When effecting a merger between two companies, advisers should consider the EU Merger Directive (Council Directive 2009/133/EC) alongside more traditional methods. The Directive is potentially suitable both for merging two independent groups of companies and also for tidying up surplus subsidiaries within a group. In order to fall within the Directive, the transaction must involve companies resident in at least two different EU member states; the companies must be of the type on the approved list; and where relevant the parent company must hold all the subsidiary’s capital. Potential procedural complexities mean that the EU merger route will not always be appropriate, but it remains a useful addition to the adviser’s toolbox.
UK tax advisers do not come across EU style mergers involving UK companies very often. Whilst the relevant domestic legislation was enacted in 2007, this is still not the usual way to structure such transactions. By comparison, our colleagues in continental Europe are very used to effecting transactions this way. Are we missing a trick in the UK, or should we stick to the form of transactions with which we are more familiar?
In particular, what questions should we ask to see if this procedure is suitable for a proposed transaction?
A merger for the purposes of the Directive includes a transaction under which:
a) a company transfers all its assets and liabilities to another existing company in exchange for the issue to its shareholders of securities representing the capital of that other company;
b) two companies transfer all their assets and liabilities to a company that they form, in exchange for the issue to their shareholders of securities representing the capital of that new company; or
c) a company transfers all its assets and liabilities to the company holding all the securities representing its capital.
The Directive is therefore potentially suitable, for example, both for merging two independent groups of companies and also for tidying up surplus subsidiaries within a group.
In each case, the relevant transferor companies are dissolved without going into liquidation. The Directive potentially limits any cash consideration in (a) and (b) to 10% of the nominal value of the consideration securities, but the UK has chosen not to impose this 10% limit.
Is your transaction cross-border within the EU?
In order to fall within the Directive, the transaction must involve companies resident in at least two different EU member states.
Do you have the right sort of company?
The companies need not only to be tax resident in different EU member states, but must also be on the approved list of types of company for which the procedure is available. This means that the companies need to be incorporated in an EU member state. Some common corporate entities not included on this list include, for example, Dutch co-ops.
Due to drafting ambiguities in the UK cross-border merger regulations (The Companies (Cross-Border Mergers) Regulations, SI 2007/2974), there is some uncertainty as to whether the UK regime may be used for mergers involving a newly incorporated transferee company.
This is because of the reference in the UK regulations to ‘existing transferee company’ in the requirements for mergers of the types described in (a) and (c) above. In Re Itau [2012] EWHC 1783 (Ch), the UK High Court decided that the words ‘existing transferee company’ did not prevent the use of a newly incorporated transferee, but company lawyers can be nervous about relying on this decision.
Does the company have ordinary share capital?
In the context of a merger of a subsidiary with its parent company, the Directive requires the parent company to hold all the securities representing the subsidiary’s capital. This has been enacted into the UK tax provisions as a requirement that the parent owns the whole of the ordinary share capital in the subsidiary. The use of ‘ordinary share capital’, rather than ‘issued share capital’, does seem a little surprising (the UK company law regulations refer to all ‘the shares or other securities representing its capital’). Problems may also arise if the subsidiary is a corporate entity that does not issue securities that constitute ‘ordinary share capital’.
Why are special UK tax rules required?
In many cases, special UK tax rules are not required. For example, where a non-UK company transfers its non-UK assets and liabilities to a UK company in exchange for the issue of shares to the transferor shareholders, there may be no material UK tax implications for the transferor and any UK shareholders should be able to rely on TCGA 1992 s 136 to avoid a capital gain.
However, special tax rules are required for a UK resident parent company on the merger of a subsidiary into the parent company, because it needs to rely on TCGA 1992 s 140GA to avoid there being a CGT charge in respect of its shares in the subsidiary on the dissolution of the subsidiary.
Special tax rules are also necessary in certain circumstances when the transferor company is UK resident, because TCGA 1992 s 139 applies only to transfers between two UK resident companies, or where the assets relate to a business carried on in the UK, and so will remain within the charge to UK tax. TCGA 1992 s 140F therefore applies for other business transfers, by calculating the ‘single chargeable gain’ accruing on all the chargeable assets transferred. Credit is then given against this single gain for notional double tax relief, calculated as the tax payable (or which would have been payable in the absence of the Directive) in the EU member state in which the business is situated.
