EXIT TAXATION. Publication of European Union Direct Taxes Centre of Excellence (EUDT CoE) NATIONAL DEVELOP- MENTS IN EUROPE EXIT TAXATION

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1 NOVEMBER 2015 EDITION 1 Publication of European Union Direct Taxes Centre of Excellence (EUDT CoE) IN EUROPE PAGE 2 THE NATIONAL GRID INDUS DECISION PAGE 2 NATIONAL DEVELOP- MENTS IN EUROPE PAGE 3 CONTENTS Summary Exit taxation in Europe after National Grid Indus, DMC Beteiligungsgesellschaft mbh and Verder LabTec GmbH & Co. KG SUMMARY When entities leave a country or transfer assets abroad, the country of exit usually cannot tax future foreign income of these entities. Therefore, many countries have passed exit taxation provisions according to which hidden reserves are to be disclosed (and taxed) immediately on exit. For several years it has been questioned whether such exit taxes for businesses are compatible with EU law at all and, if so, under which circumstances. This publication sums up relevant case law of the Court of Justice of the European Union (ECJ) and gives an overview of current developments in several Member States. In summary we interpret the current status as follows: A Member State is entitled to tax (unrealized) capital gains generated in its territory upon an exit of the company or a transfer of assets abroad. Immediate taxation without any alternative is not allowed. The ECJ suggested that Member States may offer to the taxpayer a choice between immediate payment of the tax and deferred taxation at the time of realization of the hidden reserves, the latter possibly combined with a bank guarantee and interest. Spreading of payment of the tax owing before the capital gains are actually realized over a period of five years is allowed. Where the taxpayer chooses a deferral, the requirement to provide a bank guarantee may only be imposed on the basis of the individual actual risk of non-recovery of the tax (case by case). The National Grid Indus decision Recent case law: DMC - Facts - Decision of the Court - Impact of the judgement DMC Current case law: Verder LabTec - Facts - Decision of the Court - Impact of the judgement Verder LabTec National developments in Europe regarding exit taxation - Belgium - France - Germany - Ireland - Italy - Netherlands - Spain - Sweden - United Kingdom Conclusion Because people matter. Current pending questions are how interest may be calculated on these assessments (likely this will be different for each country depending on its local legislation) and whether the receiving country is obliged to provide for a step-up to market value of the transferred assets.

2 2 Tax Alert IN EUROPE AFTER NATIONAL GRID INDUS, DMC BETEILIGUNGSGESELLSCHAFT MBH AND VERDER LABTEC GMBH & CO. KG In detail THE NATIONAL GRID INDUS DECISION The ECJ, with its judgment of 29 November 2011 in National Grid Indus (C-371/10), shed some light on these questions. The Court decided that a Member State is entitled to tax (unrealized) capital gains generated in its territory. However, immediate taxation without any alternative was seen as disproportionate. The Court suggested that Member States may offer to the taxpayer a choice between immediate payment of the tax and deferred taxation at the time of realization of the hidden reserves, the latter possibly combined with a bank guarantee and interest. After this judgment, many questions were raised, some of which the ECJ had a chance to answer in the judgment of 23 January 2014 in the German case DMC Beteiligungsgesellschaft mbh (C-164/12). RECENT CASE LAW: DMC In DMC the ECJ held that a German exit tax rule providing for the immediate taxation of unrealized capital gains - with a deferral option - may be justified by the objective of preserving the balanced allocation of the power to impose taxes between Member States. The Court also commented on the possibility of a bank guarantee being required. FACTS Two Austrian corporations (GmbHs) were the limited partners of a limited partnership (KG) established in Germany. They made a non-cash contribution to DMC GmbH (the general partner, a German corporation) in the form of the interests held by them in the KG. In consideration of this transfer, the Austrian GmbHs obtained new shares in DMC GmbH. As all interests in the KG had been transferred to DMC GmbH, the limited partnership was dissolved. The companies involved conducted the transfer at book value. However, the tax authorities reasoned that the Austrian GmbHs, as limited partners in the KG, no longer had an establishment in Germany following its dissolution. Therefore, according to the double taxation treaty concluded with Austria, Germany no longer had a right to tax the gains accruing to the Austrian corporations in respect of the received shares. In accordance with the former version of sec. 20 par. 3 of the German Reorganization Tax Act (RTA), the tax authorities assessed the interests contributed to DMC GmbH at going concern value, thus giving rise to taxation of the unrealized gains contained therein. The referring court asked whether the German provision, which prescribes a transfer at going concern