The possibility to amortize for tax purposes the goodwill arising in a merger has historically been allowed in several jurisdictions, including Spain, Austria –see EUCJ Finanzamt Linz case– or notably Brazil – the so-called “ágio”– in South America.
Such goodwill represents the overprice paid by the absorbing entity over the market value of the net assets of the absorbed entity. This difference also appears in the process of accounting consolidation, where it is commonly known as “first time consolidation difference.”
From a tax perspective, if the purchaser has paid a price over the market value of the underlying assets, it is likely that the seller has paid taxes over such amount. That is why this tax-amortizable goodwill has been considered a method to eliminate double taxation in many countries. This is a strange method, because the seller pays the tax and the purchaser gets the tax credit, but we will all agree that sometimes tax rules are not completely logical.
To make this cocktail even more complex, EU jurisdictions have a special tax-neutral regime based on Council Directive 2009/133/EC (the “Mergers Directive”). Under this regime, underlying gains in the assets of the absorbed entity are not subject to tax as a result of the merger, provided that the absorbing entity values them at their historic tax cost. But Member States are allowed to reject this tax deferral when the merger has tax evasion or tax avoidance as one of its main objectives.
You will not be surprised when learning that, for the Spanish tax inspection, a merger whose outcome is the birth of a tax-depreciable amortizable asset is a suspicious transaction. This is even clearer when the absorbing entity is a holding company incorporated to purchase the shares in the absorbed subsidiary. In these cases, which are common in M&A transactions, the Spanish tax inspectors have always rejected the EU Mergers Directive neutrality.
I have never understood how following a rule whose rationale is to protect from double taxation could be understood as illicit tax avoidance. But for years, carrying out an upstream merger in Spain entailed the risk of being taxed on the underlying gains of the subsidiary’s assets. This risk was particularly present in those cases where the parent company had financed the acquisition of the shares in the absorbed subsidiary with debt. Spanish courts reviewing tax cases have always disliked upstream merges of companies acquired through leveraged buy-out transactions, as they are considered a way to circumvent the prohibition of a company giving financial assistance for the purchase of its own shares.
The good news is that a recent judgment of the Spanish High Court (here its Spanish version) has confirmed the tax depreciation of a merger goodwill amounting to EUR 59 million in a clearly planned M&A transaction.
The background of the case relates to a foreign group that created a Spanish holding company with the only purpose of acquiring the shares in an operating company. Several contractual agreements within the purchase stated the acquiring group’s will to approve an upstream merger in the search of the goodwill tax benefit, so the intention of the parties to pursue a tax goal was obvious.
The tax inspection considered this transaction a clear case of tax avoidance and rejected the application of the tax roll-over relief usually given to mergers. This position resulted in denial of the tax amortizable goodwill and an additional tax bill for over EUR 7 million. But the Spanish High Court finally annulled the tax inspection’s assessment on the grounds that goodwill arising in a merger is not an illicit goal but the normal consequence that the tax provisions establish when a company pays overprice for assets and liabilities that are, as a whole, a going concern.
It is too soon to say that this judgment is a turning point in our court’s doctrine against giving any benefits to merger transactions carried out within LBO transactions. Yet, it is a remarkable precedent that reminds us that not all tax benefits are illegal; some are in place to avoid double taxation and, therefore, should be utilized by taxpayers without fear of facing disproportionate tax bills.