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28 September 2020
Companies Law and Income Tax Law go hand in hand in partial divisions
Two laws, two distinct procedures, one desired outcome: challenges ahead?
Key pointers when advising on corporate aspects of partial divisions
There are many reasons why shareholders may seek the partial division of their Cyprus company as the most appropriate means of corporate reorganisation. Among them, a partial division:
Section 200 of the Companies Law (Cap 113) provides, in general terms, for the corporate reorganisation or merger of companies. Section 200(1) provides for the transfer of all or part of a company's business or assets, as outlined in a reorganisation plan which is subsequently approved by the court on a relevant petition. The section provides six ways in which the court may use its discretion when evaluating a petition for reorganisation, including:
Approaching a partial division solely from a Companies Law perspective is only half of the story. In most scenarios, companies that opt for partial division want to ensure that the reorganisation is tax cleared. This is possible due to EU Directive 2005/19/EC, which was transposed into Cypriot law in 2007 by Amendment 80(I)/2007 of Section 30 of the Income Tax Law (2002, 118/(I)/2002). This is where the whole partial division venture becomes interesting. The Companies Law's adaptability to the corporate and business realities of splitting a company's operations, personnel and functions to optimise its performance meets the Income Tax Law's rigidity in safeguarding against reorganisations used as a means to evade tax 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 a 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.
The boards of companies instructing their advisers to pursue a partial division usually consist of pragmatic people, with longstanding experience in business. Pragmatic people often require clear-cut answers to questions such as "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 specific legal conditions must be met before a partial division can be achieved, but also the reality that the partial division procedure is young, 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 which, in interpreting such provision, are not bound by the Companies Law provisions on reorganisation or the fact that a partial division is, at its core, a corporate procedure.
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, is outlined solely in the Companies Law. The tax authorities are concerned solely with the Income Tax Law, whereas the Cypriot courts apply the Companies Law. It is possible to have a partial division that is not deemed as such under the Income Tax Law.
Lack of guidance
There is little if any guidance on how the test for a tax-clear reorganisation can be fulfilled. The test itself is restrictive. Applicants must 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 approving an application as tax neutral.
The 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' includes unincorporated entities, which will be incorporated on the issue of the court's order for partial division. Arguably, the 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. Arguably, the two procedures should be followed in parallel so that the respective authorities have a clear overview of the intended reorganisation by partial division. In fact, the two laws should be amended to avoid a scenario in which a court rules a reorganisation to be a partial division and the tax authorities fail to rule that it is tax neutral, especially where tax liabilities will be incurred. That would be contrary to the spirit of the relevant EU directive, aimed at simplifying and promoting reorganisations as an effective means of corporate reorganisation.
When advising on the corporate aspects of a partial division, parties should remember the following:
A reorganisation by partial division has many benefits, especially in an economy where corporate reorganisations may be the sole means of survival for larger businesses and organisations. For this reason, it is important that professionals and business people alike are aware of the existence of the procedure and the possible ways in which it may benefit their business. At the same time, it is imperative that the two laws governing this process are finally aligned, so that it can be adequately promoted and serve the business reality that it was enacted to govern.
For further information on this topic please contact Stella Koukounis at Solsidus Law by telephone (+357 22 007700) or email (firstname.lastname@example.org). The Solsidus Law website can be accessed at www.solsiduslaw.com.
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