value resulting in immediate taxation of unrealized capital gains generated in Germany in cases where Germany loses its right to tax, is compatible with the freedom of establishment. It also asked if the national provision would be proportionate, if the transferor was entitled to apply for an interest-free deferral of the tax arising from the disclosure of hidden reserves, with the effect that the tax may be paid in five annual instalments, providing that payment is secured. DECISION OF THE COURT The Court of Justice held that the case must be examined solely in the light of the free movement of capital - not the freedom of establishment. Firstly, the application of the provision was not dependent on the extent of an investor s interest in the limited partnership; the investor is not required to have a holding which enables him to exert definite influence on the partnership s decisions, or those of the acquiring capital company. Secondly, since the limited partnership was dissolved, the ECJ found that the legislation at issue had less bearing on the procedure of establishment than on the procedure for the transfer of assets between a limited partnership and a capital company. With reference to its decision in National Grid Indus, the ECJ found that the German legislation constitutes a restriction of the free movement of capital. However, this restriction may be justified by the objective of preserving the balanced allocation of the power to impose taxes between the Member States, provided that Germany in fact has no powers of taxation in relation to the hidden reserves in the contributed assets when they are realized. The ECJ leaves this to be determined by the national court. The Court repeats with reference to its decision in Commission v. Denmark (C-261/11) that Member States have the power, for the purposes of taxing the capital gains, to make provision for a chargeable event other than the actual realization of those gains, in order to ensure that those assets are taxed. In this context, the ECJ clarifies that since the risk of non-recovery increases with the passing of time, the ability to spread payment of the tax owing before the capital gains are actually realized over a period of five years constitutes a satisfactory and proportionate measure to attain the objective of preserving the balanced allocation of taxing rights. The ECJ further held that, where the taxpayer chooses a deferral, the requirement to provide a bank guarantee may only be imposed on the basis of the individual actual risk of non-recovery of the tax. IMPACT OF THE JUDGMENT DMC The RTA was revised in 2006 and for the continuation of the book values now only requires that the contributed assets remain taxable in Germany. Whether or not Germany has a right of taxation regarding the shares received in return is no longer of interest. Yet, there are two important aspects: Firstly, this is the first exit tax case where the ECJ applied the free movement of capital, which non-eu companies may also rely on. The RTA currently only applies to EU/EEA companies as contributors. Relying on the DMC judgment, third country companies may try to also make use of the provisions. Secondly, in relation to exit taxes, sec. 4 par. 1 sentence 3 in connection with sec. 4g of the German Income Tax Code provides for a general exit tax rule that - with a different mechanism - also provides for a spread of the tax payable over five years. The judgment seems to confirm that these provisions are compatible with EU law. Incidentally, a new referral had been pending at the ECJ (Verder LabTec, C-657/13) regarding these exact provisions and has now been decided. CURRENT CASE LAW: VERDER LABTEC In Verder LabTec the ECJ held that a Member State is not precluded to provide for rules pursuant to which unrealized capital gains in assets that are transferred from a tax-transparent partnership to this very partnership s permanent establishment in another Member State are dissolved and subject to income taxation if such national rules provide for a staggered recovery of the tax over 10 annual instalments. FACTS Verder LabTec is a tax-transparent limited partnership under German law established in Germany. From May 2005 that partnership dealt exclusively with the administration of its own patent, trademark and model rights. By a contract of 25 May 2005, it transferred those rights to its permanent establishment located in the Netherlands. During a tax audit, the tax authorities came to the view that the transfer of those rights had to take place with disclosure of the unrealized capital gains pertaining to those rights at their arm s length value at the time of the transfer. However, the tax authorities considered that those unrealized capital gains should not immediately be subject to taxation in full. For reasons of equity, the amount of those unrealized capital gains was, according to the tax authorities, to be offset by a nominal item of the same value and incorporated in profits on a straight line basis over a period of 10 years. The tax assessments have been issued accordingly. In the subsequent

