The Taxation of Partial Demerger.

The Legal basis for the Partial Division

The Council Directive 2005/19/EC of 17 February 2005 amended the Directive 90/434/EEC 1990 (the "Merger Directive") on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States.

Finland has incorporated the provisions of the Directive 2005/19/EC into Finnish legislation. One of the amendments is a new regulation concerning partial demerger (or division), which has been made possible as a tax neutral transaction in the 2007 tax year through the amendment of Section 52c of the Finnish Business Income Tax Act ("BITA"). The partial demerger had already previously been implemented in Chapter 17 of the Finnish Companies Act. The new tax legislation is applicable to partial demergers carried out on 1 January 2007 or thereafter.

According to the BITA, the tax neutral partial demerger means a division in which a limited liability company, without being subject to liquidation procedure or dissolution, transfers one or more business units to one or more existing or new limited liability companies leaving at least one business unit in the transferring company. The shareholders of the company subject to the partial demerger should as consideration receive newly issued shares in each receiving company in proportion to their shareholding. Part of the consideration may also be cash. The cash payment must not exceed 10 % of the nominal value or, in the absence of a nominal value, the share of the paid-in share capital in proportion to the issued shares.

The interpretation of the amended legislation

For the time being, there is neither any jurisprudence from the courts or tax authorities nor Finnish National Tax Board guidelines as to when a partial demerger is tax neutral. Therefore, support for the interpretation of the amended statutes can only be found in the preparatory works of the relevant Act. In accordance with the Government Bill (HE 247/2006), the term "business unit" is, as a starting point, comparable to the term used in connection with the transfer of assets in accordance with Section 52d in the BITA. Thus, the existing legal and tax practice concerning tax neutral transfer of assets should be applicable. It is required according to the Government Bill that both the partially demerged business unit and the remaining business unit constitute independent business units which are able to operate on their own both from an organizational and from a financial perspective. According to the Government Bill, the new rules of partial demerger are also applicable to companies which are taxed in accordance with the Income Tax Act (i.e. "passive" entities typically including holding companies and real estate companies) and which, by definition do not have any "business". However, it is expressly stated that both the transferred and the remaining activities should meet the requirements of organizational and financial independency.

Taking into account that the tax neutral transfer of assets is not applicable at all for a company, which is taxed in accordance with the Income Tax Act (i.e. a company which only has an ordinary income source but no business income source for tax purposes), it seems to be especially unclear in which circumstances the new rules could be applied to a partial demerger of a company which is not taxed in accordance with the BITA, e.g. a real estate company. The wording of the BITA would require as a minimum that the activities of both the transferred and the remaining units would on a stand alone basis qualify as "business activities" in accordance with the requirements for organizational and financial independence.

Conclusions

With respect to the remaining business activities, the partial demerger seems to demand more justifications from the reorganization of a company, compared to the transfer of assets, in order for it to be considered tax neutral. The demands set for the partial demerger are noteworthy, also due to the fact that similar provisions have not been set for the demerger where a company completely demerges and dissolves without being subject to liquidation procedures.

The partial demerger is more comparable to a transfer of assets. The partial demerger applies to companies which are taxed in accordance with the Income Tax Act (which does not apply to the transfer of assets). However, direct support for the interpretation of the regulation can not be drawn from legal praxis concerning the transfer of assets.

Therefore, the applicability of the tax neutral partial demerger rules especially as they apply to companies other than those taxed in accordance with the BITA, must be confirmed by a preliminary ruling from the local Tax Office or the Central Tax Board. This is particularly relevant, as a demerger is a very real and useful alternative to restructure especially real estate holdings, in addition to restructuring of actual active companies or groups conducting more typical business activities.

For further information please contact Gunnar Westerlund, Partner at Roschier in Helsinki.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Mr Gunnar Westerlund

Roschier, Attorneys Ltd

Keskuskatu 7 A

Helsinki

00100

FINLAND

E-mail: [e-mail]

URL: www.roschier.com

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