The European Merger Directive 90/434/EEC provides for a tax deferral regime for reorganisations taking the form of a merger, a division or a transfer of business in exchange for shares issued by the recipient company. In legal terms, this is a “a contribution in kind”.
Most of the EU member states have implemented the Merger Directive in their domestic law. This regime allows cross-border reorganisations to be achieved without any capital gains tax liabilities resulting from the businesses transfer. The regime is also applied to domestic reorganisations.
However, in the case of Brexit transfers, UK companies have been reluctant to use these applicable forms of transfers, opting for simplified ways of transferring employees. Valuation of the business in question is a key issue. UK groups find it difficult to assess any goodwill attached to the activities being transferred, even though the business activities were profitable.
Two main arguments are put forward. First, Brexit means it is no longer possible for a UK-regulated company to perform its activity from the UK, due to the loss of the licence required to operate throughout the EU. For this reason, the activity to be transferred cannot be considered to be valuable.
Second, clients cannot be considered to be specifically attached to any company or local branch of the UK group. Converting a UK company’s local branch into an EU company’s branch in the same group should therefore not be regarded as transferring any turnover or business.
In our experience, the UK groups performing Brexit reorganisations are often achieving their transfers simply through the movement of employees, without structuring them through a contribution in kind or even a sale of business.
Some companies are seeking rulings from the tax authorities of the EU member states involved in the transfers to get comfort on using very low values attached to the business transferred. In France, a specific office was dedicated to reviewing the methodologies used by UK groups to achieve proposed transfers. In the UK, intensive discussions on valuations are ongoing with HMRC, the UK tax authority. Brexit is being used as an argument to try and convince the tax authorities not to refer to fair market values for transferring the businesses to another country or to another legal entity.
At this stage, it is impossible to foresee whether these transfers with very low compensations for the UK entities, when not approved through prior tax rulings, will pass through future tax audits without any dispute.
It is worth noting that VAT is not an issue, as movements of entire businesses from an entity to another, including in cross-border transfers, do not trigger any VAT liability (under to the concept of TOGC – transfer of a business as an ongoing concern).