3 3 Tax Alert proceedings Verder LabTec - amongst others - argued that the recovery of such capital gains tax at the time of the realization would be a less restrictive option. DECISION OF THE COURT Other than the currently applicable rule under sec. 4g para. 2 that basically provides for a spread of taxable gain over five consecutive years, the tax authorities in the Verder LabTec case granted a staggered recovery over a period of ten years on the grounds of equity. The referring local fiscal court covered both terms (five and/or ten) years in its preliminary ruling request. The ECJ made clear that it does not decide on hypothetical questions, i.e. it based its decision only on the concrete facts that referred to a tax deferral over ten years. The ECJ further held that the freedom of establishment (Art. 49 TFEU) is applicable to the transfer of activities of a company in the territory of a Member State to another Member State, irrespective of whether the company in question transfers its registered office and its effective management outside that territory or whether it transfers assets of a permanent establishment located within that territory to another Member State. As one of the results, all measures by a Member State which prohibit, impede or render less attractive the exercise of freedom of establishment must be considered to be restrictions on that freedom. An immediate taxation of unrealized capital gains upon a transfer of assets restricts that freedom. However, more balanced measures may be objectively justified by overriding reasons in the public interest. One of those reasons is the preservation of the balanced allocation of powers of taxation between the Member States. Therefore, a Member State is not forced to waive its right for taxation, it is not necessary to wait until the actual realization of the potential capital gains. As regards the recovery of such a tax, the Court has held that it was appropriate to give the taxable person the choice between, on the one hand, immediate payment of that tax, and, on the other hand, deferred payment of that tax, together with, if appropriate, interest in accordance with the applicable national legislation. In the concrete case as staggered taxation of unrealized capital gains in the assets Verder LabTec transferred to its permanent establishment in the Netherlands was held to be acceptable. IMPACT OF THE JUDGEMENT VERDER LABTEC Unfortunately, the ECJ refused to cover the current national provisions on a staggered recovery by way of allowing a compensatory item in the tax accounts upon application. Such a compensatory item has to be dissolved over a period of five years, each year resulting in an increase of taxable profit. However, the rules in detail provide for more ways of hypothetical realization and thus taxation before the end of the five years period. There are controversial discussions on the underlying rules. In essence one can conclude that the current national rules should not violate the freedom of establishment if their concrete application to each individual case results in a staggered recovery over a period of at least five years regarding the taxation of unrealized capital gains in assets that are transferred to a permanent establishment in another Member State. Any other variant of its application would still have to be examined separately. NATIONAL DEVELOPMENTS IN EUROPE REGARDING BELGIUM Belgium applies an immediate taxation upon the migration of a Belgian company to another country and this to the extent that company s assets are not maintained in a Belgian permanent establishment after the migration. In such case the liquidation regime applies, meaning that the hidden capital gains inherent to the assets transferred as well as the tax exempt reserves become taxable at the moment of exit. Each withdrawal of assets from a Belgian permanent establishment by its foreign head office should be considered as a realization of the assets and lead to capital gain (if any) taxation. With respect to assets transferred from the Belgian head office to its foreign permanent establishment, it can be argued that such transaction is not subject to an exit tax regime in absence of any specific provisions in Belgian tax law. The current Belgian exit tax regime is one of immediate taxation without any option for deferred taxation. Hence, to date, Belgian exit tax provisions are not yet aligned with the ECJ decisions on corporate exit taxation. Given its non-conformity, we expect further evolutions in the Belgian exit tax regime. For further information, please contact Marc Verbeek, Partner, marc.verbeek@bdo.be FRANCE Corporate income tax Exit tax rules in case of transfer of French head office or establishment (Article 221, 2 of the FTC) From France to EU Member State/eligible EEA Member State if such transfer also includes the transfer of the head office or establishment s underlying capital assets. The regime is codified under Section of the French Tax Code. Under this regime, latent gains on assets transferred upon the migration of a corporate headquarter or an establishment from France to another EU member State or to an eligible