivalent to the partner of the transparent company directly holding the opaque company.
Example: SA 1 owns SA 2 via a general partnership (société en nom collectif - SENC). SA 2 may be subject to tax consolidation in SA 1.
- the consolidating company must hold, directly or indirectly, at least 95 % of the capital of the subsidiary to be consolidated (this rate can be reduced to 75 % if approved by the Minister of Finance; the holding must also be recognised as being particularly suitable for the economic development of the country). An indirect holding is one where the dominant company holds all or part of the share capital of the company being consolidated by means of an intermediate company.
Example: SA 1 holds 100 % less 1 share of SA 2 and 50 % of the share capital of SA 3. The rest of the shares of SA 3 are owned by SA 2. SA 1 therefore holds 50 % of SA 3 directly and 50 % indirectly. SA 1 and SA 3 can therefore opt for the tax consolidation regime.
- the companies to be consolidated must submit a joint written application to their respective tax offices (bureau d'imposition) before the end of the first financial year of the period for which the consolidation regime is requested. Administrative approval is given for a minimum period of 5 years. Offsetting can only be carried out as from the date of approval.
Consolidation of the subsidiary’s income with that of the parent company
The results of the dominated and dominant companies are drawn up separately. The (positive or negative) income of the subsidiary is allocated to the dominant company so that the (positive or negative) results of the two companies are offset against each other.
Example: SA1 and SA2 are two companies to be consolidated. SA1 makes a profit of 500 while SA2 records losses of 400. The taxable consolidated profit is 100 (500 – 400).
The tax results of the companies to be consolidated are added together without taking into account the fact that part of the tax results may come from intra-group operations. In other words, the operations carried out between the parent company and its subsidiary are treated as operations concluded between third parties.
Exception: the value adjustment that the parent company may have carried out on the securities of its subsidiary is to be reinstated for the tax calculation, so as to eliminate the risks of double deduction (value adjustment at the parent company, tax loss at the subsidiary).
Example: SA 1 is the parent company of SA 2 with which it is consolidated. SA 2 generated an accounting result of –1,000, including profit of 200 on sales to SA 1. SA 1 makes a book profit of 1,400, once 200 has been deducted for purchases made from SA 2 and a value adjustment of 500 recorded on equity shares in SA 2 has been made.
=> SA 2's income is to be taken as-is, even if it includes intra-group profit.
=> SA 1's income must be corrected by the value adjustment amount, while the loss by SA 2 does not require rectification.
=> The final consolidated amount is: 1,400 + 500 – 1000 = 900.
From the point of view of the regime of withholding taxes, the subsidiaries are deemed, for tax purposes, not to distribute dividends to the parent company. Because of this, no withholding tax is payable, in the same way as the dividend will not constitute income for the parent company.
Carrying forward of losses for the subsidiary
The advantage of the consolidated profit regime lies in being able to offset the losses of the different consolidated companies against the profits made by the other consolidated companies.
This only applies, however, for the tax losses recorded by the different consolidated companies from the date of application of the tax consolidation regime. Previous deficits of a subsidiary are not to be taken into account in the calculation of the consolidated profit, unless the isolated tax result of the subsidiary that made the loss and the consolidated tax result for a specific year are positive.
Tax declaration obligations
Subsidiaries continue to file annual tax returns as if they had not been consolidated. Besides filing its own return, the parent company must file an overall return showing the taxable amount from the viewpoint of the consolidated profit regime.
Communal business tax
Where companies are consolidated with regard to corporate income tax, they will automatically be consolidated for communal business tax. It is not possible for companies to be consolidated for corporate income tax without being consolidated for communal business tax.
Net wealth tax
Net wealth tax does not provide for a tax consolidation regime. Double taxation within groups of companies is indeed already avoided by the application of the parent/subsidiary directive.
The mechanism for allocating the net wealth tax burden allows the neutrality of net wealth tax to be preserved. The company may therefore allocate the total net wealth tax burden by entering and keeping for 5 years a special financial reserve equaling 5 times the net wealth tax burden in its accounts (on condition that the corporate income tax burden equals the net wealth tax burden owed). This mechanism ensures that a company that decides to hold on to company profits is not penalised compared to one distributing sometimes high dividends.
Merger of companies
A merger is an operation whereby one or more companies, dissolved but not liquidated, pass on all of their net assets (assets and liabilities included) to an existing or new company. Their contributions are remunerated by the allocation of shares in the pre-existing or new company and, where applicable, the payment of a balancing cash adjustment that does not exceed 10 % of the nominal value of the units or shares distributed.
The basic mechanism of a merger operation has three different but related legal effects, namely:
- the universal transfer of the net assets of the absorbed company to the absorbing company or to the new company resulting from the merger;
- following the transfer of its net assets, the merger operation automatically results in the dissolution of the absorbed company;
- the merger presumes the remuneration of the absorbed company’s contributions. This is carried out by means of an allocation of shares in the company. Thus, the partners of the absorbed company must receive shares in the absorbing company in exchange for their contributions.
