On 20 May 2010, the European Court of Justice ("ECJ") issued a ruling in the Modehuis A Zwijnenburg BV case regarding the application of the anti-abuse provision of the Tax Merger Directive.
The ECJ ruled in favour of the taxpayer, holding that the tax neutral treatment provided for by the directive may not be refused in the context of a merger on the sole ground that a principal objective of the merger is to avoid a tax not covered by the directive, such as a transfer tax on real estate.
The Tax Merger Directive obliges the Member States to ensure that cross-border mergers (or demergers) involving entities located in different Members States are tax neutral. Neither the entities concerned nor their shareholders are subject to tax on e.g., gains on the reorganization.
However, where it appears that a principal objective of the merger is to evade or avoid tax, the Member States may refuse to apply the directive pursuant to the anti-avoidance provision contained in Article 11(1)(a). A merger which is not driven by valid commercial or business reasons (e.g., the restructuring or rationalization of activities) may be presumed to constitute tax avoidance.
The son of Mr and Mrs Zwijnenburg owned a Dutch clothing company, Modehuis A Zwijnenburg BV. The company operated two shops, one in its own premises and another in premises leased from a real estate company owned by Mr and Mrs Zwijnenburg, Zwijnenburg Beheer.
The family wished to consolidate the shops and premises into a single entity. However, a transfer of real estate (or the shares in a real estate company) triggers transfer tax. To avoid this tax, Modehuis A Zwijnenburg BV had to transfer its clothing business to Zwijnenburg Beheer, so that the latter would no longer be considered a real estate company. In this way, the parents could sell their shares in Zwijnenburg Beheer without triggering transfer tax. Initially, the taxpayers considered giving Modehuis A Zwijnenburg BV an option to acquire the shares held by the parents in Zwijnenburg Beheer after the latter had been converted into a commercial company .
By structuring the transfer of the clothing business to Zwijnenburg Beheer as a merger, the taxpayers could avoid corporate tax under Dutch law. However, the Dutch tax administration held that the merger could not benefit from the exemption provided for by the Tax Merger Directive since it was not, as such, driven by commercial reasons but rather was carried out for the purpose of avoiding transfer tax.
The ECJ ruled that since the Tax Merger Directive does not cover transfer tax, the avoidance of this tax cannot constitute a sufficient reason for denying the benefit of the directive. The directive must be applied, except in the case of wholly artificial arrangements clearly aimed at avoiding taxes specifically covered by the directive.
In her opinion, the Advocate-General went one step further, stating that if the overall transaction has a legitimate economic purpose, such as consolidating a business, it is not necessary to verify whether the principal objective of the merger is to avoid tax. The ECJ, however, limited its decision to the issue raised in the request for a preliminary ruling.
This judgment applies to both cross-border and domestic mergers in Member States such as the Netherlands and Belgium whose implementing legislation covers both types of mergers. As far as Belgium is concerned, the judgment will oblige the Ruling Commission to amend its recent draft opinion on mergers and contributions (DUT/FRE). The Ruling Commission indicated that it would refuse to issue a positive ruling if the structure yields tax advantages but has no economic purpose. In the wake of the Zwijnenburg judgment, however, a positive ruling may only be refused if a (or the) principal objective of the merger is to avoid corporate tax.