Report on a conference session at the 14th Annual IBA Finance & Capital Markets Tax Conference held in London on 21 January 2025

Session Chair

Jodi J Schwartz, Wachtell Lipton Rosen & Katz, New York

Panelists

Guillermo Canalejo, Uría Menéndez, Madrid

Pia Dorfmueller, Dentons, Frankfurt

Nina Kielman, NautaDutilh, Amsterdam

Gregory Price, Macfarlanes, London

Timothy S Shuman, McDermott Will & Emery, Washington, DC

Cesare Silvani, Maisto e Associati, Milan

Reporter

Antti Lehtimaja, Krogerus Attorneys, Helsinki

Introduction

Jodi J Schwartz started the session by introducing the panel and noting that the separation of businesses through the use of a demerger has been a trend in the United States in regard to multinational companies with multiple lines of business, due to the pressure from investors to simplify the business. Such separated businesses have either been made public or have been sold to third parties.

US group spin-offs

Structure

Timothy S Shuman presented a spin-off structure, where a US multinational group, with two business lines and a Dutch holding company in regard to the European operations, wishes to separate the two business lines. There are basically two ways to conduct the spin-off: either to distribute the stock through a subsidiary or to contribute the assets to a subsidiary and, thereafter, distribute the stock in the subsidiary (the presented structure is the latter). Such a spin-off is implemented from the bottom-up: the assets of various business lines in each country are contributed to separate subsidiaries and the stock of the subsidiaries is distributed to the Dutch holding company, which will contribute it to a Dutch holding company spin-off. The Dutch holding company will distribute the stock in the Dutch holding company spin-off to the US parent. Finally, the stock in the Dutch holding company spin-off is contributed to a US spin-off together with the corresponding US assets and stock of the US operative subsidiaries.

Tax considerations in various countries

Shuman noted that it is important that each internal transaction qualifies for the US tax-free spin-off rules, as otherwise any gain may be subject to the Subpart F regime or global intangible low-taxed income (GILTI) taxation. A key focus should be on the ‘five-year active business’ test and on the ‘purchased bases’ test. It should also be noted that for US tax purposes steps taken in the subsidiary jurisdictions may be recharacterised based on the substance-over-form approach regardless of the legal form of the business in the said jurisdictions. These steps could include, for eg, selling shares to the parent company followed by a cash distribution (circular cash flow), selling the bottom tier structure to the top followed by distribution of cash to the top tier (jump spin) or local brother–sister demergers.

Cesare Silvani pointed out that in Italy a local spin-off would be carried out through a statutory demerger rather than contributing assets to a subsidiary, followed by distributing the shares of the subsidiary to the Dutch holding company, as the distribution would not be fully tax exempt under the Italian participation exemption rules. The drawback in regard to this structure is the cross-liability between the surviving companies in the demerger.

Guillermo Canalejo noted that in addition to a tax-neutral demerger, or a taxable asset contribution/share distribution transaction, in Spain a ‘special contribution in kind’ is possible, in which the asset contribution will be tax exempt, provided that the acquiring company is a Spanish company, a requirement that may infringe EU rules.

Pia Dorfmueller noted that the transfer of shares in this context is not an issue in Germany since the participation exemption applies, but the transfer of an asset is, in general, a tax triggering event, unless a whole ‘business unit’ is transferred.  

Gregory Price pointed out that in the UK assets in the group can be moved between sister companies on a tax-neutral basis, but when these subsidiaries are spun out of the group, a tax will be triggered based on the market value, unless the UK participation exemption applies.

US group ‘flip-to-foreign’ spin-offs

Shuman considered an alternative scenario, where the US parent would like to use a non-US spin-off company to prepare the spin-off to a non-US group. The transfer of stock in the US subsidiary to the non-US spin-off company could trigger taxes based on the anti-inversion rules. Even if the anti-inversion rules are passed, a taxable gain would be recognised in the US in such circumstance. Another possibility is to execute a spin-off to a US spin-off company coupled with a (reverse triangular) merger with the US subsidiary of a non-US merger partner. However, this can also cause US taxes based on the anti-inversion rules in instances where strict rules concerning ownership thresholds in the merger partner are not followed.

