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Anti-Abuse measures in tax-Free reorganisation
Published: 9/10/2012 at 01:53 PM
Newspaper section: Business
Modifying tax incentives as part of a series of transactions is similar to an effort to disentangle puzzle rings, leading to further complexity. The new tax rules, Royal Decree No.542 and Ministerial Regulation No.291, legislated two weeks ago are good examples.
Unfortunately, while most people thought the package came out to promote the long-yearned-for share-for-share swap, the rules limit the scope of the current tax incentive regime in an attempt to deal with abusive transactions.
There are two major types of corporate reorganisations in Thailand that are eligible for tax incentives: the statutory merger and the "entire business transfer" or EBT. (The "partial business transfer" is intentionally omitted from today's discussion, as it does not fall within the scope of the new legislation.)
The statutory merger is a straightforward mechanism and by implication is already involved with an indirect exchange between the old shares held by the existing shareholders of the merged companies and the shares issued by the surviving entity after the merger.
Therefore, neither Royal Decree No.542 nor Ministerial Regulation No.291 has much impact on it.
The EBT occurs when a target company transfers all its assets and liabilities to an acquiring company, ceases all business operations on the closing date and is subsequently dissolved/liquidated within the same accounting year.
While an abuse in relation to the statutory merger scarcely arises because the transaction does not involve cash consideration, there is also continuity of interest whereby existing shareholders will continue to be shareholders in the new entity after the merger.
An abuse often arises in the course of the EBT, as the relevant legislation allows the existing shareholders in the transferring company to exit the transaction with cash at no tax cost. Hence, most EBT transactions are not implemented with the genuine corporate reorganisation purpose, but simply to sell the business under the tax incentive scheme.
Until recently, a great effort was made to ensure transactions' eligibility for the tax incentives. Royal Decree No.542 and Ministerial Regulation No.291 provide that, when a statutory merger or EBT takes place, and the shareholders derive gains from an exchange of the shares in the target company with the shares in the newly merged company or the acquiring company, such gains will be tax-exempt.
In order to be eligible for such tax exemption, the exchange of shares must take place within the same accounting year as the statutory merger or the EBT's closing. Also, the rules are subject to a notification to be issued by the director-general of the Revenue Department.
Since the new legislation says an "exchange" of shares must take place, it seems that henceforth the shareholders in the target (transferring) company are required to directly exchange the target company's shares with the newly issued shares of the merged company or the acquiring company.
While we anticipate that the registration of a statutory merger and the automatic cancellation of shares in the merged companies will later be interpreted by the Revenue Department as a qualified "exchange" with the new shares issued by the new entity after the merger, fulfilment of the EBT is one step more complicated.
That is to say an issue arises as to how the shareholders of the target (transferring) company, who are not parties to the EBT agreement, could receive the newly issued shares from the acquiring company directly. Due to limitations under the Civil and Commercial Code as well as corporate laws, the old shares in the target company are in fact not exchanged with such newly issued shares, but instead cancelled in the course of liquidating the target company.
The acquiring company will actually issue new shares in exchange for the acquired business to the target company, which will distribute such newly issued shares to its shareholders in the course of liquidation. So this two-step process differs from the normal share-for-share swap in other countries and is obviously different from the simple language adopted in both Royal Decree No.542 and Ministerial Regulation No.291.
Unless there is a notification from the Revenue Department to accept the two-step process under the Civil and Commercial Code as well as the corporate laws as a qualified reorganisation plan for tax purposes, it means that, even though the target company will be tax-exempt for the gains it receives from the EBT transaction, its shareholders will not be entitled to tax exemption for such gains _ absent a genuine share-for-share swap.
As this distorted phenomenon could have an impact not just on preventing abusive transactions but also narrowing the scope of tax incentives at the level of the shareholders, our friends at the Revenue Department will have a lot of homework to do in preparing clarifications of these new rules.
Prepared by Rachanee Prasongprasit and Professor Piphob Veraphong. They can be reached at email@example.com