Facilitating cross-border reorganisations is one of the main targets within the framework of the unified European market.

No doubt, one of the main obstacles was, and is, tax.

Obviously, taxation should be restricted so that it does not hinder cross-border reorganisations and integration of enterprises, particularly in cases where the tangible and intangible elements of an enterprise remain within the original jurisdiction, although the ownership may have shifted to another party, resident in another member state. In this case the original jurisdiction may keep its tax claim on these elements.

Although this principle might seem quite obvious, it took 20 years of discussion within the European Council to meet the immediate problems through directive 90/434/EEC of July 23 1990

The main principle is that, upon certain types of international reorganisations, no tax will be levied (that is, tax will be postponed) with respect to capital gains and reserves existing within an enterprise that is part of a reorganisation involving companies resident in two or more member states of the EU.

The merger directive of July 23 1990 was amended and completed by the directive dated February 17 2005 (the Directive).

The scope of the Directive

The Directive envisages the following operations, in which companies from two or more member states are involved:

• Three types of mergers, that is, operations whereby one or more companies, on being dissolved without going into liquidation, transfer all assets and liabilities: 1) either to a newly incorporated company; or 2) an existing company, with issuance of shares to the shareholders of the dissolved companies; and 3) an operation whereby one company, on being dissolved without going into liquidation, transfers all its assets and liabilities to the company holding all the securities representing its share capital (silent merger).

• Divisions, that is, operations whereby a company, on being dissolved without going into liquidation, transfers all its assets and liabilities to two or more existing or new companies, in exchange for the pro rata issue to its shareholders of securities representing the share capital of the companies receiving the assets and liabilities.

• Partial divisions (added in 2005), that is, operations whereby a company transfers, without being dissolved, 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.

• Transfer of assets, that is, an operation whereby a company transfers, without being dissolved, all or one or more branches of activity to another company (including the conversion of a branch into a company) in exchange for the securities representing the capital of the company receiving the transfers.

• Exchange of shares, that is, the operation whereby a company acquires a holding in another company such that it obtains a majority of the voting rights in that company or, holding such majority, acquires a further holding, in exchange for the issue to the shareholders of the latter company, in exchange for their securities, of securities representing the share capital of the former company.

The Directive covers the transfer of the registered office of a Societas Europaea (European company – SE) and a European Cooperative Society (SCE) from one member state to another.

According to the Directive, the implementation of the above transactions should be possible in a tax-neutral environment.

Principles of the Directive

The leading principle of the Directive is tax deferral linked to neutrality.

In case of a merger, division, partial division or transfer of assets, no tax will be levied by the member state of the merged, (partially) divided or transferring company on any capital gain (that is, the difference between the real values of assets and liabilities transferred and their values for tax purposes), provided these assets remain effectively connected, as a consequence of the operation, to a permanent establishment of the receiving company in the member state of the transferring company and contribute to profits and losses taken into account for tax purposes.

Neutrality further implies that no step-up in basis will apply with respect to the assets and liabilities transferred – which results in a tax deferral – and that the tax-free reserves constituted by the transferring company may be carried over, within the same jurisdiction (so excluding reserves derived from foreign establishments), to the permanent establishment of the receiving company while maintaining the specific features of the tax exemption, the receiving company assuming the rights and obligations of the transferring company.

Lastly, where the domestic law of a member state allows that, in local qualifying transactions, losses may be carried over from the transferring company to the receiving company, the transfer must also be allowed in favour of the permanent establishment of the receiving company in a cross-border qualifying transaction.

Neutrality and tax deferral also prevail at the level of the shareholder. The qualifying operations might not, as such, give rise to taxation of a capital gain. Upon later disposal of the shares received in exchange, these shares will have the same value as the original shares existing before the transaction, allowing the member state where the shareholder is a resident to tax at that point the initial capital gain.

Anti-avoidance provision

Member states may refuse to apply the Directive if it appears that the merger, division, partial division, transfer of assets, exchange of shares or transfer of the registered office (of an SE or SCE) has as its principal, or one of its principal, objectives tax evasion or tax avoidance.

A member state that is refusing to apply the Directive should provide evidence of the intention to evade or avoid tax, but the Directive provides for a presumption of tax avoidance or tax evasion: the fact that the transaction is not carried out for valid commercial reasons may constitute a presumption that the transaction has tax avoidance or evasion as its principal objective or as one of its principal objectives.

Conversely, if a transaction is definitely supported by valid commercial reasons, any intention to evade or avoid tax should be precluded.