Nina Kielman explained that in the Netherlands, Dutch corporate law does not provide for reverse triangular mergers, but there is a tried and tested structure that replicates a reverse triangular merger in order for a Dutch merger partner to acquire a US spin-off company. In regard to this structure, US spin-off company shareholders will ultimately receive Dutch merger partner shares in exchange for their US spin-off company shares through the Dutch merger partner, establishing a US merger subsidiary and merging that subsidiary with and into the US spin-off company, with a US spin-off company as the surviving corporation. In regard to the merger, the shares in the US merger subsidiary are cancelled, the existing US spin-off company shares are cancelled and, in exchange, the US spin-off company, as the surviving corporation, issues to an escrow agent, to account for and for the benefit of the former US spin-off company shareholders, a number of new shares, which are then contributed to the Dutch merger partner in exchange for the Dutch merger partner shares. The escrow agent subsequently delivers the Dutch merger partner shares to the former US spin-off company shareholders. Shuman noted that the potential US tax consequences of this utilisation of this type of structure depends on the applicability of the anti-inversion rules (the 80 per cent and 60 per cent ownership thresholds). Kielman added that in order for the Dutch participation to apply with respect to the US SpinCo shares acquired by the Dutch merger partner in the reverse triangular merger, it is important that the merger subsidiary meets the subject-to-tax requirement.

Shuman pointed out that even if the spin-off passes the anti-inversion test, its qualifying US tax-neutral status requires that the US spin-off company shareholders own at least 50 per cent of the non-US merger partner stock post-merger. On the other hand, in that case, the US shareholders will recognise a taxable gain. Spin-offs are probably the most common transactions wherein companies request a private letter ruling from the US Internal Revenue Service (IRS). There has been a significant change in these rules lately as the US government no longer grants rulings on certain ‘significant issues’ relating to such transactions rather than rulings on the entire transaction, including tightened procedural requirements in regard to such rulings. The transaction structure needs to be explained in detail in the application to the IRS. However, in many cases, the structure changes after the filing process is complete, which complicates matters. Canalejo pointed out that in Spain, the tax authorities no longer provide confirmation in regard to tax rulings as to whether a transaction has a proper business purpose (as opposed to being used for tax avoidance).

Dutch considerations in regard to cross-border spin-offs

General

Kielman noted that in the Netherlands, a transaction can be implemented as a contribution in kind for a share premium or in exchange for the issuance of new shares. Such a contribution in kind is a taxable event, unless the assets consist of shares in a subsidiary in respect of which the participation exemption applies. A transfer of assets in an intra-group situation is tax neutral if the companies involved are included in a fiscal unity (tax group) for Dutch tax purposes, which means that a transfer of assets within such fiscal unity is tax free. However, the anti-abuse rules limit the use of such fiscal unities. If the recipient subsidiary is transferred out of the fiscal unity within a certain period of time, generally six years, following the transfer of assets, the assets transferred to the subsidiary need to be revaluated according to the fair market value for tax purposes.

Another option for conducting a spin-off is a legal demerger, which may be tax neutral under certain conditions (one being that it is motivated by business reasons), but if the recipient company is sold within three years after the demerger, the transaction is considered abusive and, in principle, not tax neutral, unless the taxpayer successfully demonstrates that the demerger is not aimed at tax avoidance. From a corporate law point of view, a demerger may not always be the preferred option due to the cross-liabilities between the companies participating in the demerger.

When distributing the shares in a Dutch holding spin-off company to the US parent by the Dutch holding company, there is no corporate income tax applicable at the level of the Dutch holding company as a result of the participation exemption and no withholding tax is due in the Netherlands by the US parent company, assuming that the US parent company is actually a taxpayer in the US (not disregarded) and carrying on an active trade or business. One must also consider other tax consequences stemming from the transfer of assets, such as the application of value-added tax (VAT), transfer taxes, recapture tax facilities, the arm’s length principle and shareholder taxation.

Dutch ‘back-end’ transactions

Kielman presented a Dutch transaction structure, which is used in the Netherlands by buyers who hold a certain percentage interest in a Dutch target (generally at least 80 per cent), to acquire full ownership in the Dutch target company (for example after a public offer), a so-called pre-wired, pre-agreed back-end transaction.

During the first phase, the Dutch target incorporates a new Dutch subsidiary, the New TopCo, which incorporates another Dutch subsidiary, the New Merger Sub. After these steps, the Dutch target merges with and into the New Merger Sub. As a merger consideration, the New TopCo will issue new shares to the former Dutch target shareholders (the buyer and the minority owners) (a triangular merger). During the second phase, the New TopCo sells and transfers all the shares in the New Merger Sub to the buyer in consideration for cash and a loan note (asset sale). During the last phase, the New TopCo liquidates and distributes as an advance liquidation payment the cash component of the purchase price to the minority owners. The loan note is set-off against the buyer’s entitlement to the advance liquidation payment.

