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JOINT COMMITTEE ON FINANCE AND THE PUBLIC SERVICE debate -
Wednesday, 24 Mar 2004

Scrutiny of EU Proposals.

Last January, the committee decided to scrutinise EU proposal COM (2003) 613 which concerns the common system of taxation applicable to mergers, divisions, transfer of assets and exchange of shares concerning companies of different member states. We are joined today by Ms Karen Cullen and Mr. Michael McGrath from the Department of Finance and by Mr. Jim Kelly from the Revenue Commissioners. They are all welcome and I thank them for providing the briefing note which was circulated to members of the committee. Ms Cullen will make a brief presentation following which members of the committee will comment and address questions to officials as appropriate. I advise our guests that while the comments of members of the committee are protected by parliamentary privilege, those of visitors are not.

I work in the corporation tax policy section of the budget division in the Department of Finance. My colleagues with me are Mr. Michael McGrath from the international tax section of the Department of Finance and Mr. Jim Kelly from the policy and legislation section of the Revenue Commissioners. I will present the Commission proposal for an EU directive recommending what is commonly known as the 1990 Mergers Directive. I will speak a little about the current proposal and then go into some background. I will explain how the 1990 directive operates, set out how it grants relief from tax and Ireland's implementation of it. I will then go into the main elements of the current proposal, speak about the implications for Ireland and discuss the progress to date at Council working party level and the anticipated negotiating period.

The current proposal is a Commission proposal for an EU directive to update, clarify and broaden the scope of the 1990 Mergers Directive. The 1990 directive provides tax neutrality for cross-border company restructuring carried out in the form of mergers, divisions, transfers of assets or exchanges of shares. It provides in the main for the deferral of taxation of capital gains arising from such transactions. It also addresses the question of capital allowances and allows these to continue in the case of a cross-border transaction covered by the directive without the crystallisation of any balancing charge. This proposal addresses specific problems with the 1990 directive by extending tax deferral to a larger number of cases and improving the methods to secure tax neutrality while safeguarding the financial interests of member states.

I will give some background to how the 1990 Mergers Directive operates. In essence, under the 1990 directive, taxation is not to crystallise at the time of the merger or other transactions, but is deferred until a later disposal of the assets. For example, a merger could involve a German company and an Irish company being dissolved and a new company being created to take over the business of the companies. In return, the shareholders in the German and Irish companies are given shares in the new company. Under general tax law, tax charges would crystallise at that time. For example, the German and Irish companies would have disposed of their businesses. This would in the ordinary course give rise to a charge to capital gains tax on the companies. Also, the shareholders in the German and Irish companies would be subject to capital gains tax on disposal of their shares in those companies.

Another aspect is that a balancing charge could crystallise at the time of the merger to claw back any excess capital allowances that may have been given. One of the conditions of the directive is that the income earning business remains in the member state in which it was located prior to the merger, division or other transaction covered by it. This protects the tax base of the member state concerned.

The rationale behind the directive is that, as there has been no substantive disposal of the business and as the business carries on as before, there should not be any crystallisation of a tax charge. To do so would inhibit cross-border mergers. It provides for the following tax neutrality: that once the assets of the Irish company continue to be used for an Irish branch of the new company, a capital gains tax charge should not arise nor should there be any crystallisation of any balancing charge. Instead, the new company should be regarded as having acquired the assets at the time and for the cost at which they were acquired by the Irish company.

Consequently, when the assets are eventually sold, any gain will be calculated by comparing their cost to the Irish company with their sale price when sold by the new company. Ireland will be entitled to tax the new company on the gain as it arises in an Irish branch. This means that the full gain will be taxed when there is a real disposal. In addition, any balancing charge will be calculated at that point on the basis that the company disposing of the asset had owned it since it was originally purchased and had received all of the capital allowances in respect of it. In this way it provides both neutrality for the merger and protection for the two member states.

As far as the shareholders are concerned, they had shares in the Irish and German companies. After the merger they no longer have such shares but instead have shares in the new company. This is a "paper for paper" transaction involving no cash. The directive provides for tax neutrality in this situation also. This means that no gain or loss is treated as crystallising at that time but the shares in the new company are generally treated as taken over at the value that the original shares had immediately before the merger.

Since first introduced, the corporation tax and capital gains legislation has contained provisions which ensure that most mergers, referred to in the legislation as reorganisations of share capital and company reconstructions, are treated in a tax neutral fashion. Given that mergers play a significant part in economic development in Ireland these provisions were framed as widely as possible. Thus the implementation of the mergers directive required a refinement of Irish law rather than a major overhaul in the Finance Act 1992.

