Newsletter no 2/2010 - Tax

Publisert: 2010-02-09 11:23

On 18 January, the Ministry of Finance recently presented a consultation paper regarding changes in the Norwegian Tax Act with respect to various forms of reorganisations, including mergers and demergers, which will influence both national and international reorganisations subject to the Norwegian Tax Act.

In broad terms, the Ministry’s proposal implies that the tax rules for reorganisations will become both simpler and more predictable, by inter alia, allowing mergers and demergers for tax purposes between Norwegian and foreign entities incorporated within the EEA. However, at the same time, the Ministry proposes to extend the tax authority’s right to deny utilisation of tax positions in tax-motivated transactions.

The deadline for submitting comments is 1 June 2010. The formal proposal for legislative amendments to the Tax Act may be expected in connection with the presentation of the national budget in October 2010, at the earliest.

Set out below is a brief account of the most important amendment proposals.

Mergers and demergers – abolition of the legality requirement

In order to implement a merger or a demerger without tax implications pursuant to the provisions in Chapter 11 of the Tax Act (with so-called tax continuity), there is currently a requirement that the transaction must be legally implemented pursuant to rules pertaining both to company law and accounting law (the legality requirement). Hence, a mistake made with respect to either of these rather comprehensive sets of rules, would in principle make the merger or demerger taxable, resulting in taxation of both the transferor company and its shareholders. In practice, the Ministry has stated that the tax authorities should not revoke the tax exemption if the error is insignificant and of a more procedural nature, but the borderline has not been quite clear. Under the current rules, the transferor company and its shareholders also risk that the tax authorities revoke the tax exemption up to 10 years after the year the merger or demerger was completed. Hence, the parties may for several years be exposed to a substantial tax risk.

In the consultation paper, the Ministry proposes that the legality requirement is abolished. This will most likely imply that the tax exemption will only be denied if the merger/demerger is deemed to be invalid under the Company Act or if registration with the Register of Business Enterprises is denied. As for the accounting rules, the tax exemption will no longer be influenced by potential errors regarding how the merger or demerger is carried out from an accounting perspective.

The proposal is substantiated by the fact that the Ministry considers that the necessary terms for tax exemption already follow from other provisions of the Tax Act. Should these amendments be adopted (which there is reason to believe), this will entail a far better predictability for Norwegian tax residents involved in a merger or demerger. Hence, this proposal is highly welcome and will represent a desirable clarification of the conditions for a merger/demerger to be tax exempt.

Cross-border reorganisation – implementation of current tax relief practice

Currently, tax exempt mergers and demergers can only be carried out between Norwegian entities. If a Norwegian company is to merge into a foreign company, the Norwegian company and its shareholders must apply for a tax relief by the Ministry of Finance. Provided that the assets of the Norwegian entity are transferred to a Norwegian branch of the acquiring company, such relief is normally granted. However, the application must be submitted prior to the merger, and the merger cannot be completed before the relief is granted. Hence, this has been both a comprehensive and time-consuming process.

In order to ensure that Norway complies with its obligations pursuant to the EEA agreement, and to arrange for tax exempt implementations of international transactions without having to apply to the Ministry for tax relief, the Ministry proposes to codify that the following cross-border reorganisations, subject to certain terms and conditions, shall be tax exempt:

• Mergers and demergers of private limited companies or public limited companies with one or more similar companies resident within the EEA. If the Norwegian company is the transferor company, assets, rights and liabilities of this company must be transferred with tax continuity to a branch in Norway of the acquiring (foreign) company.
• Transfer of all shares in a Norwegian private limited company or public limited company to one or more foreign companies resident in a high-tax country outside of EEA, with shares in the foreign company as contribution (exchange of shares).
• Mergers and demergers, as well as exchange of shares, by foreign companies with Norwegian shareholders. If the transferor company has a branch in Norway, tax exemption is conditional upon the acquiring company continuing the transferor company’s business activities in a branch in Norway.
• Conversion of a foreign branch of a Norwegian company to a company with limited liability in the same country, provided that the newly established company does not become resident in a low-tax country outside of the EEA.
• Conversion of a Norwegian branch of a foreign company to a Norwegian limited company.
• Incorporation of an SE company or an SCE enterprise through a merger. If the Norwegian company is the transferor company in the merger, the company’s assets, rights and liabilities must be continued with tax continuity in a branch in Norway of the SE company/the SCE-enterprise.
• Relocation of the head office and commercial office of an SE company and an SCE enterprise to another EEA country.

