The commercial enterprise of a company constitutes a set of rights, obligations, and factual relationships. As a company grows, the scope of its commercial enterprise also expands, which means that the number of rights and obligations increases as well.
At any given moment, a company may choose—whether for accounting reasons or in order to separate a specific core activity—to divide or separate out part of this set into a separate company. Others may prefer a different legal form and transform their company from a limited liability company (LLC) into a joint-stock company (JSC), or vice versa.
In any case, however, an important question arises: what would be the tax effect?
Commercial Law Perspective
In each of the above hypotheses, which we may generally refer to as corporate restructuring, from a commercial law perspective we are dealing with a corresponding type of transformation within the meaning of Chapter Sixteen of the Commerce Act (“CA”).
Transformations may take various forms. Among them are, for example:
- Spin-off into a newly established or existing company;
- Division into two or more newly established companies;
- Change of legal form.
In each case, there is also a corresponding type of legal succession, meaning the transfer of rights and obligations from one entity to another. For example, in the case of a spin-off, there is partial succession—specific rights and obligations included in the transformation agreement or plan are transferred. In the case of a change of legal form, the succession is universal—all rights and obligations pass from the transforming company to the receiving company.
Tax Effect
Since in any type of transformation there is a transfer of certain assets from one legal entity to another, it is reasonable to ask what the tax effect of such a transformation would be. Will it be considered a supply of goods within the meaning of the Value Added Tax Act (“VAT Act”)? Accordingly, will any of the companies participating in the transformation be required to pay VAT?
The answer can be found in Article 10 of the VAT Act. According to item 1 of that provision, “the supply to the acquirer by the transforming entity […] as a result of a transformation of a commercial company under Chapter Sixteen of the Commerce Act shall not be regarded as a supply of goods or services.”
The interpretation of this provision leads to the conclusion that all types of transformations fall within the scope of Article 10 of the VAT Act. In other words, regardless of the type of transformation chosen, the transfer of assets resulting from the transformation will not be regarded as a supply of goods and no VAT will be due on it.
In fact, in such a transformation the receiving company becomes the successor to all rights and obligations under the VAT Act, including the right to deduct tax credit and the obligation to make adjustments to previously deducted tax credit.
All of this leads to the conclusion that transformations represent a very convenient and economically and legally sound way to separate a specific set of rights and obligations into a new or already existing company.
Additional Effects under the Corporate Income Tax Act and the Local Taxes and Fees Act
The above statement regarding the transfer of all rights and obligations arising under the VAT Act also applies to rights and obligations under the Corporate Income Tax Act, arising from actions carried out by the transforming companies in the current and previous periods. These also pass in full from the transforming company to the receiving company. Their scope, of course, is limited according to the specific rights and obligations (in the general commercial and legal sense) that are the subject of the transformation.
The transformation also does not fall within the cases where a local tax on the acquisition of property is due under the Local Taxes and Fees Act.
The article above is for information purposes only. It is not a (binding) legal advice. For a thorough understanding of the subjects covered and prior acting on any issue discussed we kindly recommend Readers consult Ilieva, Voutcheva & Co. Law Firm attorneys at law.