The transaction should not create any Dutch tax consequences, assuming the Dutch target is a pure holding company, holding shares in its operative subsidiaries. It should be noted that liquidation proceeds are subject to withholding tax for foreign minority shareholders, to the extent the liquidation distribution payable to the minority shareholders exceeds the fiscally recognised capital of the shares held by the minority shareholders in the liquidated company.

German tax considerations in terms of cross-border spin-offs

Dorfmueller commented on a German court ruling in the Kraft Food case (Federal Tax Court, 19 October 2021 (VIII R 7/20)), wherein a German shareholder owned shares as ‘private assets’ in the US company Kraft Food Inc. Kraft Food contributed its food business to a new company (Kraft Food Group Inc.) against shares in the new company and then distributed the shares of the new company to its shareholders, with a ratio of three/one, without capital reduction. The Court found that the fair market value of the new company shares was, in the first place, deemed to be a capital gain rather than a capital reduction, but since the transaction fell under the tax-neutral US spin-off rules, which were in general comparable to the German spin-off provisions, it did not, considering EU laws, trigger the application of any German taxes.

When US shares are held as business assets, the treatment is different. Considering a structure with a German entity holding a US spin-off target (a US holding company) through a Dutch holding company, direct comparability of the US transaction is required in regard to the German qualified demerger. Since a US spin-off is generally a contribution of assets to a subsidiary, followed by distribution of the shares in the subsidiary, whereas a German demerger consists of the transfer of assets by way of universal succession to the recipient company, which issues its shares to the shareholders of the transferring entity, these two structures are not comparable. Therefore, as there is no exemption available for the whole transaction, one must analyse the potential German tax consequences of the individual steps in the transaction. In regard to the contribution of assets step, the German shareholder may need to report controlled foreign company (CFC) income if the assets transferred are ‘passive assets’. It would be advisable to issue shares in the new company to avoid ‘hidden contribution’ taxation in Germany. In regard to the distribution of the new company shares to the Dutch holding company, it must be considered whether such distribution qualifies, for German CFC purposes, as a disposal of the shares (without any remuneration) or a deemed dividend distribution at the level of the US holding company and the Dutch holding company.

There is the possibility to ask for an advance ruling in Germany, but in practice it does not make sense to ask for a ruling as to whether a transaction constitutes tax avoidance. In regard to spin-off transactions, one should rather ask whether a certain exemption in the German tax law would be applicable for the transaction at hand. Each taxpayer needs to apply for their own ruling (or provide power of attorney for another party to make the application).

UK tax consequences of cross-border spin-offs

Price noted that there is a statutory demerger regime in the UK, but its use is becoming less common in regard to spin-off structures. The reason for this is that the restrictions in terms of those rules (eg, the need to have two distinct separate business lines in the group, the need to have a business purpose and for there not to be a change of control) are quite strict. Instead, what companies tend to do is spin-off the business assets to an outside group spin-off company that issues shares directly to the shareholders of the transferring company. On the shareholder level, one must note that the capital gain tax rate is 24 per cent, while the highest dividend tax rate is 40 per cent, so any structuring will need to focus on designing a transaction that is treated as a capital event rather than giving rise to dividend income.

There are various ways to implement a spin-off, but one would want to avoid alternatives that create dry unfunded tax charges for the shareholders: one can establish a spin-off company and transfer assets to the spin-off company, but this will likely be a taxable event for shareholders, unless further steps are taken to achieve a tax-neutral transaction. Alternatively, one can either implement a statutory demerger tax neutrally, liquidate the UK parent company or have the UK parent company distribute assets to the shareholders as a form of capital reduction. Neither liquidation proceeds nor capital reductions are deemed to be income distribution for UK tax purposes. When returning capital to shareholders one must be able to trace the original acquisition/subscription price for the shares owned in order to obtain tax-free treatment. If there is insufficient capital paid up on the shares, one can add a new holding company on top of the parent company to obtain a step-up in the acquisition cost. After demerging the parent, the shares of the demerged companies will be distributed as a capital reduction in terms of the new holding company.

