Corporate Taxation News: Clearer Rules For Business Transfer?

Lithuania has taken steps to modify its Corporate Tax Law to comply with the provisions of EU Directive 2005/19/EC (February 17, 2005) amending Directive 90/434/EEC 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets, and exchanges of shares concerning companies of different EU member states. It is foreseen that the proposed legislation would go into effect January 1, 2006.

The corporate tax rate would remain unaltered, as the European Union does not require harmonization of corporate income tax rates. EU Internal Market and Services Commissioner Charlie McCreevy on November 4 said he favors competition among EU member states. However, national taxes should not create obstacles for companies’ movement between the EU member states, interstate reorganizations, or mergers.

To date, provisions on taxation of goodwill (or negative goodwill) are not explicitly regulated for the purposes of corporate taxation, which may give rise to problems, especially in company reorganizations and transfers of assets.

The proposed law would establish that for corporate tax purposes goodwill would emerge from corporate acquisition, in whole or in part, as the aggregate of rights and obligations; acquisition of another company’s shares with the purpose of controlling its net profit and activity; and when money paid constitutes more than the value of the acquired portion of the company’s net assets evaluated in the real market price.

In other cases, goodwill (or negative goodwill) would be attributed to taxable income or deductibles. It is also proposed that goodwill would be acknowledged at the moment of its emergence, except for cases of acquisition of another company’s shares with the purpose to gain control over its net profit and activity. In the latter case, goodwill would be accounted separately and taxed at the moment of later reorganization or transfer of assets. For example, if a company gained control over another company in the course of shares’ acquisition and the company was transferred to other persons later, not only that transfer, but also the prior goodwill would be taxable. Thus, goodwill creates preconditions for tax deterrence, and thereby maintains business control.

One may argue that instead of the somewhat vague term "net assets value," Lithuanian legislators should have used the EU Directive term "value for tax purposes," which is the value on the basis of which any gain or loss would have been computed for the purposes of tax on income, profits, or capital gains of the transferring company if the assets or liabilities had been sold at the Furthermore, the content of the goodwill criteria "intention to exercise the control over the assets and company’s activity" is somewhat vague, and it is unclear how it will be applied in practice. It could mean that upon acquisition of a controlling shareholding for financial investment purposes only, this tax deduction would not be applicable. Or it could mean that upon acquisition of shares that do not grant the right to make a decisive influence on the company, the right is, however, conferred on the grounds of a shareholder or voting agreement. It is considered that the legislator could either invoke competition law rules that define the control over the undertaking, or could have established the specific criteria (for example, by acquisition of 10 percent of shares).

When a company’s shareholders, as a result of a merger or reorganization, receive shares of another company (for example, that is merged or newly established) in exchange for shares owned thereby, an increase in assets value is not considered to be income of the shareholders that acquired the new shares.

It is not clear how general taxation of goodwill is related to the rule according to which the difference that emerges at the moment of reorganization or transfer (amount by which the price paid by the acquiring company exceeds the value of the acquired net profit) is not computed from income, and negative difference (amount by which the price paid by the acquirer is less than the value of the acquired net profit) is not included in the income.

We can presume that the assets value increase will be taxed at the moment of other transfers. However, the essence is that the acquisition of shares and profit as the result of reorganization might not be related with the intention to exercise control its net profit and activity that is essential for the taxation deference according to the definition of goodwill.

In that way, double taxation is avoided and the neutrality principle is established –- assets or shares acquired by way of reorganization are considered to have been acquired at the acquisition price that was applied to the transferor before the transfer. It means that for such reason a value increase does not apply for the transferor. A value increase applies for the acquirer only during later transfer of the company or its merger.

It is not clear how provisions on tax postponement as the result of reorganization correlate with the taxation of goodwill. It is not clear whether, for example, during the reorganization process a company has acquired another company’s assets for its newly issued shares; in such case control of neither of them is gained. Does that mean that even in case of failure to satisfy the aforementioned criteria "intended to control assets and company’s activity," taxation of the difference between shares and assets is subject to tax exemption?

Negative goodwill is subject to taxation upon further reorganization of the company. However, it is not clear how goodwill will be treated at the outcome of the reorganization, as the proposed law, when addressing the taxation of gains or losses that have occurred as a consequence of reorganization, establishes the above-mentioned general tax relief rule.

Taking into consideration the case of company’s partial division provided for by the Law on Companies, the new legislation proposes to supplement the law with one more case of profit transfer, during which the same provisions regarding assets value increases would be applied as in other established cases of reorganization and transfer of assets.

Thus, one more way of reorganization avoiding taxation –- through "partial division" –- is foreseen. Partial division is an operation whereby a company, without being dissolved, transfers one or more branches of activity to one or more existing or new companies, leaving at least one branch of activity in the transferring company, in exchange for the pro rata issue to its shareholders of securities representing the capital of the companies receiving the assets and liabilities, and if applicable, a cash payment not exceeding 10 percent of the nominal value or, in the absence of a nominal value, of the accounting par value of those securities.

The new law would establish that when a European company or European cooperative company having its seat in Lithuania transfers its registered seat to another EU member state, the assets value would not increase. Regarding a taxable company continuing its activity in Lithuania through a permanent establishment, asset depreciation, and losses transfer, the same provisions are applicable as for a Lithuanian company that has not transferred its registered seat.

Instead of the transparency criteria for nonresidents that is laid down in the EU Directive for the purposes of tax postponement (that is, the state does not tax any income, profit, or income from assets increase, calculated according to the difference between the real value of assets and the liabilities transferred and their value for tax purposes), Lithuania’s new law would establish that for cases of reorganization or asset transfer, foreign taxable companies that participate in the acquisition of a legal person existing in Lithuania, its activity, or part of its activity, the taxation of assets value increase is deferred only when the foreign companies further pursue their activities through a permanent establishment (or affiliate or branch) in Lithuania.

That provision means that the transfer of activity or assets of a foreign company into another EU member state can be taxable. In that way Lithuania, as well as some other states, seeks to protect both its market and economy, promoting maintenance and facilitate further development of investments and business in Lithuania.

As a matter of practice, due to attribution of deductibles to tax-exempt income, the actual net result of a company’s activity may be distorted because although the company operates profitably, losses are recorded for tax purposes. Therefore, the draft law proposes to disallow attribution of deductibles to tax-exempt income.

The new law would allow for clearer taxation of business and asset transfer for profit tax purposes. It is progressive regarding business transfers. However, obscurities remain (for example, value added taxation of business transfers). Moreover, imperfect formulations could cause useless obstacles in their practical application and thus might not reach the aim of the proposed legislation. The tax consequences of the transfer of the seat of a European company into another state are clearly stated.

It is foreseen that the proposed draft law would prevent the state from receiving LTL 4.1 million in revenue.

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