member State of the European Economic Area (EEA), are taxed for CIT purposes but the relevant tax may, upon request of the company, be paid in five annual instalments. Specific tax filing requirements and payments are then applicable. Outstanding instalments become immediately payable if: (i) an instalment is not paid when due, (ii) the transferred assets are sold to another party (whether related or not), (iii) the transferred assets are transferred into a non-eu/noneligible EEA member State, or if (iv) the company is wound-up. From France to non-ue member State/noneligible EEA member State. This implies an immediate determination and payment of the CIT payable on the latent gains related to capital assets and on the revenues not previously taxed, without any possibility to defer the tax payment. Individual income tax Exit tax on unrealized capital gains upon transfer of tax residency (Article 167 bis of the FTC) Scope An exit tax is applicable on restricted categories of income, i.e. mainly capital gains related to securities, values or rights hold directly or indirectly in companies and claimable debts connected with earn-out provisions. It may apply to taxpayers who departed France if the cumulative conditions are fulfilled: they have been tax residents of France during at least six out of the ten years preceding the transfer of their tax residency out of France; they own more than 50% of the stocks of a company or have more than EUR 800,000 in shares the day before breaking their French tax residency (these thresholds are in force for departures on or after 1 January 2014). Rate The unrealized capital gains are subject to French income tax (progressive scale) plus additional social contributions (15,5% for FY15). The exit tax on the unrealized capital gain during the period of French tax residency may be postponed with or without a financial guarantee, depending on the country to which the taxpayer transfers her or his tax residency. Deferral of tax payment Tax payment deferral upon request (i.e. without offer of guarantees): A tax payment deferral is granted as a right and without the request for guarantees (under certain conditions) if the

4 4 Tax Alert taxpayer transfers his/her tax residency in a State part of the European Economic Area, Lichtenstein excluded. It is also the case upon the taxpayer s request who must justify that his/ her tax residency transfer is due to professional purposes (even for transfers to a State not part of the EEA, under certain conditions). Tax payment deferral with offer of guarantees: If the taxpayer transfer his/her tax residency in a third party State, in general the taxation is due at the date of departure from France. However, upon his/her request and provided he/she offers specific guarantees, a tax payment deferral can be granted. In all cases, specific tax filling/formalities are applicable. Breach of deferred tax payment Effective from 1 January 2014, after the departure from France, the taxpayer must hold his or her shares for at least 15 years. If the taxpayer decides to sell his or her shares before the end of the 15-year period, the postponement of the taxation ends and the taxpayer is taxable on the gains. The taxpayer must comply with filing obligations before the departure from France and every year thereafter. For further information, please contact Carine Duchemin, Partner, cduchemin@djp-avocats-bdo.fr GERMANY In a recent decision in Commission vs. Germany (C-591/13) the ECJ held that a German provision that allows a roll-over of capital gains from the disposal of certain business assets to newly acquired business assets that are located in Germany is a violation of the freedom of establishment. Currently changes of the respective national rule are under discussion on the legislative level. At this time it is not clear what this amendment would look like. For further information, please contact Christian Erbut, Tax advisor, christian.erbut@bdo.de IRELAND Ireland operates an exit tax on companies migrating residence, by way of deeming the company to have simultaneously disposed of and reacquired its assets at open market value. Exemptions apply to assets used by an Irish branch post-exit, to non-irish situs assets of 75% subsidiaries of Irish companies, and broadly to companies controlled by treaty residents. The migration of residence normally fractures a capital tax group, with potential adverse implications for historic group relief claims. In response to a European Commission reasoned opinion on the potential discriminatory aspects of the Irish provisions, Ireland has introduced a deferral option for exit tax. The deferral takes the form of an election to pay the tax in six equal annual instalments, or not later than 60 days after the disposal of the assets subject to a maximum deferral period of 10 years. The new rules apply for transactions from 1 January For further information, please contact Kevin Doyle, Partner, kdoyle@bdo.ie ITALY Italy had modified its exit tax legislation in after the European Commission had initiated an infringement procedure -, introducing the possibility to either defer