Recently, the Austrian Parliament adopted the Tax Reform Act of 2005 (Steuerreformgesetz 2005), which will have a significant impact upon the taxation of corporations in Austria. The most important elements of the Act include:
- a considerable reduction in the corporate income tax rate;
- the introduction of new group taxation rules, which allow setting off the profits of group members with the losses of other group members for tax purposes;
- the introduction (within the framework of the new group taxation rules) of the amortization of goodwill acquired in a share deal;
- the statutory recognition of recent case law regarding the application of the losses of foreign permanent establishments against the income of their Austrian head offices; and
- the introduction of the deductibility of interest on loans taken out in connection with the acquisition of shares.
2. Corporate Income Tax Rate
In the last few years, more than 1,000 leading international companies have established headquarters in Austria for their Central Eastern European operations, effectively transforming Vienna into a hub for companies working the markets in this increasingly important region. These include well-known corporations such as Alcatel, Beiersdorf, Bosch, Coca-Cola, Eli Lilly, Flextronics, Generali, Henkel, Hewlett Packard, HypoVereinsbank, IBM, Masterfoods, McDonalds, SAP, and Siemens. While Austria has, and will have until the end of this year, a nominal corporate income tax rate of 34%, tax rate competition is on the rise, with the EC accession countries having dramatically slashed their rates recently (e.g. as of 1 January 2004, the Czech Republic has a corporate income tax rate of 28%, Poland 19%, the Slovak Republic 19%, and Hungary a rate of 16%).
In order to preserve Austria’s attractiveness as a business location, the Tax Reform Act of 2005 provides for a reduction in the corporate income tax rate to 25% for all profits earned after 1 January 2005. According to the legislative materials, this translates into an effective rate of approx. 21%, as Austrian rules for determining the tax base are quite favorable, in comparison to other countries.
3. Group Taxation
3.1 Status Quo
Under the concept of fiscal unity (Organschaft) presently in force, Austrian corporations (a parent and its subsidiary) may elect to form a fiscal unity, the consequence of which is that the subsidiary’s income is attributed to the parent. In addition to the requirement of concluding a profit and loss transfer agreement (Ergebnisabführungsvertrag), the parent must exercise financial, economic, and operational control over the subsidiary:
- financial control is only presumed if the parent owns at least a 75% stake in the subsidiary (this requirement was criticized since the control threshold is rather high and effectively precludes many companies from forming a fiscal unity);
- economic control requires that the subsidiary’s business complement the parent’s business (in the case of a pure holding company, no such complementary function is deemed to exist, and thus holding companies are generally prohibited from forming a fiscal unity); and
- operational control is presumed if members of the parent’s board of directors also sit on the subsidiary’s board of directors (this requirement is rather awkward insofar as it leads to arbitrary organizational structures incentivized by tax law rather than driven by business necessities).
It is these stringent and inflexible criteria mentioned above that have, for some time now, led to calls for a complete revision of the fiscal unity rules. The new group taxation rules introduced by the Tax Reform Act of 2005 are intended to replace the fiscal unity concept with a more modern, state-of-the-art regime, which is to enter into force at the beginning of 2005.
3.2 Prerequisites of a Tax Group
Affiliated corporations may form a tax group by jointly filing a group taxation application with the tax authorities. Affiliated corporations are corporations that are connected through a direct or indirect participation of more than 50% of the nominal capital and voting rights. Such participation must exist throughout the entire fiscal year of the member of the tax group. Economic and operational control over subsidiaries is no longer required, nor will a profit and loss transfer agreement be necessary for the purpose of setting up a tax group under the new concept.
The top-tier corporation in a tax group (Gruppenträger) may be:
- a corporation with its legal seat or place of management in Austria (resident corporation);
- a corporation with its legal seat and place of management outside of Austria (non-resident corporation) if such non-resident corporation has a permanent establishment (Zweigniederlassung) in Austria entered into the commercial register (Firmenbuch) and the required participations are attributable to such permanent establishment; or
- a consortium (Beteiligungsgemeinschaft) consisting of two or more corporations as specified above (whether structured on a company law basis or a purely contractual basis), provided that one consortium partner has a participation of at least 40% and each of the other consortium partners has participations of at least 15% (cf. Schematic 2, infra).
Members of a tax group (Gruppenmitglieder) may be
- resident corporations; and
- non-resident corporations if the critical participations in such non-resident corporations are exclusively held by resident corporations in the tax group or the top-tier corporation in the tax group (i.e. whereas resident corporations of all tiers may be included in a tax group, only first tier non-resident corporations are allowed – this seems to contradict the fundamental freedoms of the EC Treaty as far as non-resident corporations in other Member States are concerned).
Whether the companies in a group earn active or passive income is irrelevant. Thus, pure holding companies are no longer precluded from participating in a tax group.
3.3 Consequences of Establishing a Tax Group
The formation of a tax group under the new concept results in 100% of the taxable income of each member of the group being attributed to the top-tier corporation in the tax group. The incomes of the various group members are calculated separately and then attributed to such top-tier corporation. Thus, unlike in consolidation processes, income resulting from intra-group transactions is not eliminated for the purpose of calculating group income. Since the income of a group member is taxed in the fiscal year of the top-tier corporation in which the fiscal year of the group member ends, staggering fiscal years of the members of a tax group may be used as a method for deferring income. Furthermore, it is important to note that setting up a tax group in no way affects the profits of the corporations involved under financial accounting rules.
