There are many reasons why shareholders may seek the partial division of their Cyprus company, as the most appropriate means of corporate restructuring. Among them, a partial division secures:
- a more efficient structure that better supports distinct income streams of the Company’s assets;
- maintains and evolves the corporate entity and brand built by the original Company which will continue to exist without dissolving and will seed the creation of the new company;
- ability to transfer same-group assets within an acceptable tax-neutral framework;
- a sound corporate management environment where the relationship between the boards and the shareholders of the same-group companies (old and new) continues to run smooth, albeit now operating as two separate costs centers;
- an ability to diversify and expand operations safeguarded against potential claims that no longer relate to the new lines of activity or operation.
- Represents an alternative to restructure real estate holdings.
Companies Law and Income Tax go hand-in hand in a partial division
Cyprus Companies Law Cap.113 (“Companies Law”) section 200 provides, in rather general terms, for the corporate reorganization or merger of companies. Section 200 (1) provides for the transfer of a whole or part of a company’s business or assets, as outlined in a reorganization plan which is subsequently sanctioned by the Court on a relevant petition. The section goes on to provide (6) six ways in which the Court may use its discretion when evaluating a petition for reorganization, including the power to order for the transfer of assets, the allotment of shares or other securities or interests, the continuation of pending legal proceedings, the dissolution of a company without liquidation, consideration of dissenting views in respect to the proposed reorganization, such other incidental matters which are relevant and conducive to a successful reorganization.
Approaching a partial division solely from a Companies Law perspective, is only half the story. In most scenarios, companies opting for partial division, want to ensure the reorganization is tax-cleared. This is possible due to the EU Directive 2005/19/EC transposed into Cypriot law, in 2007 by amendment 80(I)/2007 of section 30 of the Income Law N.2002 (118/(I)/2002) (“Income Tax Law”). And that’s where the whole partial division venture becomes interesting. Because, Companies’ Law adaptability to the corporate and business realities of splitting a company’s operations, personnel and functions to optimize its performance meets Income Tax Law’s rigidity, in safeguarding against reorganizations used as a means to evade taxable obligations.
According to section 30 (b1) of the Income Tax Law a ‘partial division’ is a division in which a limited liability company, without being subject to liquidation procedure or dissolution, transfers one or more business units to one or more existing or new limited liability companies, leaving at least one business unit in the transferring company. The shareholders of the company undergoing the partial division should, as consideration, receive newly issued shares in each receiving company in proportion to their shareholding. Consideration may also be paid in cash. Any cash paid, cannot exceed 10% of the nominal value or in the absence of a nominal value, the share of the paid-in-share capital in proportion to the issued shares.
Two laws, two distinct procedures, one desired outcome. Challenges ahead?
The boards of companies instructing their advisors to pursue a partial division consist usually of pragmatic people, with long-standing experience in business. Pragmatic people, often require clear-cut answers, to questions like, will the transfer of properties from Company 1 to Company 2 as part of a partial division, be subject to taxation in Cyprus? A simple “yes” or “no” answer is often preferable; however in the case of a partial division in Cyprus, the answer to this question is usually “it depends”. This laconic answer encompasses not only the fact that there are specific legal conditions that have to be met before a partial division can be achieved, but also, the reality that as a procedure it is a ‘young’ one, untested by time or case law. It is also, heavily dependent on the interpretation of section 30 of the Income Tax Law, by the local tax authorities who in interpreting the said provision, are not bound by the Companies Law provisions on reorganization or by with the fact that a partial division is at its core, a corporate procedure.
Main challenges in summary:
- The tax test. The test to be fulfilled for a tax neutral partial division is provided solely in the Income Tax Law. The procedure itself, including the permissible transfers in the course of a partial division, are outlined solely in the Companies Law. The tax authorities are concerned solely with the provisions of the Income Tax Law, whereas the Cypriot courts apply the provisions of the Companies Law. It is possible to have a partial division that is not deemed a partial division under Income Tax Law;
- Lack of guidance. There is little if any guidance on how the test for a tax clear reorganization can be fulfilled. The test itself is quite restrictive. Applicants are required to prove that there is a true division of business units as the underlying reason and purpose of the partial division. However, no guidelines are available as to how the tax authorities apply their discretion in approving or not an application as tax neutral;
- New companies. Companies Law provides that there can be a transfer of assets or liabilities to existing or new companies, with no clarification as to whether reference to “new companies” in Companies Law includes unincorporated entities, which will be incorporated upon the issue of the court’s order for partial division. It is our submission that Companies Law (by reference to decided case law) includes unincorporated entities to be set up following the issue of the court’s order;
- Lack of priority. There is no codified order of priority setting out whether the tax clearance application should precede the court application for a partial division. It is our submission that the two procedures should be followed in parallel so that the respective authorities have a clear overview of the intended reorganization by partial division. In fact, our view is that the two laws should be amended to avoid a scenario where a court rules a reorganization as partial division and the tax authorities fail to rule that it is tax neutral especially, where tax liabilities will be incurred. In our view, that would be contrary to the spirit of the relevant EU directive, aimed at simplifying and promoting reorganizations as an effective means of corporate restructuring.
Key pointers when advising on the corporate aspects of a partial division:
- The reorganization by partial division plan should refer to the purpose of the partial division. The purpose should derive from business practice and commercial realities.
- Make a point of including the tax aspect of reorganization and assessing the requirement for a tax neutral partial division.
- The reorganization by partial division plan should be presented to court in detail, with specific focus on the manner in which assets and liabilities will be divided and how the capital of the new company (if unincorporated) will be allotted.
- Management accounts as at the date of filing of the court order are preferable, and the partial division plan should refer to the same up to date values both for the purposes of the tax clearance application and the court application.
In conclusion, it is our view that a reorganization by partial division has many benefits to offer especially in an economy where corporate restructurings may be the sole means of survival for larger businesses and organisations. For this reason, it is important that professionals, business people alike are aware of the existence of the procedure and the possible ways it may benefit their businesses. At the same time, it is imperative the two laws governing this process are finally aligned, so that it can be adequately promoted and serve the business reality, it was enacted to govern.
For more information on corporate restructurings please feel free to contact advocate Stella Koukounis at [email protected] or at +35722007700. Stella is a Barrister of England and Wales (Lincoln’s Inn) since 2004, a practicing advocate at the Nicosia Bar since 2006 specialising in corporate and commercial law.