On December 3, 2008 Italy's tax administration issued ruling n. 470/E, by which it clarified that cross-border mergers between non-EU companies with permanent establishments in Italy can be carried out tax free.
Italian law provides for nonrecognition treatment of mergers between domestic companies, in which all of the assets of the target company are transferred to the acquiring company in a statutory merger, and the target company's shareholders exchange their stock in the target company for stock of the acquiring company. No boot can be exchanged in the transaction. The acquiring company takes a carryover basis in the assets of the target company, and the target company's shareholders get an transferred basis in the stock of the acquiring company received in the transaction.
The EU directive 90/434/CEE (the mergers directive) provides for a tax deferral treatment of mergers that are carried out between companies resident in two different EU member states. In this case, ten per cent of the consideration can be cash.
In the ruling, the tax administration clarifies that the Tax Code non recognition treatment of domestic mergers can apply also to cross border mergers that fall outside the scope of application of the EU mergers directive.
The ruling is extremely important because it facilitates the possibility to carry out cross-border reorganizations involving Italian assets or Italian companies without immediate recognition of gain.
Italian Law on Domestic Mergers.
Under Tax Code section 172, a merger can be carried out with nonrecognition of gain by either the target company or its shareholders, if the target shareholders receive only stock of the acquiring company in exchange for their stock of the target. The target shareholders take a substituted basis in the stock received in the transaction, and the acquiring company takes a carryover basis in the assets and liabilities acquired in the merger. The tax deferral treatment applies only to mergers between domestic companies.
EU Mergers Directive.
EU directive 90/434/ECC provides for non recognition treatment of mergers between EU companies.The conditions to be met are the following:
- the companies involved in the merger are resident in two or more EU member states;
- the companies involved in the merger are taxable entities subject to corporate income tax in their state of residence;
- the transaction qualifies as a merger under the definition of the directive, i.e., one or more companies transfer all of their assets and liabilities to an existing or newly formed company, on being dissolved without going into liquidation, with the shareholders of the merged companies receiving solely stock of the surviving company in exchange of their stock of the merged companies and, if applicable, a cash payment not exceeding 10 per cent of the nominal value or the accounting par value of their stock in the merged companies.
If the assets transferred in the merger include a permanent establishment of the merged company situated in another EU member state, both the member state of the merged company and the member state of the permanent establishment renounce their right to tax the gain on the assets of the permanent establishment, and the acquiring company receives takes a carryover basis in the assets of the permanent establishment.
The mergers directive was amended by way of the EU directive n. 2005/19/CE.
Italy implemented both directives with provisions that are now contained in Tax Code sections 178 to 181. As a result, a merger of a company resident in Italy and a company resident in another EU member state, or of two companies resident in two different EU member states with a permanent establishment in Italy, are governed by the directive and can be carried out with non recognition of gain if the conditions for the tax free treatment are met.
The Facts of the Ruling.
The ruling deal with the merger of two banks resident in Germany with permanent establishments in Italy.
The transaction qualifies as a merger under both domestic law and the EU mergers directive. However, since it is a merger between two companies that are resident in the same EU member state (Germany), technically the mergers directive cannot apply.
The Opinion of the Italian Tax Authority.
According to the Italian tax administration, the general nonrecognition treatment of domestic mergers can apply also to the merger in question.
The tax administration refers to the provisions of Tax Code article 176 on the contributions of assets to a company in exchange for stock of the company (equivalent to the section 351 transactions under US Internal revenue Code), as amended with the Budget Law for 2007, which expressly apply also to the case in which the transferring or the transferee companies are non resident in Italy, whether or not they are resident in a EU or non-EU country, and grant non recognition treatment with respect to the business assets of the transferring company located in Italy.
The tax administration observes that the Italian legislator deemed it appropriate to extend the tax free treatment in the above case also to transactions carried out between companies resident outside of Italy and the EU. As a result, it seems appropriate to extend the tax free treatment also to mergers carried out between foreign companies, which do not fall within the scope of the mergers directive, when all other conditions for the non recognition treatment are respected and the Italian assets are transferred to the acquiring company with a carry over basis that preserve Italy's right to tax the gain on those assets.
The ruling is very important because it clarifies the Italian legal background in case of cross border reorganization. The Italian legal system is very favorable, because under its international private law it recognizes mergers carried out pursuant to foreign law, and grants non recognition treatment to foreign cross border mergers involving Italian companies or assets located in Italy. The same nonrecognition treatment can apply also in case of transfer of Italian assets or stock in a contribution transaction between two foreign companies.