Mergers Directive

Background
On 17 February 2005, the EU Council of Economic and Finance Ministers (ECOFIN) formally adopted amendments expanding and updating Directive 90/434/EEC (the Mergers Directive). The Mergers Directive provides for the deferral of taxation in certain types of cross-border transactions, namely mergers, divisions, transfers of assets and exchanges of shares involving companies of more than one EU Member State. The revisions entered into force on 24 March 2005.

The Mergers Directive was implemented in Ireland in 1992 by virtue of what is now contained in Sections 630 to 638 of the Taxes Consolidation Act, 1997 (TCA 97). In view of the widening of domestic provisions elsewhere in the tax code to deal with transfers of assets and exchanges of shares involving companies established throughout the EU, the use of the legislation transposing the Mergers Directive has been somewhat limited. The inability under Irish company law to perform many of the cross-border merger transactions envisaged by the directive has also limited its relevance to date.

The Department of Finance is currently preparing the necessary enabling legislation to incorporate the revisions to the Mergers Directive into Irish law.

Societas Europaea (SE)
On 8 October 2001, Regulation EC 2157/2001 was adopted providing for the introduction of a European Company (the SE). The regulation took effect from 8 October 2004, but no specific procedures for establishing an Irish SE have yet been established. Similarly, the necessary transposition of Directive 2001/86/EC into Irish law (dealing with worker participation rights) has not yet taken place.

An important feature of an SE is its ability to transfer its registered office to another Member State without any requirement to dissolve or be liquidated. In some instances, the domestic law of a Member State might treat such a transfer as triggering a change in corporate tax residence with resultant taxation. The amended Mergers Directive contains a number of provisions designed to ensure that any transfer is as tax-neutral as possible. These are:

The transfer of a registered office of an SE (or indeed a European Cooperative Society or SCE) from one Member State to another will not give rise to immediate capital gains taxation in respect of assets remaining in the first Member State. The assets must be connected with a permanent establishment of the SE in the transferring Member State after the transfer and the tax base of the assets for capital allowances/gains purposes must be unaffected by the transfer. The Directive is silent on the treatment of assets that are unconnected with a permanent establishment in the former Member State of residence, so exit charges, assuming they are compatible with the EC Treaty, might apply.

• Following the transfer of the registered office of an SE or SCE, any tax exempt provisions or reserves arising prior to the transfer of the registered office should be available to the permanent establishment of the SE or SCE on the same tax-free basis, provided the exempt provisions or reserves are not attributable to overseas permanent establishments.
• If a domestic transfer of a registered office would not impact on the utilisation of losses (as in Ireland), a Member State must allow the resultant permanent establishment of an SE or SCE transferring its registered office to utilise available losses in the same manner as for a company that retained its registered office or residence in that Member State.
• The transfer of the registered office of an SE or SCE should not give rise to any taxation of the income, profits or capital gains of the shareholders, although this does not preclude Member States from taxing any gain arising from a subsequent transfer of the securities held in the SE or SCE. It is unclear how this provision might interact with double taxation agreements.

Scope
A main conclusion of a European Commission paper produced in 2001 was that the scope of the Mergers Directive was too limited. A decision was made to improve the coverage of the directive by extending the list of legal entities referred to in its annex. The amended list includes the SE and SCE referred to above and also additional entities that are liable to corporation tax in their home Member State. Some of these entities may be regarded as tax-transparent in other Member States and there are special rules applicable to such hybrid entities.

The most relevant aspect from an Irish perspective is that Irish unlimited liability companies will be able to avail of the Mergers Directive for the first time.

Partial divisions
The 1990 Directive applied to mergers, divisions, transfers of assets and exchanges of shares. A key amendment to the directive is that it will now also apply to partial divisions, whereby a company transfers part of its activities in return for the pro rata issue of securities to its shareholders. In order for the directive to apply, the assets and liabilities transferred must remain connected with a permanent establishment located in the transferor Member State. This type of transaction is already catered for in Ireland, most notably by virtue of Section 615 TCA 97 and the share for undertaking relief in the stamp duty code.