In the absence of special measures, each legal stage of the merger is taxed separately:
- the dissolution of the company involves the immediate taxation of the liquidation proceeds, and in particular that of the unrealised capital gains made during the operation;
- the absorbing company has to pay the registration fees required in respect of capital increases;
- as for the partners of the absorbed company, they will be taxed on the capital gain made on the exchange of shares.
In accordance with the previous principle, the tax cost of the operation may end up being very high. So as not to discourage companies from carrying out company restructuring operations, a preferential regime has been set up, guided by a double objective which is to facilitate mergers as much as possible from a tax point of view and preserve the right to charge tax on the unrealised capital gains existing on the date of the merger.
This regime consists of a deferral of taxation of hidden reserves. This regime is intended to facilitate the grouping together of companies subject to corporate income tax, by allowing the operation to benefit from tax neutrality. Indeed, the purpose of this regime is to make mergers equivalent to an intermediate operation which does not entail the cessation of activity but rather a situation where the absorbing company carries on the business of the absorbed company.
Taxation of the absorbed company
In order to benefit from the tax deferral, the transfer of net assets must meet a certain number of conditions:
- the absorbing company must be a fully taxable opaque company resident in Luxembourg;
- the transfer must be carried out in exchange for shares in the absorbing company or by cancelling a participating interest held by the absorbing company in the absorbed company. However, the payment of a balancing cash adjustment may accompany the handover of shares, provided that said payment does not exceed 10 % of the nominal value of the shares handed over to the absorbed company’s partners;
- the handover must take place under conditions exposing the hidden reserves to subsequent taxation. This aim can only be achieved if the absorbing company adopts the values as they appeared in the absorbed company’s balance sheet in its own balance sheet.
Taxation of the absorbing company
A distinction should be made between various scenarios, depending on whether the absorbing company held a participating interest in the absorbed company or not. Where applicable, the percentage held must also be taken into account.
The absorbing company did not hold a participating interest
- To benefit from the deferral, the absorbed company must be taken over at the book value of its net assets.
- Merger premium
The number of shares to be issued to former shareholders of the absorbed company depends on the exchange parity between the value of an absorbing company share and that of an absorbed company share. Furthermore, as the nominal value of the absorbing company’s shares is constant, it follows that there may be an accounting difference because of the takeover of the net assets at their book value and the issue of new shares. This is the merger premium.
Example: SA 1 absorbs SA 2. The real value of an SA 1 share is 3,000 and that of an SA 2 share is 2,000.
The exchange ratio is therefore 3,000 : 2,000 = 1.5. Each shareholder of the absorbed company therefore receives 2 shares in the absorbing company SA 1 in exchange for 3 shares in the absorbed company SA 2.
SA 1’s capital will therefore be 1,000 shares with a nominal value of 5,000 each, that of SA 2 will be 3.000 shares with a nominal value of 4.000 each. The net book value transferred to SA 1 by SA 2 is 15,000,000.
=> SA 1's capital will increase by 2,000 shares (exchange of 3,000 SA 2 shares at an exchange ratio of 1.5).
The newly issued shares must have the same nominal value as the old shares: 5,000.
=> The increase in SA 1’s capital will therefore be 10,000,000 (=2,000 shares with a nominal value of 5,000 each). As the net assets received by SA 1 amount to 15,000,000, the difference, i.e. 5,000,000 (=15,000,000 – 10,000,000), constitutes the merger premium.
The merger premium is an additional non-taxable contribution for the absorbing company. It forms part of the absorbing company's shareholders' equity.
The absorbing company held a participating interest of 10 % => tax exemption
In this case, a preferential regime, different from the deferral regime, applies. This regime does not require the absorbing company to meet all of the conditions provided for under tax law in order to benefit from the preferential treatment offered by the parent/subsidiary directive in the case of the distribution of dividends (duration conditions, etc.).
The absorbing company simply has to own at least 10 % of the share capital of the absorbed company. In this case, this preferential regime extends the benefit provided under the parent/subsidiary directive to the capital gain from the exchange of company securities, as if it were a dividend.
This solution is based on the regime concerning proceeds from the liquidation of a capital company which is deemed equivalent to the payment of a dividend, when the beneficiary of said income is itself a capital company. The unrealised capital gains existing on the date of the merger must, however, remain taxable for the future. That is why the tax exemption regime only applies to mergers whereby the absorbing company takes over the assets of the absorbed company at their book value.
The absorbing company held a participating interest of less than 10 %
The merger operation is normally shown in the books of the absorbing company by a cancellation of the participating interest and the recording of the assets and liabilities corresponding to said participating interest. If the historical acquisition cost of the participating interest is lower than the book value of the assets transferred, a book profit will be recorded.