Mergers and divisions as defined by the directive are rare in Ireland as they require the sanction of the High Court. Furthermore, certain transactions envisaged by the mergers directive in a cross-border context are not yet possible under Irish or EU company law. Should company law change to allow for such transactions in the future, companies will get immediate benefit from the directive under a catch-all provision which allows Revenue to grant relief in accordance with the 1990 directive. Irish tax law was amended in 1992 to deal with the transactions that are possible under current law — cross-border transfers of assets and exchanges of shares.

The European Commission proposed on 20 October 2003 to amend the 1990 Mergers Directive. The main elements of the proposal to improve the operation of the directive are as follows. With regard to scope, the proposal would update the list of companies to which the directive applies to cover legal entities which were not included in the 1990 directive, including mutual companies, savings banks and, in an Irish context, unlimited companies. This will thus level the playing field with other corporate legal forms. The revised scope would also include the European Company and the European Co-operative Society. It will be possible to create these from October 2004 and August 2006, respectively, with the result that companies and co-operatives operating in more than one member state will have the option of establishing themselves as single entities under Community law.

On the issue of partial divisions, the existing directive applies where there is a total division of a company, that is, where the assets and liabilities of a company are transferred to two or more companies and the original company is dissolved. It is now proposed that the directive should also apply where there is a partial division, that is, where a part of the company is hived off and the original company continues to exist.

On the transfer of the registered office of a European company or of a European co-operative society, the proposal provides for tax neutrality in the case of the transfer of the registered office of a European company or a European co-operative society from one member state to another. This neutrality involves deferral of any charge to tax arising out of the transfer of the registered office.

The proposal also deals with the conversion of branches into companies. The proposal would clarify that the tax deferral regime in the directive can apply where a company from one member state having a branch in another member state converts that branch into a subsidiary in that other member state. The proposal clarifies the rules on the valuation to be attributed to securities received in cross-border exchanges of shares and transfer of assets to ensure that there will be no double taxation when those securities are eventually sold.

With regard to the implications for Ireland, business in Ireland and the EU should benefit from the proposed directive which contributes to the re-organisation of companies with a European dimension. These transactions will be possible without tax obstacles while at the same time financial interests of the member states are safeguarded. If the proposal is adopted, one immediate practical implication for Ireland is that the 1990 directive will in future apply to a broader range of companies including Irish unlimited companies. These were not covered by the description of "company" in the 1990 text and Ireland has been seeking to have them included.

Ireland has been examining the technicalities of the proposed directive to ensure that the wording achieves the desired objective and that financial interests of the State are protected in any broader application of the directive. For instance, the proposal provides for a deferral of any charge to tax arising from the transfer of the registered office of a European company from one member state to another. Such a company will enjoy tax deferral for the capital gains relating only to those of its assets becoming connected with the branch remaining in the state of tax residence before the transfer of registered office.

On the anticipated negotiating period and the progress to date, discussions commenced in the Italian Presidency at Council working party level and are continuing under the Irish Presidency. The subject matter is technically complex and while good progress is being made on the proposed directive, it may not be agreed during the Irish Presidency. The target date for implementation of the proposed directive is 1 January 2005. The voting method is based on Article 94 of the EU treaty which means it is based on unanimity.

I thank Ms Cullen for her presentation.

I compliment Ms Cullen on her presentation which is fairly explanatory. There seems to have been a disincentive up to now for companies to merge or, if not a disincentive, the tax treatment in certain circumstances seems to have been peculiar, to put it mildly. In Ms Cullen's view will there be an immediate positive effect for Irish companies or will it be a gradual process whereby companies will eventually see the merit of it?

Why could this not have been included in a Finance Act? Was it necessary to proceed by regulation instead of by a Finance Bill?

I will answer the second question first. The proposal sets out a directive to amend the 1990 mergers directive which would apply in an EU context. If and when the directive is agreed, we then propose to implement it by way of a public finance Bill or perhaps by way of statutory instrument, depending on the timing of it.

The proposed implementation date is 1 January 2005. To have everything in place by that date would require implementation in the Finance Bill 2004. The problem is that the proposal was only put forward in October 2003. It is a very complex proposal and nobody is ready to sign off on it yet. Assuming it is agreed at some stage in 2004, maybe under the Irish Presidency but more likely under the Dutch Presidency, then it will be a question of putting it in place from 1 January 2005, unless that date changes. If it is to be in place from 1 January 2005, there are two possibilities: it could be provided for in the Finance Bill 2005 but made retrospective to 1 January 2005. That might be a little unsatisfactory for companies who want to do a deal in January 2005. The alternative way is to make a regulation under the European CommunitiesAct 1972.The decision will be made later in the year. It will require Irish legislation because it will not take automatic effect.