In Leur-Bloem v Inspecteur der Belastingdienst/ Ondernemingen Amsterdam 2 (C-28/95, July 17 1997), the European Court of Justice has given a precise ruling on how the anti-avoidance provision must be interpreted.

The Court has ruled that the Directive does not authorise a member state to promulgate a general rule, based on certain criteria, according to which certain categories of transactions would automatically be excluded from the advantages the Directive provides, irrespective whether or not there is tax evasion or avoidance.

To verify whether there is an intention to evade or avoid tax, the tax authorities must in every individual case carry out a global investigation of the transaction, under the control of the judicial authorities.

The Court has also emphasised that the concept valid commercial reasons has a meaning that goes beyond the mere search of a tax advantage, such as loss compensation.

The absence of valid commercial reasons provides a mere presumption of fraud that can be invalidated. As such it is not enough to deny the advantages of the Directive as other reasons may be present for carrying out a transaction, even if perhaps non-commercial ones (such as family or health), excluding any intention of fraud.

Belgian tax law

To date the Directive has been implemented in Belgian tax law to a limited extent only (Law of July 28 1992).

The following cross-border transactions may be carried out in tax neutrality:

• If a company established in an EU member state has effected a contribution of its Belgian branch within the framework of a merger, division or contribution of a branch of activity or of a universality of goods (that is, of all assets and liabilities) that has been carried out within a foreign tax-free scheme, then the capital gain that appears with respect to that Belgian branch will not be taxed, provided that subsequent to the transaction a Belgian branch is kept in existence or that the assets are maintained in Belgium. No step-up in basis is granted. Losses of the initial branch carried forward may not be transferred to the branch of the acquiring company. There is no business purpose test to be met.

• If a Belgian company or a Belgian branch of a foreign company contributes a branch of activity or a universality of goods (that is, all assets and liabilities) to a company established within the EU, the capital gain appearing from the transaction is not taxed, on the condition that a branch or the assets concerned are maintained in Belgium after to the transaction. No step-up in basis is available and losses carried forward are not transferred. However, tax neutrality here is subject to a business purpose test.

• Capital gains appearing on the contribution of a Belgian branch to a Belgian company in exchange for shares (that is, conversion of a branch into a company) are not taxed. Again no step-up in basis is available and losses of the branch carried forward are not transferred to the acquiring company. No business purpose test has to be met.

• Capital gains realised upon an exchange of shares are fully tax exempt under the general participation exemption, provided the exchanged shares qualify for the dividend received deduction, basically meaning that these shares must be held in companies that are subject to tax, either in Belgium or abroad. As such the exchange of shares is not tax neutral (although effectively exempt) because the contribution for tax purposes takes place at market value and leads to a corresponding increase of paid-in share capital of the recipient company that may be repaid under exemption of (withholding) tax.

In summary, only the transfer of assets as defined in the Directive benefits from a tax-neutral regime that is largely compliant with the Directive, whereas the exchange of shares is covered by the even broader domestic participation exemption regime. On the contrary, cross-border mergers, divisions and partial divisions whereby a Belgian resident company is wholly or partly taken over by a foreign company, although an EU resident company, might still not be implemented within a tax-neutral scheme.

Where, in a purely domestic context, a subsidiary is merged into its parent, the transaction does not necessarily benefit from full tax neutrality. First, to the extent that the subsidiary has (certain) tax-free reserves, which will in principle be effectively taxed at the full corporate tax rate (33.99%) commensurate to the participation that the parent had in the subsidiary. Secondly, the excess of the subsidiary's net assets over the investment value in the parent's books is treated as a dividend and will in principle be taxable for 5% (the dividend-received deduction being limited to 95%).

Lastly, the rules promulgated in 1992, as summarised above, are not Directive-compliant in that transfer of losses carried forward in favour of the permanent establishment of the receiving or acquiring company is denied, where in domestic transactions losses carried forward of a merged company may be transferred to the receiving company, within certain restrictions.

Pending draft law

The Belgian government is preparing a draft bill of law aiming at achieving full implementation of the Directive in Belgian tax law.

This draft bill is intended to take (retrospective) effect as of January 1 2007.

Although political discussions continue within the government (pertaining to issues not related to the basic principles of the Directive), it is clear that the most important subject to be regulated is the cross-border integration of companies within the EU and in particular cross-border mergers, divisions and partial divisions.

