ATAD’s GAAR Of No Surprise: Czech Courts Affirm A Complex Cross-Border Intra-Group Restructuring Was A Disregardable Abusive Transaction
Without exaggeration, one can say that the aftereffects of the 2007 financial crisis launched a new era in tax compliance that has been characterised by an unprecedented number of anti-tax avoidance initiatives across all fields of taxation at both global and EU level. Besides measures focused on comprehensive data collection and reporting, the domestic extension of which was briefly addressed in our last year’s contribution, there have also been certain significant actions in the field of substantive tax laws. An apt example falling into the latter category is the EU Anti-Tax Avoidance Directive (the ATAD), which forms part of a wider anti-tax avoidance package released by the European Commission at the beginning of this year. The ATAD, which represents a partial implementation of the OECD’s BEPS recommendations,should serve as a minimum-standard basis for EU-wide implementation of five key anti-avoidance measures that are designed to counteract some of the most common types of aggressive tax planning.
As the direct taxation field is, as a rule, the preserve of the Member States, the extent to which the ATAD’s transposition will impact the individual national corporate tax policies will inevitably vary. The Czech taxpayers will, for example, be new to the controlled foreign company rules, or to a large extent, to the exit taxation rules. It will also be interesting to see what will be the approach of the Czech legislator towards the new interest limitation rule and how the position of Czech taxpayers will be affected compared to the existing plain vanilla debt-to-equity-based limitation. By contrast, having regard to the position of both the Czech tax authorities and the Czech courts with respect to the application of abuse-of-law doctrine in tax matters, the ATAD’s general anti-abuse rule (the GAAR) designed to tackle "non-genuine" arrangements should come as no surprise to any vigilant Czech taxpayer. This is all the more true following the recent landmark decision of the Czech Supreme Administrative Court (the SAC).
GAAR’s Strike In Prenatal Phase
Tax has always played an important role in the structuring of mergers and acquisitions, with one of the key objectives being to ensure tax deductions for the finance costs on acquisition debt. In a landscape where there has been a growing perception that debt is “bad”, this can be difficult to achieve. However, as the following SAC’s case demonstrates, it can even turn into a taxpayer’s nightmare where a once-profitable business sinks into huge losses post-completion, without a robust commercial underpinning readily at hand.
1.1 Case summary
The main facts of the case were as follows:
- A non-Czech real estate group transferred shares in its Czech operating subsidiary (the Target) to a Czech SPV (the SPV) with the acquisition of the Target’s shares being financed through a substantial intra-group debt (the Debt);
- The Debt (which arose as a consequence of a complex intra-group purchase-price receivable assignment and cashless conversion) was pushed down to the Target’s level using a post-acquisition merger of the Target into the SPV. This resulted into the interest expenses on the Debt being set against the post-merger profits of the SPV. Nevertheless, the debt load was so massive that it sent the once-profitable and tax-paying business deep into the red, generating huge (tax) losses.
Following a notification from foreign tax authorities, the Czech tax authorities challenged, under the Halifax-case consistent abuse of law doctrine, the tax deduction of the interest payments made by the SPV under the Debt, on the grounds that the entire sophisticated cross-border restructuring was purely tax–motivated and lacking any commercial rationale.
The SPV countered and argued inter alia that the restructuring aimed at (i) a structural separation of rental-income generating assets from more-risky development activities, (ii) harmonising the group corporate structure with both the Dutch and the European laws, (iii) creating a transparent management structure, (iv) enabling employees and key advisors to participate in the group's results, and (v) securing bank funding at the group level. The restructuring was also claimed to form part of a going-public process (the IPO eventually did not materialise due to the credit crunch).
The SAC, as did the lower court, ruled in favour of the Czech tax authorities, essentially rejecting all of the (non-tax) justifications presented by the SPV while noting that:
- The Halifax-case consistent abuse of law doctrine serves as an "emergency brake" in situations not yet covered by specifically targeted provisions where the formal application of law would run counter to its purpose. As such, even if not explicitly codified in law, the proposition made by the SPV that this principle is to be restricted only to the field of VAT is unfounded and its application in cases such as the one at hand is fully legitimate.
- The objectives of the intra-group reorganization as put forward by the SPV did not represent clear and sound, economically rational and justifiable reasons or, put differently, must have been seen as plainly secondary in consideration of the multi-million dollar bill for advisory fees and the massive post-merger Debt load wiping out taxable profits of what once used to be a prosperous business for many years to come.
- The outcome of the case could have been otherwise had there existed a clearly articulated rational purpose for the reorganisation (such as an actual change in ownership structure, an acquisition of a new business or cost savings measures). Under such circumstances, taking account of a tax aspect of the transaction is a legitimate approach and neither intra-group debt financing nor the acquisition of shares in a company followed by an up-stream merger are, on their own, off limits.
In M&A context, it has always been a crucial feature to ensure that the finance costs incurred on the acquisition debt qualify for tax relief. This is because any restriction in this respect may cause the acquisition to be no longer economically viable. Accordingly, in the absence of tax consolidation rules, a tax efficient debt push-down merger constitutes an essential part of Czech acquisitions’ structuring. It is beyond all doubt that the SAC’s case at hand does not contribute to legal certainty, however, in our view, itdoes not rule out this commonly used acquisition technique in its entirety. In
any case, it serves as a useful warning that any arrangement or scheme, whatever elaborate, that lacks a sound commercial underpinning that is clearly explainable to the tax authorities, becomes susceptible to a successful challenge by the tax authorities. The SAC confirms that this is so GAAR notwithstanding.