On the second question raised about whether it would have an immediate impact on companies, it is probably important to state that generally, if Irish companies wish to enter into some kind of reconstruction or amalgamation they will swap shares. Tax neutrality is already provided for in the law for that type of merger. The model provided for in the directive is probably mainly a European model. It will give another method of merging to companies. I am not sure that the existing Irish law would inhibit companies from merging but it would probably limit the ways in which they can do it. If I am correct in that assumption, then it is unlikely that there will be a big rush to avail of the directive.

Will the ten accession states be part of the negotiations or will they come in at a later date as part of these regulations?

The accession states are currently present at Council working party level. They may speak on the proposal but at present they do not have the right to vote. On 1 May 2004 they will have the right to vote.

Will the delegation explain to the committee the difference between a merger and a take-over? In lay man's English, two companies merge together but in practice it can be an effective take-over. Does the directive cover take-overs, where a company effectively takes over another company?

There is a provision allowing for an exchange of shares which means a situation where one company exchanges shares for shares in another company with a view to gaining control of the other company. I assume that is what the Chairman is referring to as a take-over.

And is that covered by this proposal?

Is this taken to mean a share transaction or a paper take-over? If there is a cash part to the merger or acquisition, does it come under this directive? If cash is changing hands it means something is crystallising.

The transaction is covered because there could be some shares and some cash, but to the extent that there is cash, there would be a charge crystallising.

In other words, there could be a proportion of a crystallisation if a proportion of the consideration was by way of cash?

Yes. To the extent that shareholders get cash, they will have a charge to be gained at that point.

If the assets remain in the country where they are currently in use does crystallisation only occur if they come to be sold at a later date or moved to some other state?

Yes. The key point is to protect the financial interest of the member state concerned. If a company in Ireland transfers its assets to a company in the UK, the directive will not apply unless the UK company has a business in Ireland and the former company becomes a branch of the UK company.

Or a subsidiary.

If it were a subsidiary, I do not think it would arise. If it were a subsidiary and located here it is taxable here and I do not think the merger directive applies to that. However, if the directive is to apply it must leave a taxable entity, being a branch, in the State. In the event that the assets are subsequently sold then a chargeable gain will crystallise at that point.

In which country? Will it be where the assets are based?

The UK company with the branch in Ireland is taxable on the profits and gains arising from the Irish branch. In the event that those assets are sold, the charge will arise here. There would also be a charge in the UK, but the Irish tax would be deducted from the UK tax.

Would that be through double taxation agreements?

If there are no other questions, I believe we are happy to conclude our consideration of the matter. On behalf of the committee I thank Ms Cullen, Mr. Kelly and Mr. McGrath for assisting us with our scrutiny of the directive. The documentation we received in advance was helpful to our understanding.

We will consider our views in the matter and report in due course. The committee must prepare a report on its views of the proposal and, when agreed, a report must be placed before the Dáil and Seanad, and communicated to the sub-committee on EU scrutiny of the Joint Committee on European Affairs. Does the committee agree its views at this stage so that the Clerk can prepare a draft report for the next meeting? Agreed. The Clerk will prepare a report for the next meeting indicating we are satisfied with the proposal, negotiations and discussions as we discussed today.

Item No. 7 on the agenda relates to any other business. The Clerk has been informed that the Oireachtas Joint Committee on Foreign Affairs has arranged an informal meeting with Eveline Herfkens, special UN envoy on the Millennium Development Goals. As the goals address issues of international trade and finance, Ms Herfkens is interested in meeting representatives of the committee dealing with these matters. The meeting will take place on Tuesday, 6 April at 2.15 p.m. in meeting room 2. I suggest that the Clerk write to all members of the committee with details and any member may attend if he or she so wishes. Is that agreed? Agreed.

The next meeting of this committee would ordinarily take place on Wednesday, 31 March. However, the select committee will consider Estimates from the Department of Finance and the Office of Public Works on the previous day. Wednesday, 7 April has been earmarked for the Committee Stage of the Public Service Management (Recruitment and Appointments) Bill. However, this Bill has not completed Second Stage, which will resume in the Dáil tomorrow. In view of the fluid situation, I propose that we adjourn sine die. Is that agreed? Agreed.

The joint committee adjourned at 11.05 a.m., sine die.

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