Both for domestic and cross-border mergers and (partial) divisions, tax-neutral status will be available provided:

• the company receiving the assets is a Belgian resident company or an intra-European company. An intra-European company is defined as a company that is not a Belgian resident company, that has a legal form specified in the annexes to the Directive, that is resident in a member state of the EU and that is subject to corporate tax in that state.

• the transaction is carried out in compliance with the Belgian Companies Code and with similar rules (if any) applicable to the intra-European company;

• the main purpose of the transaction is not to evade or avoid tax. The draft bill adds here that a transaction will be deemed to have as its main purpose tax evasion or tax avoidance if it is not justified by legitimate financial or economic needs. This anti-avoidance rule is clearly not compliant with the Directive interpreted in line with the decision of the European Court of Justice in Leur-Bloem in that the new text introduces an irrefutable presumption. This debatable version of the anti-avoidance principle is made applicable to all tax-neutral reorganisation transactions, including those for which under current law no such condition exists.

• if the absorbing company is an intra-European company, the assets taken over are maintained within a Belgian branch of the absorbing company and contribute to profits and losses taken into account for tax purposes.

The new rules ensure full tax neutrality in that the – partial – taxation that could arise in particular on a parent-subsidiary merger is eliminated.

First, the parent company may re-constitute the tax-free reserves of the absorbed subsidiary. Under current law, these reserves were deemed distributed as a dividend and so considered taxable in the hands of the subsidiary. The re-constitution of these reserves by the parent company may occur through converting existing taxable reserves into tax-free reserves or, if not enough taxed reserves are present, by constituting – only for corporate tax purposes – an additional tax free reserve that has the nature of an advance on future profits. Further guidance from the tax authorities on the technicalities of these new concepts will be needed.

Secondly, the merger gain that the parent company may realise on its investment in the subsidiary will, although still considered a dividend, benefit from a 100% exemption.

For Belgian tax purposes, the non-Belgian assets transferred to a Belgian receiving company (for example, assets belonging to a foreign branch of the merged or divided company) will have a fiscal value equal to their book value at the time of the transaction. To calculate fiscal amortisation, depreciation or capital losses with respect to these non-Belgian assets, any pre-transaction (non-taxed) revaluation will be ignored. Consequently, an increased foreign branch loss that under domestic imputation rules would be deductible is avoided.

The non-Belgian assets will give rise to paid-in capital only to the extent that the intra-European merged or divided company disposed of paid-in capital as defined by Belgian rules (comprising, among others, certain issuance premiums that are assimilated to paid-in capital). The balance of equity will be considered taxed reserve, except for the tax-free reserves attached to a Belgian branch of the merged or divided intra-European company, which will keep their qualification of tax-free reserves.

Unlike the recognition of paid-in capital in the event of a cross-border merger or (partial) division, the non-Belgian assets transferred by an intra-European company to a Belgian company in the framework of a contribution of a branch of activity or of a universality of goods will give rise to an increase of paid-in share capital with the receiving Belgian company equal to the market value of the assets concerned.

With respect to Belgian branches of intra-European companies, the concept of capital allocation is introduced, which is very near to the concept of paid-in share capital of a Belgian resident company and may be defined as any form of equity financing provided by the foreign head office to its Belgian branch.

If a Belgian branch receives Belgian assets from an intra-European company as a consequence of a tax-neutral contribution of a branch of activity or of a universality of goods, the capital allocation will be increased with the net fiscal value of these assets.

In a cross-border merger or (partial) division of a Belgian company into an intra-European company, the taxed and tax-free reserves of the Belgian company will be taken into account as taxed and/or tax-free reserves within the Belgian branch of the absorbing intra-European company.

Upon subsequent integration of the branch in a Belgian company as a consequence of a cross-border merger with an intra-European company, the amount of capital allocation of the branch will be considered as paid-in share capital of the Belgian company.

Rather surprisingly, the draft bill comprises explicit rules dealing with the situation where a foreign company transfers its seat to Belgium to the effect that it becomes tax resident of Belgium. The tax consequences of this transaction are in line with those applicable to a merger where an intra-European company is absorbed by a Belgium resident company:

• The non-Belgian assets of the immigrating company will have a fiscal value equal to their book value at the time of the transfer of seat. Pre-transfer revaluations will be disregarded for amortisation, depreciation and loss calculation purposes (avoiding unjustified branch loss compensation).

• The company's paid-in capital recognised for Belgian tax purposes will be determined according to Belgian principles, the remaining equity being given the qualification of taxed reserve, be it that tax-free reserves attached to a Belgian branch of the immigrated company will keep their qualification of tax-free reserves.

