Inbound dividends from low-tax jurisdictions may not be exempt from Austrian corporate income tax under the Austrian international participation exemption but may be subject to a switch-over to the credit method. In the past, such profits could be repatriated by way of a tax neutral import merger instead. However, a recent amendment to the Austrian Reorganisation Tax Act may lead to a fictitious distribution in such cases.
Switch-over for inbound dividends
Under the (Austrian) international participation exemption (at least 10% shareholding held for at least one year), foreign source dividends received by the Austrian parent corporation are generally exempt from Austrian corporate income tax. However, under a statutory assumption of misuse the exemption does not apply if (simplified) the predominant business purpose of the foreign corporation is the generation of passive income (passive-income test) and the income of the foreign corporation is subject to taxation that is not comparable to Austrian corporate income taxation (no-comparable-taxation test).
If misuse is assumed under these tests, a switch-over from the exemption method to the credit method applies. That is, the foreign dividends are not exempt from Austrian corporate income tax at the level of the Austrian parent corporation but the foreign tax is credited against the Austrian corporate income tax liability.
Repatriation of profits by import merger
Due to this switch-over rule, the repatriation by way of a dividend of profits from a subsidiary generating predominantly passive income (eg, interest or royalties) in a low-tax jurisdiction would be subject to Austrian corporate income tax and there would only be a credit for the (low) foreign tax on the distributed amount. As a consequence, such profits were not distributed but retained in the foreign subsidiary (cash-box).
Instead of the repatriation of profits by way of a dividend, the retained foreign profits could be repatriated by a tax neutral (import) merger of the cash-box corporation into the Austrian parent corporation within the scope of the Austrian International Reorganisation Tax Act. In this case, the difference between the book value of the shareholding and the received net assets (including the retained profits) resulted in a tax neutral book profit at the level of the Austrian parent corporation.
With the Tax Amendment Act 2010, a new provision was introduced that applies to mergers resolved after 30 June 2010. According to this provision, there shall be a fictitious distribution in the case of an import merger if, at the effective date of the merger, the prerequisites for a switch-over under the Austrian international participation exemption are met. The new provision also covers the special switch-over rules for certain foreign portfolio shareholdings (less than 10% shareholdings). However, portfolio shareholdings should not be practically relevant within the present context.
If the prerequisites for the switch-over are met, the difference between the net assets accounted for in the balance sheet of the foreign subsidiary and the paid-in registered capital are deemed distributed as an overt distribution at the beginning of the day following the effective date of the merger.
Amount of fictitious distribution
The above-mentioned calculation of the fictitiously distributed amount (net assets reduced by paid-in registered capital) does not take into account other contributions than those made on registered capital. Under Austrian accounting law, such other contributions would be accounted for as a capital reserve. Consequently, if the prerequisites for the switch-over are met, the import merger may result in a taxable (fictitious) distribution of previous contributions accounted for as a capital reserve.
Disregarding contributions to capital reserves for present purposes was reasoned with the suspicion that there is not always a clear distinction between profit reserves and capital reserves in low tax jurisdictions. However, under the Decree of the Austrian Federal Ministry of Finance on the Repayment of Contributions, the principles of contributions and repayments of contributions shall also apply to comparable foreign corporations to the extent proof is provided that a certain payment is a repayment of a contribution. On that basis, the general restriction to paid-in registered capital seems unreasonable in cases where proof of repayment of a contribution can be provided.
Further, not the entire registered capital reduces the amount of the fictitious distribution, but only paid-in registered capital. In contrast, registered capital due to a capital increase that is funded out of the profits of the foreign corporation would not be taken into account (because such registered capital is not considered "paid-in").
Assessment at the effective date of the merger
The business purpose of a corporation may change over time. As a consequence, the retained profits of the foreign corporation may consist of profits from both periods with a predominantly passive business purpose and periods with a predominantly active business purpose. Equally, changes in the applicable local tax regime may result in profits that were subject to a tax comparable to Austrian corporate income tax and profits which were not.
When applying the passive-income test and the no-comparable-taxation test under the international participation exemption, such changes are taken into consideration. As a result, certain portions of a dividend may fall under the exemption while other portions are subject to the switch-over.
Under the new provision for import mergers, the facts and circumstances at the effective date of the merger are decisive as to whether the retained profits are deemed distributed. If the prerequisites for the switch-over are met at this time, the fictitious distribution is triggered. However, if a fictitious distribution is triggered, the exemption method should apply to portions of the fictitious distribution that were not generated under circumstances that would lead to a switch-over.
Conformity with union law?
Commentators have questioned the new provision in light of the freedom of establishment and the Merger Directive. Arguments were brought forward both for and against conformity with union law. These considerations may be relevant with respect to the import merger of a foreign subsidiary resident in another EU member state, particularly Ireland or Cyprus, however not in low-tax jurisdictions outside the EU.