For group structuring purposes in the UK, a separate investment portfolio subgroup can be used to support the capital needs of trading subgroups, as capital can be tax neutrally distributed from the investment portfolio and contributed to the trading subgroups. In the case of a private group, the balance between the values of the investment portfolio subgroup and the trading subgroups may have a significant effect on the inheritance tax at the shareholder level (because companies that derive most of their value from trading activities are treated more favourably). Any spin-off of the trading subgroups, carried out to make sure that the €750m threshold is not surpassed in regard to the applicability of the Organisation for Economic Co-operation and Development’s Pillar Two rules, may on the other hand have an effect on the applicability of the ‘business relief’ in terms of the UK inheritance tax on the shares of the remaining group parent company.

Spanish tax consequences of cross-border spin-offs

Canalejo noted that in Spain you can implement a tax-neutral cross-border spin-off as a ‘total spin-off’ through a full demerger, meaning that the assets of the transferring Spanish entity will be allocated to non-Spanish entities, or as a ‘partial spin-off’ through a partial demerger in which at least one branch of activity is allocated to a non-Spanish acquiring entity and as long as the transferring Spanish company retains at least one branch of activity. The definition of ‘branch of activity’ is a key issue, it can consist of a controlling stake in an operative company or assets in a certain business branch within the transferring company, for eg, two hotels operated by the same company constitutes one branch of a business and cannot be separated through a partial demerger. In a full demerger, one must allocate the share of the acquiring entities in the same proportion to the shareholders of the transferring entity, unless one transfers branches of activity to the acquiring entities, in which case one can make an exception and distribute the shares disproportionally to the shareholders of the transferring entity (this exception is questionable in regard to the EU Merger Directive, Council Directive 2009/133/EC).

To prevent income taxes on spin-off transactions, the latter should qualify as a ‘corporate restructuring’ or, at least, an undue tax advantage should be sought. In a cross-border setting, this may be challenging due to the wording of the ‘corporate restructuring’ definition and, for this reason, a tax ruling has been obtained frequently in such circumstances. EU resident shareholders’ tax in regard to the spin-off is rolled over, but the deferred capital gain tax can be levied if the shareholders migrate out of the EU. Tax credits and losses are transferrable in regard to a qualifying spin-off. There is also an anti-abuse rule relating to full and partial demergers: one needs to be able to prove that the tax-neutral transaction, even if based on valid economic business reasons, does not primarily relate to the obtaining of a tax advantage. Although there have been a number of rulings issued by the Spanish tax courts this year, the interpretation of the concept is still not certain as it cannot be clarified in advance by the tax authorities through such rulings. Finally, if the application of the tax-neutral regime is denied because the restructuring was primarily motivated by an undue tax advantage, then the taxes due would be assessed based on the relevant taxpayers.

Italian tax consequences of cross-border spin-offs

Silvani presented a structure according to which a Dutch company with an Italian permanent establishment (PE) spun-off its Italian business either through a contribution in kind or a legal demerger.

Contributing the PE’s assets to an Italian new company is a tax-neutral transaction covered by the EU Merger Directive. However, as the transaction is not a universal succession, the fiscal unit between the Italian PE and its Italian subsidiaries will not survive. In addition, any existing tax losses at the level of the Italian PE cannot be pushed down to the new company. Finally, tax-deferred reserves (originating from the profits in past years when a special corporate tax exemption applied) will not survive either as the PE no longer exists, which is a showstopper for some sizable Italian PEs originating from former Italian companies. The shares in the new company must be issued to a PE of the Dutch company and if the PE is closed afterwards, this will trigger tax leakage in the form of exit taxation, as Italy does not provide a full participation exemption.

An alternative way to conduct the spin-off is through a legal demerger by contributing assets into a new company against shares in a new company to be issued to the transferring company. This is a new form of transaction (division by separation) enabled by the 2019 amendment to the EU Company Law Directive (Directive (EU) 2017/1132). In regard to this form of transaction, the Italian tax rules on demergers are generally applied, so the fiscal unit between the PE and its Italian subsidiaries can survive (as there is universal succession). As the shares are issued directly to the (head office of the) transferring Dutch company itself, the transaction will not be subject to exit taxation (assuming the Dutch company is resident in an EU Member State). However, in regard to this form of transaction, although it is more tax efficient than the contribution of assets, the tax-deferred reserves of the transferring company/PE cannot be pushed down to the acquiring company (the new spin-off company) and the problem of cross-liability with the transferring company still exists.