An exemption from dividend withholding is also being introduced for distributions of taxed reserves originating from the immigration to non-resident shareholders who did not acquire the shares from Belgium resident individuals or Belgian non-profit organisations.

It is even more surprising that these rules are not restricted to immigrating intra-European companies, nor to companies resident of a tax treaty jurisdiction.

With respect to share-for-share exchanges, as defined in the Directive, the bill of law provides for a regime of tax neutrality. The new rules, however, will primarily affect individual shareholders. For companies there should in principle be no consequences as the domestic participation exemption continues to apply. The draft texts, which are at present proposed by the government, are not fully clear on this point.

The draft law provides for a new set of loss carry-over rules that apply to all kinds of tax-neutral reorganisations in a consistent way. In compliance with the Directive it will be possible, within the framework of a cross-border tax-neutral merger or (partial) division, to transfer tax losses carried forward from a Belgian branch or a Belgian company to the Belgian branch subsisting after the transaction, with the same pro rata limitation as currently applicable to domestic transactions. This limitation is based on the net fiscal value of the transferred assets, on the one hand, and of the receiving entity, on the other. It is now clearly provided for that in calculating this pro rata limitation only assets in Belgium have to be taken into account.

Where under current law tax losses of a foreign branch can be offset against Belgian profits without restriction, most tax treaties Belgium has concluded provide that this loss compensation is recaptured at the time the branch becomes profitable. The recapture principle entails that, to the extent this loss is compensated abroad with branch profit, the profit is not exempt in Belgium.

This recapture principle will now be integrated into Belgian domestic law. Also, the draft bill stipulates that upfront branch loss compensation will no longer be allowed, unless the taxpayer is able to prove that the loss has not been deducted from branch profit. This proof will have to be provided for the year the branch loss was incurred and for each subsequent year. Failing this proof for any year, the loss initially deducted will be added back to the Belgian taxable income. Lastly, the formerly deducted branch losses will also be added to the income if the branch is transferred within the framework of a merger or a division.

Expect more debate

It looks as though Belgian tax law is going to take a big step forward in implementing the merger directive. Although the intended modifications are generally speaking in line with the Directive, a lot of technical fine-tuning will surely be required to bring the new rules into practice.

The main concern raised by the draft bill of law relates to the proposed version of the anti-avoidance rule, which clearly goes beyond the scope of the anti-avoidance provision of the merger directive as clarified by the European Court of Justice in the Leur-Bloem case. This is likely to give rise to further debate and challenge.

Marc Tahon
		KPMG Tax & Legal Advisers Tel: +32 3 821 19 24 Fax: +32 3 825 38 38 Email: mtahon@kpmg.com Marc Tahon is a partner at KPMG Tax & Legal Advisers in Antwerp. Tahon holds a degree in law (University of Antwerp) and a special degree in fiscal sciences (Fiscale Hogeschool, Brussels). He is member of the Belgian Institute for Accountants and Tax Advisers (IAB) and of the International Fiscal Association (IFA). Tahon joined KPMG in 1977 and was admitted as a partner in 1985. During his almost 30-year career as a tax adviser, Tahon has gained extensive experience and expertise in matters such as financial structures, management buyouts, mergers and acquisitions, corporate reorganisations, both on a national and an international level. His sector expertise comprises pharmaceuticals, chemicals, industrial products, consumer products, and shipping and logistics. Tahon advises both foreign-based (US, UK, Germany and The Netherlands) and Belgium-based multinational groups on an ongoing basis as well as on special projects. Tahon is a lecturer at UAMS, the University of Antwerp Management School. He has published various articles on reorganisation issues. He is member of the KPMG Global M&A Tax Network and representative of Belgium at the KPMG European Tax Centre (ETC).

Marc De Muynck
		KPMG Tax & Legal Advisers Tel: +32 2 708 44 12 Fax: +32 2 708 44 44 Email: mdemuynck@kpmg.com Marc De Muynck is a director at KPMG Tax & Legal Advisers in Brussels. De Muynck received a master in law at the University of Ghent. He worked for nearly 10 years as a tax official at the litigation department of the central administration of direct taxes. He was responsible for organizing and preparing the defence of the Belgian state in tax litigation procedures. In 1987 he joined a law firm, where he was involved in the consulting practice related to cross-border tax planning. In 1996 De Muynck joined KPMG. His experience and expertise comprises particularly mergers and acquisitions, cross-border tax planning, and corporate and business tax consulting.