Ten noteworthy points arising out of the CMS Annual Tax Conference on European cross-border reorganisations held in Paris on 18th November 2002

(1) Where a section 139 Taxation of Capital Gains Act (TCGA) 1992 roll-over claim is made in relation to a transfer of assets in a reconstruction situation which involves the transferee being or becoming in the same group as the transferor or the parent, then as an unfortunate (and possibly unintended) side effect, there may potentially be a section 179 TCGA 1992 exit charge if the transferee leaves the group within six years. Notably, section 179 TCGA 1992 does not, since the Finance Act 2000, require section 171 TCGA 1992 to have applied to the original transfer - it applies to reconstructions involving a transfer of business under section 139 TCGA 1992; it also bites if the transferee company is not grouped at the time of the transfer but is later. Careful tax planning may be needed to escape this unexpected side effect.

(2) Similarly, in relation to a section 140A TCGA 1992 roll-over claim on the subsidiarisation of a UK branch of an EU company, if the recipient company is or becomes a member of the 75 per cent group of the transferor then a section 179 TCGA exit charge can arise if the transferee leaves the group within six years. As stated above, section 179 TCGA 1992 does not, since the Finance Act 2000, require section 171 TCGA 1992 to have applied to the original transfer - it also applies to reconstructions involving a transfer of business under section 140A TCGA 1992; and it also bites if the transferee company is not grouped at the time of the transfer but is later.

(3) Conversely, if under a section 140A subsidiarisation a situation is engineered such that grouping does not take place perhaps with an external third party holding sufficient low value participating preference shares or by doing the business transfer into a joint venture situation, then a UK permanent establishment ("PE") can be placed tax free into a new UK company which may eventually be sold by the foreign shareholder without tax being triggered on the latent gain. Clearly, anti-avoidance and pre-clearance issues will be of importance.

(4) When creating a UK or international group then the often forgotten section 181 TCGA 1992 (exemption from charge under section 178 and section 179 TCGA 1992 in the case of certain mergers) can be of assistance to avoid a section 179 TCGA 1992 exit charge in situations where section 139 TCGA 1992, or section 140A TCGA 1992 or even section 171 TCGA 1992 deferrals take place. Section 181 TCGA 1992 was intended to address problems arising out of a significant Dunlop/Pirelli joint venture some 30 years ago. However, section 181 TCGA 1992 is considered to be awkwardly drafted and is unlikely to be attractive. One reason for this is that the joint venture company will either own part of the joint venture business through a UK resident subsidiary (which is likely to be tax inefficient and at variance with the commercial objectives of the joint venture) or will have to arrange for the UK resident subsidiary to hive up its business, thereby triggering the chargeable gains sheltered by section 181 TCGA 1992.

(5) Consider the stamp duty situation where a UK branch containing UK real estate is subsidiarised under section 140A TCGA 1992 and later merged into a joint venture vehicle. What reliefs are available!

Section 42 Finance Act 1930 (as amended)

The existing anti-avoidance provisions relating to section 42 (75 per cent) group relief (in particular, section 27 Finance Act 1967) have been recently supplemented by a provision for claw-back of any relief where UK land is transferred within a group and the transferee leaves the group within 2 years of the transfer. Under section 42, relief is denied where, at the time of an intra-group transfer, there are "arrangements" for, inter alia, the transferee to leave the group. However, the claw-back will operate even where there are no such arrangements. A secondary liability for any claw-back will attach to the real estate interests of group companies other than the transferee, and also to any person who at the relevant time was a "controlling director" of the transferee or a company controlling the transferee.

Therefore, it is now much more difficult to avoid stamp duty on the UK property sales by an intra-group transfer to a special purpose vehicle (i.e. the subsidiarisation under section 140A), followed by a change of control of that special purpose vehicle (e.g. the subsequent insertion of the subsidiary into the joint venture vehicle).

Section 76 Finance Act 1986

In the past, relief under section 76 Finance Act 1986 has been used where section 42 relief could not be claimed because "arrangements" were in place for the transferee to leave the group. Now, however, section 76 (but not section 75 or section 77) relief will itself be clawed back if the acquiring company (i.e. the subsidiary to which the UK real estate has been transferred) passes to a third party within two years of the transfer of the real estate. Secondary liability for a claw-back arises, as described above in relation to section 42 relief.

In addition, section 76 relief will be denied at the outset where at the time of the transfer there are arrangements in place for a third party to acquire the shares from the transferor. These changes were targeted at schemes involving mitigation of stamp duty on the sale of a property by use of an intermediate company.

