From its issuance in 2003, the Romanian Fiscal Code has included special provisions regarding the taxation of business companies reorganizations. In a nutshell, Article 27 of Law 571/2003 established that the simple fact that a certain business is reorganized through a merger, demerger or acquisition, was not subject of taxation, at both corporate and shareholders level, provided that the operation complied with certain conditions. Fair enough, but the text was so ill written, that it was a constant source of confusion and misinterpretation that made many companies in the past twelve years to abandon otherwise well-thought plans due to the unacceptably high level of fiscal risk.
SO, WHAT WAS WRONG WITH ARTICLE 27 ?
For starters, there were only four classes of operations that were fiscally neutral: mergers in form of amalgamation, demergers, acquisitions of businesses in exchange for shares and acquisitions of companies in exchange for shares. The mergers in form of absorption and the spin-offs (which are by far the most frequently used reorganization methods) were left out completely.
In addition, in case of acquisitions of businesses, the code missed the target completely: acquisitions of businesses in exchange for any shares, not necessarily shares newly issued by the acquiring company, were tax exempt. Unlike in the case of acquisitions of companies where it was explicitly stated that the shares had to be issued by the acquirer. So, if anyone happened to own some completely illiquid shares or shares in a financially condemned company, there was an opportunity to trade them tax free in exchange for a brand new business. And it happened, no doubt about it.
Things did not stop there.
Regarding the demergers, only those in which the shareholders of the original company acquired shares „proportionally” [sic!] in the beneficiary companies were tax exempt. Which raises a simple question: proportionally to what? Yes, I know, the answer should be proportionally to the stakes held in the demerged company, but in Romania this answer is the wrong one for two reasons.
First, unlike in other countries, in Romania unproportional (or asymmetrical) demergers are perfectly legal under the Law of Business Companies. Second, there were no provisions in the code for special cases. What if during the demerger process, one or more discontent shareholders exercise their legal right to withdraw from the company? Or, if due to the arithmetics of the demerger shares simply cannot be issued proportionally? Or, if one ore more shareholders refuse to become shareholders in the beneficiary company but do not want to have their shares repurchased by the demerged company either (which happens especially if the beneficiary company is a LLC)?
Concerning the mergers, they were exempt only if the shareholders of all the merged companies received shares in the beneficiary company. First, it should be noted that this conditions excludes from being tax exempt mergers in which the merged company is fully owned by the absorbing company and those in which the merged company has negative net assets. In both cases, the shareholders of the merged company are not entitled to receive shares issued by the absorbing company, by law. Second and again, Article 27 did not cover special situation such as the case of withdrawing shareholders and for the cases where there are shareholders in the merged companies whose shares value less than one share of the absorbing company.
AND WHAT ARE THE IMPROVEMENTS IN THE NEW FISCAL CODE ?
First, both spin-offs and mergers in form of absorption, including the special case of wholly owned merged company, are now included in the list of fiscally neutral reorganizations.
Second, acquisitions of businesses in exchange for shares are tax exempt if the shares are issued by the acquiring company.
Third, by removing the proportionality condition altogether from the definition of demergers, all the above mentioned demerger scenarios are now covered by the code. It is to be noted however, that this is a rather drastic change. It would have been better by far if these situations would have been treated as special cases. Or at least if it would have been provided that the distribution of shares must be such that the proportionality between their market value and their par value would have been preserved throughout the demerger.
Unfortunately, except the case in which the merged company is fully owned by the absorbing company, all the other special cases of merger are still not dealt with explicitly. And while in the case of withdrawing shareholders and in thee case of shareholders not receiving shares due to the low value of their holdings there are other legal provisions that alleviate the problem, the case of merged company with negative net assets value is still not covered.
But to paraphrase the last line from ”Some Like It Hot”, nothing is perfect!