The Austrian Ministry of Finance (Bundesministerium für Finanzen) has proposed certain changes regarding the international participation exemption which, if enacted, could lower the attractiveness of Austrian holding companies and adversely affect M & A transactions in Austria.
II. Current Regime
Austrian corporations are subject to corporate income tax (Körperschaftsteuer) at a rate of 34%. However, under the international participation exemption (Befreiung für internationale Schachtelbeteiligungen) set forth in sec. 10(2) of the Austrian Corporate Income Tax Act (Körperschaftsteuergesetz), dividends and capital gains resulting from qualifying participations are tax-exempt. The following conditions must be fulfilled for the international participation exemption to apply:
- An Austrian corporation ("Parent"), e.g. a stock corporation (Aktiengesellschaft) or a limited liability company (Gesellschaft mit beschränkter Haftung),
- has a participation of at least 25% in the share capital
- of a foreign company ("Subsidiary"), which either is comparable to an Austrian corporation (as opposed to a partnership) or has a legal form listed in the annex to the EC Parent/Subsidiary-Directive,
- with the participation having been held for an uninterrupted period of at least two years.
If these conditions are met, then (i) any dividends received by Parent from its participation in Subsidiary and (ii) any capital gains realized by Parent upon the sale of its participation in Subsidiary will be exempt from Austrian corporate income tax.
Regarding the two-year holding period, it should be noted that capital gains realized by Parent before the expiry of the two-year period are always taxable. If, on the other hand, Parent receives dividends from its participation in Subsidiary before the expiry of the two-year holding period, then the dividends are only temporarily subject to corporate income tax. The tax on the capital gains will be refunded after expiry of the two year holding period should Parent then still hold its participation in Subsidiary.
Sec. 10(3) of the Austrian Corporate Income Tax Act contains a special anti-abuse provision relating to the international participation exemption. This provision applies if all of the following conditions are met or if at least two of the following conditions are definitely fulfilled and a third one is closely met:
- Subsidiary focuses on earning passive income (i.e. interest income, rental income, income from royalties and income from capital gains), as opposed to engaging in an active trade or business;
- Subsidiary's effective tax burden is less than 15%; and
- Parent's ultimate shareholders are predominantly Austrian residents.
In this case, the international participation exemption is replaced by an indirect foreign tax credit system ("switch-over").
Thus, if Subsidiary is a company in a low tax jurisdiction earning only passive income, the applicability of the anti-abuse provision would depend on who the ultimate shareholders of Parent are. Should Parent's ultimate shareholders be predominantly non-Austrian residents, then the anti-abuse provision would not apply and dividends paid out by Subsidiary to Parent would be tax-free. Should Parent's ultimate shareholders be predominantly Austrian residents, then the anti-abuse provision would apply and dividends received by Parent from Subsidiary would be taxable at a rate of 34%, with the possibility of receiving a tax credit for foreign withholding taxes and taxes on underlying income.
III. Concerns voiced
The European Union's Code of Conduct Group ("Primarolo Group") voiced concerns already some years ago regarding the Austrian international participation exemption in its report to the ECOFIN Council. The two contentious issues were:
- The Austrian international participation exemption exempts from tax capital gains, while capital losses are not affected ("asymmetry"). I.e. if Parent sells its participation in Subsidiary at a loss, then this loss may (with certain limitations) be deducted for tax purposes.
- The anti-abuse provision contained in sec. 10(3) of the Austrian Corporate Income Tax Act provides tax benefits to non-residents that are not equally granted to residents ("ring-fencing"). I.e. the anti-abuse provision will never apply if Parent's ultimate shareholders are predominantly non-Austrians.
IV. Proposed Changes
The Austrian Ministry of Finance has proposed (i) excluding capital gains from the international participation exemption, and (ii) amending the anti-abuse provision by doing away with the requirement relating to Parent's ultimate shareholders. A respective bill was introduced in the Austrian Parliament in the autumn of 2002. However, due to the Austrian general elections in November 2002 and the resulting lack of time regarding the discussion of the bill, it was eventually not put up to a vote.
According to the proposal,
- capital gains realized by Parent upon the sale of its participation in Subsidiary would have become taxable (while capital losses would – consequently – have remained tax-deductible); and
- the anti-abuse provision would always have become applicable in the case of Subsidiary being subject to a low level of taxation and earning passive income, irrespective of whether Parent's ultimate shareholders are predominantly Austrians or non-Austrians.
Under a transitional rule contained in the proposal, the amendments would have entered into force as of January 1, 2003. However, for those companies registered with the Commercial Register (Firmenbuch) before January 1, 2001, the amendments would have taken effect only as of January 1, 2006. In any case, the proposed amendments would have been fairly disadvantageous to Austria as a – currently very attractive – holding location and would have negatively affected M & A transactions in Austria.
Even if the proposal described herein did not become law until now, there is reason to believe that sooner or later the Austrian legislature will enact these changes. A leading official of the Austrian Ministry of Finance has confirmed in January 2003 that in his view the changes relating to the anti-abuse provision will quite definitely be enacted, while the plans relating to the capital gains exemption could possibly be shelved. The further developments in this area will have to be closely watched.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.