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Valid economic rationale and concept of ‘tax advantage’ in corporate restructurings. TEAC Rulings 6448/2022 and 6452/2022
Corporate restructurings are a practice widely used by business groups for various reasons, among others, because all economic activity must be structured in an efficient, orderly manner and with properly managed resources in order to correctly analyse the profitability of each line of business, as well as to enhance such profitability, without any of them contaminating the others.
It is also a good measure to protect personal assets from the risks of business activity, and to safeguard against liabilities that may arise from the exercise of different activities.
In accordance with the provisions of Chapter VII of Title VII of the Corporate Income Tax Law, restructuring operations are those that meet the definition of merger, spin-off, contribution of assets or exchange of securities (FEAC). In other words, commercial operations aimed at modifying, dividing or simplifying corporate structures within the framework of a group of companies, depending on the objective pursued by the group.
As is well known, such operations, provided they comply with the legally established conditions, enjoy a special tax regime, the main objective of which is to neutralise their taxation, in order to prevent the entrepreneur from being fiscally penalised when restructuring the business organisation, in such a way that the tax burden prevents the development and continuity of the economic activity.
That said, it is sometimes difficult to maintain compliance with the requirements that must be met in order to qualify for the application of the scheme.
Without going into a detailed analysis of each of the requirements, it is true that the one most questioned by the Tax Administration, and the one that causes most conflict between the Administration and the taxpayer, is that it conditions the application of the regime to the concurrence of ‘valid economic reasons’.
WHAT IS A ‘VALID ECONOMIC REASON’ IN CORPORATE RESTRUCTURINGS?
This concept, a requirement for access to the FEAC tax neutrality regime, is the source of numerous tax consultations, and the fact is that it is configured on the basis of each factual assumption underlying each restructuring operation, and must be analysed and assessed on the basis of the specific circumstances.
Recently, this matter has once again gained importance, following the issuance, on 22 April, of resolutions 6448/2022 and 6452/2022 of the Central Economic Administrative Court, as we will now comment.
Article 89 of the Corporate Income Tax Act provides, in its second paragraph, that the special FEAC scheme does not apply when the transaction is not carried out for valid economic reasons. In other words, when the main purpose of the transaction is tax evasion or avoidance.
It establishes as an example of a valid economic motive ‘the restructuring or rationalisation of the activities of the entities involved in the transaction’. In short, it provides that the scheme will not apply where the transaction is carried out for the sole purpose of obtaining a tax advantage.
The aforementioned provision goes on to state that, in the event that the Administration determines the total or partial inapplication of the special tax regime for the aforementioned reasons, only the effects of the tax advantage will be eliminated, as we will see below.
HOW DOES TEAC ANALYSE THE VALIDITY OF THE ECONOMIC RATIONALE OF A CORPORATE RESTRUCTURING?
In this context, the abovementioned TEAC rulings analyse the case of a restructuring carried out by means of the contribution of shares to a holding company by the individual shareholders, a transaction which was covered by the special scheme on various economic grounds. These reasons are listed below for information and clarification purposes (note that these are reasons that are apparent in most restructuring operations that take place within the framework of business groups, mainly family groups):
- Separation of personal assets from business assets and limitation of liability for damages
- Simplification of the company structure
- Centralising decision-making in the management of shareholdings in a single company
- Centralising business investments in a single company
- Channelling the profits distributed by the beneficiary companies into this company in order to finance new investments.
- Centralising treasury
- Strengthening the financial capacity of the holding company
- Facilitating the implementation of family protocols in a simple and efficient way for inheritance succession.
With an extensive and detailed argumentation, the TEAC rejects each and every one of the reasons argued by the taxpayer to avail himself of the special tax regime, stating that none of them can be considered a valid economic reason, and that the main objective is very different from the previous ones, and is none other than obtaining a tax advantage.