the payment of the exit tax until realization or spread the tax payment. A respective decree followed in With a new decree of July 2014, the Italian Ministry of Finance repeals its 2013 decree and introduces new exit tax provisions. Based on the new principles laid down in DMC, the new provisions lead to significant changes. The option to defer payment of the exit tax is no longer infinite as a result of the introduction of a deemed realization -rule. The capital gains on the assets, which have been transferred abroad, are deemed realized in the following situations: 1 in case of amortizable assets, to the extent that the relevant assets are amortized; 2 in case of participations, in case of dividends distribution; 3 for all other assets, when the relevant assets are disposed of. Should these situations not apply, the capital gains are deemed realized after 10 years from the option for deferment in any case. Alternatively, taxpayers may opt for spreading the exit tax payment over a period of 6 years (reduced from 10 years). They may no longer select to exercise the option only for specific assets. Interest is now due in both cases, deferred and spread payment. An act issued on 10 July 2014 by the director of the Tax Authorities specifies which guarantees are due if the option is exercised and which monitoring duties taxpayers are required to comply with. For further information, please contact Federico Sala, Partner, f.sala@studiosala.com NETHERLANDS After the ruling of the ECJ in the National Grid Indus case, the Netherlands amended its tax legislation in order to comply with the ruling. A new Article 25a was introduced in the Dutch Tax Collecting Act 1990, having entered into force as of 29 November In cases of emigration, transfer of seat and cross-border merger that triggers the levying of an exit tax for corporate income tax purposes, the taxpayer is offered three possibilities to choose from: 1 Voluntary immediate payment of the exit tax; 2 Payment at the moment of realization of the capital gain. Depreciation against fair market value of the assets in the new home country is in this respect seen as a partial realization of the hidden capital gain; 3 Payment of the claim in ten yearly instalments, irrespective of the moment of realization. In cases 2 and 3 the taxpayer has to provide a valid security (for the risk of non-payment) and also interest is levied for late payment. In case 2 the taxpayer has to provide information to the Dutch tax administration on a yearly basis of the assets with a hidden tax claim (capital gain) concerning the fact whether the capital gain was realized in that fiscal year. This applies to every individual asset. The rule as such seems to imply that in every case, the taxpayer has to provide a security, for instance by means of a bank guarantee. The DMCjudgment so far has not lead to a discussion with the Dutch state secretary of Finance, whether the Dutch rule of always having to provide a security is in line with this judgment or can be regarded as disproportional. The same rules apply to individuals e.g. entrepreneurs that emigrate resulting in the levying of an exit tax. For further information, please contact Niek de Haan, Partner, Niek.de.Haan@bdo.nl SPAIN Spanish exit tax provisions have recently been amended in 2013 and again in 2015 in order to comply with EU law. The reason being that the wording in force until 31 December 2012 provided for an immediate taxation, without an option for deferral, of unrealized capital gains in the cases of: 1 change of the registered seat of a company outside Spain, unless the assets inherent to such company remain linked to a permanent establishment (PE) located in Spain;

5 5 Tax Alert 2 stop of the ongoing activity of a PE; 3 transfer outside Spain of all the assets that were previously linked to a PE in Spain. The ECJ ruled in the Judgment issued in Case C-64/11, EU Commission against Spain, of 25 April 2013 that Spanish exit tax provisions were in breach of EU Law. As a consequence, Spanish Government amended said provisions through Budget Law 22/2013 of 23 December This amendment, which entered into force retroactively with effect as from 1 January 2013, changed articles 17.1 and 84.1 of the CIT Act by providing the option for the deferral of the payment of the tax corresponding to the unrealized capital gains that might crystallize in the above mentioned exit tax scenarios. This is, under the wording in force since 1 January 2013 unrealized capital gains resulting from exit tax scenarios may either be taxed immediately or be deferred in time. The taxpayer has the option to decide whether he wants to apply the deferral, but only in those cases in which the transfer occurs into another EU or EEA Member State as long as there is an effective exchange of information with the jurisdiction of destination with effective exchange of information with Spain. If the transfer occurs into a jurisdiction of destination outside the EU or the EEA no deferral will be granted as Spain would lose its taxing right as well as control over the event of a hypothetical future transfer of the assets