Example: SA 1 creates a subsidiary SA 2 with capital of 100. 5 years later, SA 2 has shareholders' equity of 300, 100 in initial capital and 200 in reserves. SA 1 and SA 2 merge.
=> The merger will result in a merger profit of 200 in the books of SA 1.
As this is not a realised profit in the strictest sense of the term, it is better not to record this merger difference in the results of SA 1 but rather enter it as a liability (under shareholders' equity) as a merger premium.
As no preferential provision exists in this case, common tax law applies: in principle the exchange of assets is deemed equivalent to a sale, with the book profit thus made being taxable at the rate according to common law, unless it benefits from the deferral of capital gains regime.
The tax profit is calculated by making an imaginary sale of the holding at its going concern value, and not by comparing the book values of the assets acquired at the time of the merger.
=> Profit = going concern value of the holding – book value appearing in the initial balance sheet of the absorbing company.
Example: in the previous example, if the going concern value of the holding is 350, the merger profit for absorbing company SA 1 will be 350 – 100 = 250 (and not 200 as indicated in the financial statements).
Carrying forward the absorbed company’s losses
Since the merger relates to the transfer of all of the net assets, one might imagine that the absorbed company’s losses could be carried forward by the absorbing company, as if they were its own losses. However, under tax law only the entity that made the losses can carry them forward. Therefore the losses of the absorbed company cannot be taken over by the absorbing company, unless the absorbing and absorbed companies were subject to collective taxation.
Note: while the absorbed company’s deficit cannot be offset against the absorbing company’s profit, the absorbing company’s deficits can be offset against the absorbed company’s positive results. This could encourage taxpayers to carry out 'reverse' mergers ('the sardine swallowing the whale'), with the absorbing company often taking over the name of the absorbed company in such scenarios.
If, from an economic point of view, it seems that it is indeed the profit-making company that has absorbed the loss-making one, and not the other way around, and that the merger was only carried out so as to offset the losses of the absorbed company, it will be considered an evasion of the law that is not binding on the tax authorities. The sanction for this is the refusal of the right to carry forward the absorbing company’s losses, because, from an economic point of view, it involves the absorbed company.
Taxation of partners
In exchange for contributions, the partners receive securities of the absorbing company. The absorbing company thus carries out a capital increase based on the exchange parity of the securities, with the securities thereby issued being distributed to the partners of the absorbed company. Since the exchange is nothing other than a sale, there is a risk of taxation for the partners of the absorbed company, if the securities that they receive in exchange have a higher value than those that they held previously. So as not to hinder the restructuring operations, the legislator has therefore laid down certain provisions allowing for a tax-exempt exchange of securities:
partner of the absorbed company = natural person
The operation is not subject to taxation, regardless of the percentage holding owned.
partner of the absorbed company = sole proprietorship
The securities received in exchange are deemed to constitute the same assets as the old securities and no profit on the exchange has to be recorded.
partner of the absorbed company = capital company
Regardless of the percentage capital held, the operation will never be subject to tax.
Cross-border mergers are mergers involving one or more foreign companies in addition to one or more Luxembourg companies.
A distinction is made depending on whether the absorbing company is a Luxembourg or foreign company:
absorbing company = foreign company
The regime for cross-border mergers is the same as that applicable to domestic mergers. The merger profit will be exempt under the same conditions as if the merging companies were both Luxembourg companies. A distinction must be made depending on whether the absorbing company is resident in the European Union or not:
- if the absorbing company is resident in a non-EU country, unrealised capital gains will be disclosed. The assets of the company will be valued at their market value and subject to tax in respect of the liquidation proceeds;
- if the absorbing company is resident in a Member State of the European Union, the merger may benefit from tax neutrality, provided that Luxembourg keeps its power of subsequent taxation of the unrealised capital gains existing on the date of the merger. Tax neutrality will therefore only be possible in respect of the assets of the company still attached to a permanent Luxembourg establishment and only if the assets are transferred at their book value and not at their market value. If the foreign absorbing company subsequently sells its permanent Luxembourg establishment, the share of the profit coming from the transfer of assets at their book value will effectively be taxable in Luxembourg.
Absorbing company = Luxembourg company
A Luxembourg absorbing company will have the choice of valuing the assets received as part of the merger at their book value or at their going concern value or at any other value between these 2 values.
The valuation of the assets carried out by the absorbing company will not depend on the values assigned abroad by the absorbed company, except where foreign legislation subjects the neutrality of the cross-border merger to special valuation requirements.
If the Luxembourg absorbing company uses the book values assigned by the absorbed company in the past, the date of acquisition of the assets taken over by the absorbing company is deemed to be the effective date of acquisition by the absorbed company.
=> SA Lux is therefore deemed to have acquired SA Spain in July 2006.