The Austrian Ministry of Finance recently issued draft guidelines on the Reorganization Tax Act, which, if implemented, would have disadvantageous effects on domestic and cross-border M&A transactions. Austrian and foreign investors considering a debt-financed share deal would no longer be able to deduct interest related to the acquisition of shares through post-acquisition restructuring mechanisms.

Under current tax rules and practice, investors prefer asset deals since assets (and goodwill) can be re-valued or stepped up and the interest on debt relating to such deals is deductible. However, in circumstances where the seller intends to enjoy the tax benefits of gains arising from shares in the target company, only a share deal may be enforced.

In share deals, Austrian and foreign investors face various problems that could well be exacerbated by the new guidelines.

The ability to step up any depreciable tax basis (including goodwill) through post-acquisition mergers was abolished in 1996. In the case of debt-financed deals, post-acquisition reorganizations were used to secure at least the interest deduction. Common methods that were employed included (i) the establishment of newco in Austria, financed by debt which was then merged with the target company, or (ii) the transformation of the target company into a (tax-transparent) partnership. Austrian tax authorities ignored the link between interest payments and potential tax-exempt dividends from the target company, so that debt related interest became deductible.

Under the draft guidelines, the Austrian Ministry of Finance aims to restrict interest deduction through the use of post-acquisition restructuring techniques. The draft guidelines provide for a new interpretation of the law in this respect, and are expected to become effective retroactively for all reorganizations performed in 2002.

Tax experts and the Chamber of Certified Accountants and Tax Advisers have criticized the new guidelines, the final version of which is dependent on negotiations with the Ministry of Finance and its willingness to compromise or even withdraw the proposed restriction.

Investors considering such deals in Austria should, therefore, follow developments in this area carefully and bear in mind that another means of deducting interest (ie, by establishing fiscal unity) may also prove difficult to achieve. Previously, the Austrian Supreme Administrative Court has ruled that a holding company does not qualify as the parent company of a fiscal unity if its activities are limited to the management of subsidiaries.

For further information on this topic, please contact Reinhard Leitner or Gerald Gahleitner at Leitner & Leitner by telephone (+43 7327 0930) or by fax (+43 732 7093 303) or by email ([email protected] or [email protected]).