In the Court’s opinion, none of the events that took place after the restructuring corroborate the fact that there was no economic or organisational advantage whatsoever, and the objectives proposed by the partners in the statement of reasons that led them to carry out the operation, initially considered valid by the DGT, but undermined and invalidated by the TEAC in the light of subsequent events, have not taken place.
Mainly, in the opinion of the TEAC, it is the case that: none of the economic advantages pursued with the operation have occurred, since the operation of the partners has not changed, apart from having an intermediary company, in which a huge distribution of dividends has been made, which had not been made until that date, when the partners were natural persons. Furthermore, it is emphasised, as a reason for exclusion, that the dividends distributed were not reinvested in the economic activity, but mainly in non-affiliated assets, as well as to cover the personal expenses of the partners.
These TEAC rulings are of particular importance for two reasons:
The taxpayer consulted the Directorate General of Taxes (DGT) prior to the restructuring, obtaining the approval of the DGT, which considered the proposed reasons to be economically valid. Even so, the TEAC rejected them on the basis of subsequent events which, in the opinion of both the Inspectorate and the TEAC, were not foreseen or raised in the consultation.
This warns us that the actions carried out in periods subsequent to the restructuring are, if possible, of greater importance than the actual implementation of the restructuring itself. Not only must the requirements be met at the time the operation is carried out, but in order to benefit from the applicable regime without any surprises, the continuity of compliance must be reviewed, and it must be corroborated, with subsequent actions, that the objectives that led to the execution of the operation are maintained, and that the aim was not only to obtain a tax advantage.
WHAT IS THE TAX ADVANTAGE OBTAINED IN CORPORATE RESTRUCTURINGS UNDER THE TEAC RULINGS?
According to the TEAC, the tax advantage obtained is the distribution of dividends from results prior to the restructuring at no tax cost, since at the holding company’s headquarters, such dividends are exempt at 95%, whereas, as the shareholders are individuals, such distribution of dividends would be subject to personal income tax as part of the savings base without the right to any exemption, and would be taxed at a rate of 23%.
HOW DOES THE TEAC REGULARISE, IN A UNIFICATION OF DOCTRINE, THE TAX ADVANTAGE OBTAINED IN CORPORATE RESTRUCTURINGS?
Secondly, it is important to note the treatment given by the TEAC to the regularisation to be carried out in order to eliminate the effects of the tax advantage sought and obtained by the taxpayer with the restructuring carried out.
Thus, it establishes that, since the tax advantage is the receipt of dividends at the headquarters of the holding company, without taxation, the regularisation of that advantage must be produced by integrating the capital gain that was deferred as a result of the application of the special tax regime; however, only in respect of the dividends distributed from profits prior to the restructuring, and to the extent that these are received by the holding company.
Consequently, the deferral obtained in the transaction will be taxed to the extent that the profits accrued at the time of the contribution are received by the holding company (applying a sort of analogy with Article 14.2.d) of the Personal Income Tax Act, which regulates instalment transactions) according to that availability.
This, on the one hand, mitigates the negative effect of a complete regularisation in the event of inapplicability of the regime, since this will be carried out only to the extent that the undistributed profits are available at the time of the operation. However, a strong pronouncement is still pending to clarify the calculation of the limitation period of the Administration’s right to liquidate, in these cases in which the deferred profit must be integrated according to the availability of the profits by the new holding company (and until when?).
In addition to the legal uncertainty arising from the practical inapplicability of Article 21 of the Corporate Income Tax Act (regulating the exemption for the receipt of dividends) in the context of a corporate restructuring under the special FEAC regime.
In conclusion, apart from our professional opinion regarding the rulings mentioned in this article, we strongly recommend that, in addition to properly planning the restructuring operations that may be convenient and necessary for any business group, special care and monitoring should be taken to ensure that the requirements are met and that each and every one of the transactions carried out at the headquarters of the group and its members is adequately justified economically. The application of the tax regime, as we have seen, does not end with the execution of the operation; on the contrary, it requires a continuous exercise of review and coherence to avoid the undesired consequences of a possible subsequent regularisation.
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