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Tax issues and business transfers: The devil is in the details

25 Jul 2017 at 04:00 / NEWSPAPER SECTION: BUSINESS

Tax issues and business transfers: The devil is in the details

Ever since tax incentives for business reorganisation were introduced two decades ago, different issues have arisen intermittently, especially as they relate to an entire business transfer (EBT), which has become a popular practice.

Unlike a statutory merger, an EBT is not governed by the general rules of the Civil and Commercial Code or the Public Limited Company Act. Consequently, an EBT's merit relies solely on the provisions of the Revenue Code.

To support economic growth and increase the financial strength of local industries, the income tax burden that should have been borne by the transferor of a business is deferred and indirectly passed on to the transferee. It is not exempted, contrary to a common misunderstanding in the market.

While the law requires the assets to be evaluated at the market price, the transferor is not required to include gains arising from the transfer in its gross income. This applies as long as the transferee carries over the tax cost base of the acquired assets as it appeared on the transferor's books as if it were the transferee's own tax cost base, irrespective of the EBT price the transferee is actually paying.

For example, if the transfer price is 130 and the tax cost base is 100, the business transfer will normally result in taxable profits of 30. However, the transferor will not be required to include the 30 as a gain for tax purposes if the acquisition takes place under the terms of the EBT. In exchange, the transferee can only book 100 as its acquisition cost for tax purposes, e.g. depreciation over the residual useful life or calculation of profits upon resale, if any.

Value-added tax, specific business tax (for immovable properties) and stamp duties are also exempted.

To ensure than an EBT is genuine, the Revenue Code mandates that the transferor be dissolved within the same accounting year that the business is transferred. To accommodate the tax audit process, a "Form Kor Or 1-4", together with the details of the parties and transactions, must be prepared and filed within 30 days.

Although an EBT may sound simpler than applying for Board of Investment promotion, a lack of clear understanding among tax auditors has led to a number of questions related to the substance of such transactions. For example:

Is it possible to register the transfer of certain assets, such as land and buildings, with other authorities, e.g. the Land Department, after the EBT date or after the accounting year when the transfer takes place? Is it essential to complete the transferor's liquidation within the same accounting year as the transfer? Is an EBT at fair market value allowed, or does the law strictly require the transfer to be done at book value?

While most tax authorities have tried their best to eliminate unnecessary debates that would otherwise hinder business integration, some auditors have raised questions that have made EBT transactions difficult in some parts of the country. The same question that was never considered an issue in one tax area office could become a major obstacle or even a deal-breaker in another. Among the questions that have arisen: Is it necessary for the transferee to issue new shares to the transferor as a consideration for the transfer, or is cash payment allowable? Must accounts receivable and payable be transferred in an EBT transaction? A recent precedent case reveals that there is always a devil in the details.

A notification of the Revenue Department director-general requires that Form Kor Or 1-4 be submitted within "30 days from the day the change is registered in the case of a business transfer". It is generally understood that this means 30 days from the day the transferor company's dissolution is registered with the Department of Business Development at the Commerce Ministry. Some taxpayers also believe that submission before the dissolution date would meet the criteria.

Let's look at the example of an EBT transaction by two transferor companies to one transferee three years ago. The Kor Or 1-4 forms for both were submitted "before" the transferor companies' dissolutions were registered. A revenue official accepted them without any objection, despite the absence of certification of dissolution from the Commerce Ministry. After the expiry of the 30-day deadline, a tax auditor decided that the early submissions failed to meet the criteria because they were made before the dissolution registration, and thus both transferors should pay income tax, VAT and stamp duties, together with the relevant penalties and surcharges.

The Revenue Department finally concluded earlier this year that a transferee was not allowed to submit Kor Or 1-4 forms before the dissolution registration date. Nonetheless, as the early submission in this case was caused by a genuine misunderstanding, the forms were deemed as submitted within the deadline, provided the transferee submitted the transferors' certification of dissolution within 15 days from the day it received the ruling.

It is disturbing to other taxpayers, who may not be as lucky as the parties in this case, to learn that such overzealous application of EBT laws could raise such a serious issue. This ruling also shows that a tax auditor can still mount an attack based on a minor formality, even though there is absolutely no hint of tax avoidance or any attempt to cause disadvantage to the government.

If you plan on doing a fancy EBT transaction, take into account the possible risk factors and be ready in advance in case things go wrong.

By Rachanee Prasongprasit and Professor Piphob Veraphong. They can be reached at >admin@lawalliance.co.th

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