However, as this example shows, the impact seems to be wider than that and perhaps wider than was intended or maybe even permitted by EU law. This seems contrary to the EC Merger Directive (90/434/EEC) which does not envisage any such tax arising on transfers of business and subsequent mergers - but has not yet been tested.

It should also be noted that sections 75, 76 and 77 reliefs are only available where the receiving company's registered office is in the UK. Arguably, this too is contrary to the EU rules - but, so far, this point has not been tested in the European Court of Justice.

(6) Several different views have been taken in relation to the EC Merger Directive (90/434/EEC) by various European jurisdictions as to the extent of Article 10, which contains, inter alia, the PE subsidiarisation provision implemented in the UK by s140A TCGA 1992.

UK

In the UK we take the view that relief cannot apply to the situation where country A tries to subsidiarise the UK PE into a country A subsidiary. The UK Inland Revenue do, however, go on to conclude that both UK legislation and the EC Merger Directive, although a little unclear, permit a subsidiarisation of the UK PE into a UK subsidiary of country A. It appears that the view is taken that the transaction involves two countries i.e. country A transferring its UK PE to a UK company.

Italy

On the other hand, the Italians view the situation where country A tries to subsidiarise the Italian PE into an Italian subsidiary of country A as a domestic merger and would treat it as a liquidation giving rise to taxable profits.

France

It is not clear whether the French view it as a domestic or cross-border transaction. Although they give relief, they certainly seek an undertaking from the country A parent that it will hold shares in the French subsidiary (which has taken the French PE) in a new French PE of the country A parent or in a French holding company so that the gain on the sale of the shares in the French subsidiary can still be subject to French tax. Of course, given the capital gains tax deferral on the transfer of assets transferred to the new subsidiary, this can result in double tax. Whether this is breach of European rules may well depend on whether it is genuinely a domestic or a cross-border transaction in which Europe can interfere although following the Leur-Bloem case (C-28/95) this may not matter since it seems that the ECJ can rule on matters where the rules for cross-border transactions are copied in the local law.

Austria

The Austrians hold the same view as the UK.

Germany

The Germans view this subsidiarisation situation as a domestic merger but give relief in any event.

Belgium and Holland

The Belgians and the Dutch also provide relief.

(7) There are restrictions and claw-backs on merger tax relief that apply in many jurisdictions, including the UK (on the assumption that a section 179 TCGA 1992 exit charge is applicable to subsidiarisations). The European Commission representative (Philip Kermode, Head of Unit, Direct Taxation) suggested that e.g. seven year claw-backs and three year tainting of consideration shares are excessive to legitimately protect against tax avoidance as permitted in the EC Treaty.

(8) Although many readers will already be aware of this fact, it is noteworthy that the UK has no specific legislation reflecting the EC Merger Directive on mergers because of the Inland Revenue's belief that we do not have the company law to support a cross-border merger until the Tenth Company Law Directive is implemented in the UK.

(9) While EU statutory mergers and divisions are not currently explicitly available in the UK under the existing UK rules because of the lack of the supportive company law framework, there are situations where UK taxpayers may be involved in cross-border mergers and divisions and in particular may be shareholders in the company being merged or divided. Consider the merger of two non-UK companies into a UK operation, effected by hiving up their respective businesses to a NewCo (or merging their business into NewCo) in exchange for shares in NewCo issued to the non UK company's shareholders. Where the shareholders are UK residents, they should, in principle, be entitled to section 136 TCGA 1992 relief (although such an amalgamation may not strictly be envisaged by the UK rules). If the Inland Revenue were to deny relief in this particular situation and the UK shareholders should be able to demand "direct effect" of the EC Merger Directive to claim relief.

(10) The rather unusual provisions of sections 425 - 427 Companies Act 1985, which constitute a type of indirect demerger or reconstruction, are the closest UK equivalent to an EU statutory division. In essence, if a company makes a compromise or arrangement with its members or creditors that is sanctioned by a court it can effect almost any kind of (demerger) restructuring. This would particularly be the case if you have as the recipient company a UK incorporated but foreign resident company. A cross border restructuring involving a scheme of arrangement proposed under section 425 Companies Act 1985, must be effected according to section 427 Companies Act 1985 between two UK companies, but it does seem conceivable that one of those could be resident in another EU state.

If you would like further information on the conference or the countries covered, please contact Marie Hélène Harent on 020 7367 2642 or email [email protected].