The proposal implies that Norwegian companies wishing to be part of a tax neutral cross-border reorganisation, no longer will have to apply for tax relief to the Ministry of Finance. In addition to saving time and costs, the proposal will represent increased certainty for companies involved in cross-border reorganisations. Again, it is fair to say that the proposal is highly welcome.

Substance over form – extended scope for section 14-90 of the Tax Act

In a regular merger or demerger, tax positions (such as carry-forward losses or unrecognised gains in the so-called profit and loss account where only 20% of the remaining balance is recognised each year) will normally be transferred to the acquiring company. Furthermore, Norway does not have any general rules denying or reducing carry forward losses if the shares in a company are transferred.

In order to avoid sale of tax positions disguised as a share sale, merger or demerger, Norway has, in addition to a general substance over form doctrine, a special provision in the tax act to prevent such transactions. Section 14-90 of the Norwegian Tax Act provides that tax positions transferred in connection with a merger, demerger or share sale shall be precluded if it is likely that exploitation of the tax position is "the predominant motive for the transaction". Thus, the transaction will not be set aside as such and may still be entitled to the tax exemption, but the relevant tax position(s) in the transferor or target company will either be lost (carry-forward losses) or will become due (unrecognised gain in the profit and loss account). A typical case may be the merging of a company with no significant assets, but which has a substantial carry-forward loss. In such a case, the carry-forward loss of the transferor company will be lost in the merger.

The Ministry proposes to extend the scope of this provision. Firstly, it is proposed that the provision shall not only apply to mergers, demergers and share transactions, but to any reorganisation. It is further proposed to introduce a requirement for continuity in terms of business activities. The activity requirement implies that the tax position will be precluded if no activities are conducted in the transferor or target company both prior to and subsequent to the transaction. The activity must be continued in terms of nature and extent. Exemptions from the activity requirement are on certain conditions proposed for holding companies and other companies without separate business activities, as well as for demergers where it is sufficient that the business activity is continued in at least one of the demerged companies.

The introduction of an activity requirement is likely to represent a new area of uncertainty and discussions with the tax authorities. The Ministry of Finance accepts that the proposed language will raise issues as to what level of activity is required and for how long a period the activity must be carried out (both prior to and after the reorganisation). We believe this requirement will create new uncertainty and hope that the Ministry of Finance will give this a second thought.

Conversion – extension of the scope for tax-exempt conversions

The consultation paper also includes certain suggestions for extending the scope for tax-exempt conversions between different types of business entities. However, as this will mainly be relevant for Norwegian entities, we will not further elaborate this issue.

Application for tax relief – curtailment of the current provision on tax relief

Pursuant to § 11-22 of the Norwegian Tax Act the Ministry may, upon specific application, consent to exemption from realisation taxation at a conversion of an entity. The warrant for exemption has been frequently applied in practice.

Based on the proposals in the consultation paper, the Ministry believes that the need for individual applications for tax relief will be substantially reduced. The Ministry nevertheless proposes to uphold the possibility of applying for tax relief in individual cases, but proposes to tighten the current practise. Pursuant to the proposal, tax relief shall be limited to cases in which the general rules on tax exemption are not applicable, and there are significant financial concerns as well as weighty regards for equal treatment with respect to taxation.

Considering that a substantial number of relevant tax relief applications no longer will be necessary, this change will probably have a more limited effect. However, as the number of applications will be dramatically reduced, we do not fully see the rationale for increasing the threshold to grant tax relief for transactions which, for some reason or the other, are not comprised by the rules as such.