The allocation of securities to the shareholder should not give rise to a taxation charge in the hands of the shareholder at the time of the transaction. The provisions of Sections 586 and 587 TCA 97 should normally apply to such transactions in an Irish context. The directive does not preclude a Member State from taxing the shareholder on a subsequent transfer of the new shares nor does it preclude the taxation of any cash payments received by shareholders at the time of the partial division.

Conversion of branches to subsidiaries
The revised Mergers Directive now clarifies that its provisions apply to the conversion of branches into resident subsidiaries. In such instances, branch assets are typically hived down to a newly established subsidiary of the transferring company. The language used in the original text was unclear in this respect. Such hive-downs do not appear to be particularly problematic in Ireland and can usually be achieved on a tax-neutral basis.

Where an Irish resident company transfers an overseas branch to a company resident in a Member State, Ireland loses taxing rights over that overseas branch. The directive allows Ireland to claw-back any losses of the overseas permanent establishment that have been used to shelter taxable profits of the former Irish resident company. However, the directive also permits Ireland to tax any gains arising on the transfer, provided Ireland gives relief for any tax that would have been payable by the permanent establishment had the directive or similar domestic legislation not applied. The revised Mergers Directive makes it clear that this provision applies where the overseas branch is transferred to a company resident in the same Member State where the branch is located.

Section 634 TCA 97 implements these aspects of the directive.

Exchanges of shares
The application of the directive to an ‘exchange of shares’ has been extended to include a situation where a person holding a majority of shares in a company acquires an additional holding in return for the issue of securities to other third-party shareholders in the company. This assists the obtaining of complete control by acquiring shares in phases.

Sections 586 and 587 TCA 97 already cater for company amalgamations by way of share exchanges and company reconstructions. Unlike the Mergers Directive, these provisions are not restricted to situations where one company is seeking to acquire control of another.

Capital distributions
It is possible that, as part of a merger or division, the value of assets received by a shareholder may exceed the value of the shares cancelled by the transaction. As there is little difference between such distributions and dividends (which benefit from the Parent Subsidiary Directive), such gains are not taxable unless the Member State avails of a derogation restricting the benefit of this provision to disposals of holdings of not less than 25% of the transferring company’s capital (Article 7). In view of recent changes to the shareholding requirements in the Parent Subsidiary Directive, the derogation is being amended to reduce the shareholding requirement to 15% from 1 January 2007. From 1 January 2009, the minimum specified holding will be 10%.

Share cancellations are rare in Ireland.

Fiscally transparent entities
As noted above, the annex to the Mergers Directive now includes certain types of entities that might be considered fiscally transparent by some Member States. In order for the benefit of the directive to be effective, those Member States are required to apply the provisions of the directive to such transparent entities, but they have the option not to apply the directive when taxing shareholders of such transparent entities. However, where this option is exercised, notional tax credits will have to be granted.

Double taxation issues
In an earlier proposal to amend the Mergers Directive, the Commission had observed that double taxation could arise in certain situations where there were no objective reasons for it. Where a company transfers branch assets to another company in return for shares, the Member State in which the branch is located can effectively tax the economic gain twice. Firstly, it could tax the permanent establishment on the disposal of the branch assets. Secondly, the disposal of the shares could also be subject to tax. A Commission proposal, that the base cost of the shares acquired should be their market value at the time of the transfer of the assets, was not incorporated into the final text of the Mergers Directive.

In addition, a similar observation, that economic double taxation could adversely affect exchanges of shares, was not reflected in the final text of the directive. In such instances, economic double taxation could be avoided if the company issuing the new shares is treated as acquiring the existing shareholding for a base cost equivalent to its market value.

Entry into force
The revised Mergers Directive entered into force on 24 March 2005. Member States are required to implement its provisions in two phases. The measures pertaining to the transfer of a registered office of an SE or SCE must be adopted by 1 January 2006. The other aspects of the directive are required to be implemented by 1 January 2007.

Irish legislation already adequately caters for cross-border reconstructions and amalgamations by way of share exchanges, thus tax neutrality for the most common transactions is already provided for. The Revenue Commissioners’ officials appearing before the Joint Committee on Finance and the Public Service in March 2004 were of the view that there will not be a big rush of Irish companies seeking to avail of the directive. This may be so. Nevertheless, the revised Mergers Directive may be of greater assistance to companies operating in continental European locations, where mergers are permitted and national measures may operate in a less-than-tax-neutral manner.