Application of corporate income tax special regime for mergers and divisions to a family company split-off and subsequent donation to the children of the owners
On December 4th, 2017, the Supreme Court issued a judgment in relation to the “valid economic reason” required by the special regime for mergers and divisions of Corporate Income Tax in case of the split-off of a company and subsequent company shares donation to the owner’s children in which there was no taxation because of the tax benefit provided by the Gift Tax Law.
The special regime for mergers and divisions, known as the “Tax neutrality regime” and regulated in Title VII of Law 27/2014, was established to prevent taxation from interfering in corporate restructuring processes. Under this regime, the transferor does not pay for the income obtained in the transmission of shares to the acquirer and the latter must value the received goods at the historical value they had in the transferor, not at market value.
The subjects may defer the taxation of the increases arising as a result of the corporate operation until the moment when they are transferred to third parties, as long as the carried out operation does not have fraud or tax evasion as its main objective. In particular, the regime will not be applied when the operation is not carried out for valid economic reasons, such as the restructuring or rationalization of the activities of the companies in the operation, but with the only purpose of obtaining a tax advantage.
The Supreme Court has ruled on this issue in its Judgment no. 1902/2017 of December 4th, 2017, in which an entity, owned by a couple, agreed in 2005 to partially split the company justifying the need to separate real estate assets from assets representing shares of transportation companies. As a result of this operation, the aforementioned tax neutrality regime was applied and, therefore, the tax for the income obtained was deferred.
Months after the split-off, in 2006, the owners donated all the shares of one of the companies to their two children, profited by the reduction of 95% of the tax base, foreseen in article 20.6 of Law 29/1987 of Inheritance and Gift Tax.
The Tax Office of Catalonia started a verification procedure in which owners were notified that it was not possible to apply the regime of Tax neutrality because, in their opinion, the split-off of their companies had not been justified by a valid economic reason. The Tax Office considered that the shares transmission to the partners’ children excludes the valid economic reason required and because of that, they should apply the ordinary regime.
The owners appealed to the Central Economic and Administrative Court (TEAC), which in 2013 dismissed the claim with the same arguments as those described above.
Then, the owners appealed to the Contentious-Administrative Chamber of the National Court. The Second Section was in charge of issuing the ruling in 2016, which, on this occasion, was favorable to the owners of the company.
After this ruling, the State’s attorney appealed before the Supreme Court, which has finally ruled against the Tax Office and agreed with the taxpayer.
Throughout the court proceedings, Tax Authorities argued that the owner’s intention was to facilitate the succession of children at the head of the company and, for this reason, they reorganized the companies. As this reason does not have the economic purpose required for the application of this special regime, the corresponding tax benefit did not apply and they should be taxed under the ordinary regime.
The owners pointed out that “the shares donation to their children constitutes a valid economic reason to incorporate the second generation of a family group to the ownership of the capital and to continue with the corresponding business”.
The Supreme Court notes in its Judgment that “in a split-off can be pursued, lawfully and at the same time, a double objective: to achieve a convenient and rational business reorganization from the economic point of view, and also, the development of a succession to ensure family continuity, “by allowing the children of the partners who lead the management of the companies to continue leading the activity in the future”
Therefore, the applicable tax regime to this split-off is the special one for mergers and divisions.
After this ruling, we can affirm that the restructuring of family business to make the heirs to assume it and, as well, to benefit from the Tax neutrality regime for mergers and divisions is legal in Spain.
At SCHILLER Abogados we offer full tax advice to family businesses. We will advise you on tax planning and the analysis of the transfer of the family business ownership.