-
- Introduction
If you are working for a multinational enterprise, it is likely that you have been involved in an intragroup restructuring that includes countries.
A common question that arises in these international intragroup restructurings is whether any transfer – of shares or assets – made between entities of the same group should result in any tax implications. The answer is not straightforward, because the tax regulations in each country are different.
In this article we look at one of the tax issues that sometimes makes an intragroup share transfer deal too expensive to execute: corporate/income tax on capital gains, also known as capital gains tax (“CGT”).
Needless to say, intragroup corporate restructurings often result in several other tax implications, such as VAT and/or real estate transfer taxes, stamp duty, etc.; and also in other less apparent but equally important tax implications, such as the tax deductibility of financial and non-financial expenses, the re-evaluation or step-up of assets for tax purposes, the right to continue using previous tax losses, the tax treatment of goodwill, etc.
The views in this article are generic. For any specific legal advice in respect of a country or transaction, please do not hesitate to contact us.
- CGT: the basics
Multinational groups oftentimes restructure their corporate diagrams due to multiple reasons: to achieve an easier-to-manage corporate structure, to prepare for a future divestment and/or public listing, to improve the business operations, to comply with legal or other requirements, to obtain better financing from financial institutions, etc.
In these intragroup restructurings, it is common that one or more transfers of shares may take place, be it by way of a share sale and purchase, and in-kind contribution, a merger, a spin-off, etc. These transfers of shares in principle usually fall within the scope of income tax in most countries, which tend to subject them to income tax under either of the following schemes:
- persons who are tax residents in the country are subject to income tax on a worldwide income basis;
- persons who are not tax resident in the country are subject to income tax only in respect of income generated from a source in that country; and
- permanent establishments (“PE”) located in the country are subject to income tax in respect of the income attributable to such PE. However, certain countries such as Saudi Arabia apply force of attraction rules that may expand the income attributable to a PE.
Regarding the source of income, most countries provide that income arises from a local source if, among other events, it derives from the transfer of shares of companies incorporated in the country.
Therefore, cross border share transfer may be subject to CGT twice, in two countries: in the country of residence of the transferor (referred to as the “residence country”) as a tax resident; and again, as a non-resident, in the country where the company whose shares are transferred is incorporated (known as the “source country”).
If we were to stop the analysis here, cross border intragroup share transfers would simply not occur. No multinational group, in its right mind, would pay CGT twice – in two countries and before two different tax authorities – because of the same internal restructuring.
To make things worse, CGT on intragroup share transfers is financially more onerous than CGT on a transfer of shares made to a third party, because at least in a third-party transaction there is external cash from the buyer flowing in which can be used to pay the tax, whereas in an intragroup transaction the cash belongs to the same multinational group, and sometimes the transferor receives the cash late or does not receive cash at all (e.g. an in-kind contribution of shares, a barter, etc.). This is why in the industry jargon, CGT on intragroup restructurings is often referred to as a “dry tax”.
The good news is that countries are aware of these challenges, and they enact measures, either at the domestic level or through international treaties, aiming to relieve the double taxation.
The bad news, however, is that these measures come at the price of higher sophistication and, quite often, uncertainty in their practical application.
Below we discuss certain measures that countries often put in place to alleviate CGT on cross border intragroup share transfers.
- Relief number one: tax relief for intragroup transfers
Several countries have domestic CGT relief for qualifying intragroup share transfers. For instance, at the European Union (“EU”) level, the Council Directive 2009/133/EC of 19 October 2009 on the common system of taxation applicable to mergers, divisions, partial divisions, transfers of assets and exchanges of shares concerning companies of different Member States and to the transfer of the registered office of a Societas Europaeabetween Member States, consolidates legislation which was first enacted as far in time as 1990 and which the EU Member States are obliged to transpose into their internal legal orders. In the Gulf Cooperation Council (“GCC”) region, countries like Saudi Arabia, the UAE and Qatar (including the Qatar Financial Centre) also include certain provisions in their own income tax laws.
The tax relief tends to be construed not so much as an exemption from taxes, but instead as a tax deferral, until such time the assets are transferred outside of the group or when the conditions to qualify for the relief cease to be satisfied.
However, not all intragroup share transfers qualify for the tax relief. The formal and substance conditions required to qualify vary from country to country. A detailed analysis must be performed in every case.
In addition, even if the conditions are satisfied, when the transaction has an international, cross border component, in practice some tax authorities may deny the tax relief. In some countries companies might face several administrative challenges to apply the tax relief if the transferor or the transferee are non-resident persons.
- Relief number two: tax grouping
Several countries allow two or more legal persons of the same group that are tax resident in the country to form an income tax group. Some countries also allow PEs located in the country, belonging to non-resident entities of the same group, to join such tax group.
