ECJ Ruled That Restriction to Tax-Free Treatment of Cross-Border Transfer of Shares is Illegal

Posted on December 18, 2008 by Marco Rossi

On December 11, 2008 the European Court of Justice ("ECJ") issued its decision in case n. C-285/07 dealing with the tax treatment of a cross-border EU transfer of shares under German law.

The Court held that the requirement imposed under German law, according to which the shareholders of the transferred corporation ("target") are not taxed on the gain from the exchange of their shares in the target for the shares of the acquiring corporation, at the condition that the acquiring corporation takes a tax basis in the shares of the target equal to the transferring shareholder's tax basis in those shares prior to the transfer (carryover basis), violates the EU directive n. 90/434/CEE of July 23, 1990 (the "Mergers Directive") and EU law. 

The facts of the case concern a German public company which transferred a majority shareholding in a German private company to a French public company solely in exchange for stock of the French company. The German transferor took a tax basis in the stock of the French acquiring company received in the transaction, equal to the tax basis it had in the shares of the German transferred company (substituted basis). The French acquiring company carried the shares of the German acquired company at their fair market value at the time of the transaction. 

The EU mergers directive prescribes that, in order to qualify for tax free treatment and defer the tax on the gain from the exchange of stock in the target for stock of the acquiring company, the shareholders of the target company must take a substituted basis in the stock of the acquiring company received in the exchange. The directive is silent as to the tax basis at which the acquiring company should carry the stock of the acquired company received in the transaction. 

German law prescribed that the acquiring company took a carry over basis in the shares of the target (so called "double carry over basis requirement"). The position of the German government on the issue was that the EU directive is silent and the matter falls within the authority of the Member States.

The Court rejected the argument and held that the double carry over basis requirement imposed by German law violates the EU mergers directive and EU law in that it result in an undue restriction of a cross-border exchange of shares between to EU companies.

Italian law.

Italy implemented the EU mergers directive by way of legislative decree n. 544 of 1992. Recently, the EU mergers directive was amended and extended by Council Directive 2005/19/CE, implemented in Italy by way of Legislative Decree n. 199 of 2007.

In case of cross-border transfer of shares, Italy's tax administration with resolution n. 190 of December 13, 2000 took the position that shareholders of the target could achieve tax free treatment on their transfer of shares of the target for shares of the acquiring company at the condition that they took a substituted basis in the shares of the acquiring company and the acquiring took a carryover basis in the shares of the target received in the transaction.

Subsequently, with resolution n. 159 of July 25, 2007 the tax administration revoked its previous ruling and eliminated the double carryover basis requirement.

Consequently, Italian law is in line with the EU mergers directive and EC Treaty on this particular issue.
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Italy's Tax Administration Rules on Cross-Border Tax Free Mergers

Posted on December 6, 2008 by Marco Rossi

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.

Conclusion.

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.   
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