It may also be necessary for shareholders to rely on TCGA 1992 s 140G, which deems the merger to be a scheme of reconstruction for the purposes of s 136 if this would not otherwise be the case.
So a merger under the Directive might not be free of UK tax?
Whilst a transaction falling within the Directive should be tax free for shareholders and the transferee company, it is not necessarily tax free for the transferor company. As stated above, there may be a UK tax charge under s 140F where a UK company transfers a non-UK business. In addition, where s 139 is not in point, a UK transferor company would need to rely on the substantial shareholding exemption in relation to transfers of any subsidiary companies.
Stamp taxes may also be chargeable, to the extent that any of the assets transferred are chargeable securities, land or other stampable assets, unless it can be argued that no such taxes are payable as the transfer is effected by operation of law and/or there is no agreement to transfer the relevant assets. Even if stamp taxes are payable, however, there may be significantly less stamp taxes than might be payable on an acquisition of a UK-headed group, particularly given the changes announced in the Autumn Statement that will prevent the use of a cancellation scheme in this situation.
There are also some other differences between the UK tax rules and the Directive. For example, the UK company law rules implementing the Directive can also apply to a merger between a UK company and a company in the wider EEA. The UK tax provisions have not, however, been so extended. This means that certain mergers effected in the UK under the Directive company law procedure would not have the benefit of the relevant tax provisions.
The way that the Directive has been enacted into UK domestic law potentially creates other more subtle differences. For example, whilst the Directive requires the issue of ‘securities’ by the transferee to the transferor’s shareholders and the UK company law regulations require the issue of ‘shares or other securities’, the UK tax provisions require the issue of ‘shares or debentures’. It is by no means clear what purpose is served by using different terminology, but it is a potential booby trap, particularly given that these terms need to be applied to a wide range of different types of corporate entity.
Are either of the entities transparent for UK tax purposes?
Special UK tax rules apply for entities that, although specified in the Directive, are transparent for UK tax purposes. The UK has opted out of the Directive in respect of such entities, and instead provides for notional double tax relief (broadly along the lines of that described above in relation to s 140F), in respect of a transparent transferor or, in the case of the tax treatment of shareholders, a transparent transferee.
How long will the merger take?
This procedure is based on civil law and is therefore not a familiar one for UK company law purposes. The UK has also chosen to ‘gold-plate’ its procedure for effecting an EU-style merger, in places imposing longer timetables or additional meetings. The result of all this is that the UK procedure involves a number of court hearings, and the overall UK timetable can be a little longer than in some member states. It is sensible to allow at least four to five months for implementing a merger involving the UK.
There are also potential procedural complexities. The UK has added the ability of creditors to ask the court to hold a creditors’ meeting if they can show material prejudice. The UK also requires an independent expert’s report to be drawn up in relation to the proposed merger, although this requirement can be dispensed with in the case of a merger involving the absorption of a wholly owned subsidiary or by the unanimous agreement of every member of every merging company. The independent expert would report on matters such as the methods used to arrive at the share exchange ratio and would be required to give an opinion on whether the methods used, and the share exchange ratio itself, are reasonable.
Why do you need to go to court?
The UK does not have an equivalent of the civil law notary, so it is necessary to use the court (in a similar way to its involvement in court schemes) to validate the procedure.
This is a useful addition to the lawyer’s toolbox, but in many cases it may be simpler to rely on a more tried and tested structure. For example, the conditions and timetable to effect the merger of a subsidiary company into its parent looks to be rather tortuous, particularly if the shareholding in the subsidiary concerned qualifies for the substantial shareholdings exemption (SSE). Even if the SSE does not apply, it will often be more straightforward simply to pay up distributable reserves as a dividend and then liquidate the company. Similarly, a takeover effected by way of an offer may well be more straightforward than one effected as an EU style merger.
Having said that, there are advantages in using this procedure for cross-border transactions and advisers should not be afraid of proposing it in appropriate circumstances.