transferred abroad. In case of a transfer of assets to another EU or EEA Member State it must be highlighted that the deferral will be granted until the assets are transferred to third parties or the business is stopped. In these events, the Spanish tax will be triggered. In order to opt for the deferral, the taxpayer will have to guarantee the tax debt either through a bank guarantee or a cash deposit, amongst other possible options. Besides, the deferral will trigger interests for delayed payment (currently set at 4.375% % of the pending tax debt). As opposed to the provisions foreseen in other EU jurisdictions the Spanish legislation does not expressly foresee the spread of payment of the tax debt before its actual realization. However, in our opinion there might be grounds to understand that this should be possible with the current wording of Article 65 of the General Tax Act. Of course this option would also trigger interests. Should the tax payer not opt for such spread of payment, interests will be triggered without any limitation in time. This means that if the period of realization of the hidden reserve exceeds a certain period of time the interest to be paid may exceed the actual amount of the deferred tax debt. Thus, in certain cases it may be an option to apply for the spread of payment in e.g. 5 or 10 annual tranches as foreseen in some jurisdictions. The tax reform enacted with effects for fiscal years starting on or after 1 January 2015 split the provision in force until 31 December 2014 in two separate blocks of articles: Articles 19.1 and 78 of Law 27/2014 of 27 November, which passes the new corporate income tax law, in relation to the valuation of the assets transferred in the change of the registered seat of a Spanish company abroad and Article 18.5 of Royal Legislative Decree 5/2005, of 5 March, which passes the Non-residents income tax law, in relation to the closing of a Spanish PE of a non-resident company and the transfer of the assets of a Spanish PE outside Spain. But, the applicable tax treatment remains unaltered as compared to the tax treatment applicable until 31 December 2014, except for the express recognition of the deferral of the tax payment also for transfers of the registered seat to jurisdictions located in Member States of the EEA, which was not included until 31 December 2014, which was in breach with EU Law. For further information, please contact Eugenio Garcia, Director International Tax Services, eugenio.garcia@bdo.es SWEDEN Sweden has an exit tax rule constituting that amounts set aside to a tax allocation reserve or a replacement reserve will become immediately taxable if a corporate taxpayer ceases to be a tax resident of Sweden due to a tax treaty between Sweden and the country to which the company relocate. This rule also applies to hidden reserves in other taxable assets which means that the assets are deemed to be sold at fair market value. The taxable gain on this event is calculated accordingly. However, it is possible for a company to apply for a tax deferral if a corporate body becomes resident in another EEA country under a tax treaty. The deferral is granted for one year with a possibility of extension for one year at time if the requirements are still met. The tax payment is deferred until an event occurs that would have triggered taxation, should the company still have been resident in Sweden. For further information, please contact Peter Persson, Partner, Peter.Persson@bdo.se UNITED KINGDOM The UK has various exit provisions in its tax code, which are based around the concept of a deemed disposal and reacquisition of the asset (or cessation of the trade) at market value immediately before the departure event. The resulting notional profit or gain would thus fall to be taxed while in the UK. Some of these rules have recently been updated in order to provide for a deferral of the tax payable (it can be paid by instalments where the transfer is within the EU/EEA), although the taxpayer may choose to pay the tax instead in order to avoid having to comply with the record-keeping requirements to track whether assets have been disposed of. For further information, please contact Niek de Haan, Partner, Niek.de.Haan@bdo.nl CONCLUSION The DMC judgement, the Verder LabTec judgement and the latest national developments answer some questions that had remained open after the initial ECJ decision on corporate exit tax in National Grid Indus and the following cases. However, some questions remain unanswered, e.g. whether the country that the taxpayer moves into has to grant a step-up of the base cost. MORE INFORMATION For more information, feel free to contact Niek de Haan. Niek de Haan Chair of the EU Direct Taxes Centre of Excellence BDO Amstelveen, Netherlands Tel: +31 (0) niek.de.haan@bdo.nl Colophon This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Accountants & Belastingadviseurs B.V. to discuss these matters in the context of your particular circumstances. BDO Accountants & Belastingadviseurs B.V., its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it. 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