However, countries usually do not allow non-resident entities to join a tax group. And other countries do not allow tax grouping at all, or they only allow it in respect of certain groups of taxpayers – e.g. Saudi Arabia, in respect of companies subject to Zakat which are fully owned by the same shareholder/s.
One of the benefits of forming a tax group is that transactions made between members of the same group are disregarded for tax purposes. This means that a share transfer made between entities of the same group would not be subject to CGT.
In the European Union, it was questioned whether this different tax treatment – i.e. affording a more beneficial tax treatment to asset transfers made between entities of a domestic tax group but not to asset transfers made on a cross border basis to non-resident entities – complied with EU law. The European Court of Justice, in its judgment dated 16 February 2023, case C‑707/20 Gallaher Limited, ruled that such difference in tax treatment did not breach EU law on the following basis:
- because the right to the free movement of capital, as provided in Article 63 of the Treaty on the Functioning of the EU (“TFEU”), did not apply in this scenario; and
- because the right to freedom of establishment, as provided in Article 49 of the TFEU, had not been breached given that the difference in tax treatment was justified by the need to maintain a balanced allocation of the power to impose taxes between the EU Member States.
The European Court of Justice’s decision is debatable. Firstly, because it dismissed the applicability of the free movement of capital in a brief way, whereas in our view an argument can be made that such freedom was indeed at stake. Secondly, because it focused on how Member States should design the mechanism to pay the tax – i.e. whether imposing an immediate obligation to pay the tax without a possibility of deferral/suspension was proportional -, however it did not elaborate on whether tax should be due in the first place. And thirdly, because the Court placed excessive emphasis on the fact that the transferor had collected cash in return for the share transfer, whereas there may be several circumstances in which a transferor may not collect it (e.g. an in-kind share contribution, a barter, etc.).
In any event, it appears that achieving tax relief on cross border share transfers in the EU and in the GCC, on the basis of the tax grouping provisions, is expected to be a challenging task.
Notwithstanding the above challenges, companies should always consider the interplay of the domestic laws with international treaties – such as the TFEU, the 2001 GCC Economic Agreement, etc. – to enhance and strengthen their tax position.
- Relief number three: double tax treaties
Countries enter into double tax treaties with the primary aim to avoid double taxation and foster cross border investment and trade.
Although each tax treaty must be individually analysed, oftentimes they reduce or eliminate the CGT taxation arising in the source country as a result of a share transfer.
However, benefitting from double tax treaties is not straightforward, and certain formal and substance conditions must be satisfied.
- Relief number four: reducing or eliminating double taxation in the residence country
Lastly, several countries, when acting as a residence country, grant tax relief against double taxation. The legal basis for this relief may be found in the domestic legislation, in an applicable double tax treaty, or in both.
In terms of the scope of the relief, it may be partial (covering only some of the CGT) or total (covering all the CGT).
The conditions to avail the relief vary from country to country. Typical conditions include a minimum participation in the share capital of the subsidiary whose shares are transferred, a minimum holding period, a subject-to-tax requirement and, sometimes, even economic substance considerations.
Regarding the mechanics of the tax relief, it may operate as an exemption from the taxable base (i.e. a negative tax adjustment to the tax base), or as a tax credit which is deductible from the tax due. The practical design of the relief is critical, because sometimes the residence country may have rules limiting the amount of adjustments to the tax base or the tax credits that can be applied in a given year, and the balance of unused tax relief may or may not be carried forward to subsequent years. Sometimes the taxpayer can choose either method, sometimes it does not have the right to choose. In these circumstances, analysing the different options available and making the right choice may have a significant impact on the final tax due.
- Conclusion
Intragroup cross border share transfers are frequent. They help multinationals achieve a better corporate structure and, in the long term, attain greater results.
One key aspect of these intragroup transactions is taxation, including CGT. There are several potential tax measures that may reduce or eliminate CGT. However, achieving tax relief is subject to several and stringent requirements. In addition, it is critical to be aware of the tax authorities’ and the courts’ criteria and practice.
Lastly, the tax considerations relevant to a restructuring do not end with CGT. All the direct and indirect tax consequences arising before, during and after the transaction should be analysed. From experience, many clients tend to focus on the taxes arising after the transaction, but not on those arising as a result of the same.
- How we can help
Our tax team has extensive experience on cross border restructurings. They regularly advise and assist multinational groups restructuring their business models, structures and transactions. They are experts on the income tax laws, CGT, double tax treaties, EU and GCC laws, as well as on transfer pricing matters.
If you are working for a multinational group which is planning an international restructuring, we can guide you through the complex tax laws and bring certainty to your organisation.