Merger gain can be covered by Parent-Subsidiary Directive
CJEU rules in Punch Graphix case that a merger by acquisition does not constitute a liquidation and so can be covered by Parent-Subsidiary Directive
On 18 October 2012, the Court of Justice of the European Union (CJEU) issued its decision in the Punch Graphix Prepress Belgium NV case (C-371/11). The CJEU confirmed that a dissolution as part of a merger by acquisition does not constitute the liquidation of the absorbed company. As a result, the capital gain arising is regarded as a dividend and so can be covered by the Parent-Subsidiary Directive.
Under Belgian company law, a merger by acquisition is regarded as the dissolution of a company without a liquidation, followed by the transfer of all its assets and liabilities in exchange for shares (and possibly a limited cash payment).
However, Belgian domestic tax law deems a merger by acquisition to constitute a liquidation of the absorbed company to the extent that no new shares are issued to the shareholders (as is the case in a simple parent-subsidiary merger).
The Parent-Subsidiary Directive applies to profit distributions from a subsidiary to its parent company, except where the subsidiary is liquidated. In such a situation, a distribution from the subsidiary is treated as a liquidation surplus in the hands of the parent company.
In the case of a parent-subsidiary merger, where the book value of the subsidiary is less than the corresponding equity investment, then a ‘merger capital gain’ arises on the parent company. This gain may then be eligible for a dividends received deduction (DRD) of up to 100%. (This 100% relief was introduced in 2008 for deemed distributions arising on parent-subsidiary mergers between Belgian companies and other EU or Belgian companies in order to align domestic law with the Merger Directive. DRD for regular dividends is limited to 95%).
In the case at hand, DRD was applied to the merger capital gain but, as the gain in the absorbing parent company was insufficient to utilize the whole of the DRD, the excess was lost.
The company claimed that the loss of the excess DRD was incompatible with the Parent-Subsidiary Directive. This claim was rejected by the tax authorities and, later on, by the Court of First Instance of Bruges, which ruled that such a liquidation is not covered by the Directive. The Court of Appeal of Ghent subsequently sent a request for a preliminary ruling to the CJEU to determine whether this is the case.
The CJEU recognized that the Parent-Subsidiary Directive does not define the concept of liquidation, but it referred to the Merger Directive which defines a merger as an operation whereby a company, on being dissolved without going into liquidation, transfers all its assets and liabilities to the company holding all the securities representing its capital.
The CJEU held that, as these two directives complement each other they should be regarded as a whole, and so the definition of a merger in the Merger Directive can be used for the purpose of interpreting the concept of a liquidation in the Parent-Subsidiary Directive. This meant that the dissolution of a company in the context of a merger by acquisition cannot be considered to be a liquidation.
As a result, a merger capital gain should be covered by the Parent-Subsidiary Directive so that the resulting DRD applies and any excess DRD must be carried forward.
It is welcome news that the CJEU has confirmed the Parent-Subsidiary Directive applies to tax-neutral mergers whereby companies are dissolved without being liquidated, regardless of whether domestic tax law regards such a merger as constituting a liquidation.
It is perhaps surprising, though, that the Court of Appeal did not ask the CJEU to rule on the compatibility of the tax treatment of the merger capital gain with the Merger Directive, as this would have been another approach to resolving the problem. According to this directive, any gains made by an absorbing parent company on the cancellation of a participation in the absorbed subsidiary should not in any case be liable to taxation.
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