Group member tax loss carry-forwards resulting from taxable years ending before the tax group was established (Vorgruppenverluste) and tax loss carry-forwards assumed by group members pursuant to a restructuring (Außergruppenverluste) can only be applied against profits generated by the respective group member. On the other hand, tax loss carry-forwards of the top-tier corporation in a tax group can be applied against such corporation’s own profits and also against the profits of group members. These limitations on the usage of tax losses require careful planning since, under certain circumstances, it may be advantageous not to include all companies within a particular group of companies in the tax group right from its inception, but to rather gradually expand the scope of the tax group, thus optimizing previous tax losses.
Schematic 1: Tax Group with Austrian Subsidiary
In the case of a tax group formed by a consortium, 100% of the taxable income of each member of the group is attributed to the consortium partners on a pro-rated basis.
Schematic 2: Tax Group formed by a Consortium
In the case of non-resident corporations that are members of a tax group, it is important that only the negative income (i.e. losses) of such corporations is attributed (on a pro rata basis) to the top-tier corporation. Thus, the losses of non-Austrian subsidiaries can be utilized in Austria even though, under general principles, their profits are only taxable in the respective foreign countries (such losses have to be calculated according to Austrian tax rules). Losses will be recaptured in Austria (i.e. the losses that were previously deducted will increase the group’s taxable income) to the extent the non-Austrian subsidiary utilizes the losses abroad (by offsetting the losses with positive income) or drops out of the tax group (except due to liquidation or insolvency). Regarding the losses of foreign permanent establishments, which are in many, but not all, respects treated like losses incurred by foreign subsidiaries, see infra 5.
Schematic 3: Tax Group with non-Austrian Subsidiary
3.4 Group Taxation Application
A tax group is not formed automatically. Instead, a so-called group taxation application has to be filed in order to create a tax group. Such application must be executed by the management boards of all of the Austrian affiliated corporations that wish to participate in the group. The tax authorities will render a binding decision on whether the prerequisites necessary for establishing a tax group have been fulfilled. Further, the tax group must have a minimum duration of three years.
In addition, the application has to contain a declaration stating that an agreement has been concluded between the affiliated corporations regarding the compensation of group members for corporate income taxes paid or not paid as a result of establishing the tax group (it is, however, not necessary to set out the details of such agreement in the application). If, for example, positive income of one group member is attributed to another group member, then the latter will incur higher corporate income tax payments for which it will want to be reimbursed. If, on the other hand, the negative income of one group member is attributed to another group member by virtue of the group arrangement, then the latter will effectively pay less corporate income tax while the former will forego valuable tax loss carry-forwards for which it will require compensation (all the more so since mandatory Austrian capital maintenance rules forbid benefits of a corporation not in the form of declared dividends from being transferred to the corporation’s shareholder). Such compensatory payments (Steuerumlagen) are deemed tax-neutral.
3.5 Writing Down of Participations in a Tax Group
Last but not least, it should be mentioned that the Tax Reform Act of 2005 unfortunately stipulates that no deductions shall be allowed for any impairment in value of participations in corporations that are part of a tax group. Therefore, careful planning is necessary with respect to which entities within a group of companies should form a tax group.
4. Goodwill Amortization
At present, an Austrian corporation acquiring a business by way of an asset deal must first capitalize and then amortize over a period of 15 years any goodwill purchased in such transaction. In contrast, the acquisition of a business through a share deal results in the capitalization of the shares with no possibility of a tax-effective amortization of goodwill. In particular, unlike some other countries, Austria currently does not provide for the possibility of treating a share deal as an asset deal for tax purposes (cf. the sec. 338 election afforded by the US Internal Revenue Code).
The Tax Reform Act of 2005 contains a provision pursuant to which goodwill acquired in the acquisition of an Austrian corporation by a group member (as defined supra 3.2) is to be amortized and subsequently deducted for tax purposes – the effect of this being that asset and share deals will be treated equally in this respect. Goodwill is calculated as follows:
- the acquisition cost of the shares of the corporation being acquired
- minus the (proportionate) amount of equity of the corporation acquired (as set out in the corporation’s financial statements)
- minus the (proportionate) amount of any hidden reserves contained in the non-depreciable fixed assets of the acquired corporation (here, it is as yet unclear whether the hidden reserves pursuant to financial or tax accounting are relevant).
In any case, goodwill is limited to an amount of 50% of the acquisition cost and is to be amortized over a period of 15 years.
Thus, if, for example, 100% of the shares of a corporation were acquired against a total consideration of EUR 300m with the corporation having an equity of EUR 100m and hidden reserves of EUR 40m contained in real estate, amortizable goodwill would be calculated as:
EUR 300m (acquisition cost)
– EUR 100m (equity)
– EUR 40m (hidden reserves)
= EUR 160m
with a cap at EUR 150m (50% of the acquisition cost).
As a consequence, the taxable income of the acquiring corporation would be reduced by an amount of EUR 10m annually over the next 15 years.
Negative goodwill (badwill) is treated symmetrically: if the aforementioned corporation had equity of EUR 450m and no hidden reserves, badwill would amount to EUR 150m and would result in the acquiring corporation having EUR 10m of additional taxable income over the next 15 years. In such a case, clearly the corporation to be acquired should not be included in the tax group.
It should be noted that goodwill amortization is mandatory. Furthermore, the amortization of goodwill acquired by way of a share deal is limited to acquisitions of shares in corporations actively engaged in a trade or business (Betrieb) – thus, pure holding companies are excluded. Also, acquisitions through transparent entities (partnerships) do not benefit from the amortization rules. Furthermore, the amortization of goodwill is limited to acquisitions of shares in Austrian corporations – a discriminatory limitation clearly not in line with higher-ranking EC law.
5. Losses of Foreign Permanent Establishments
In a very surprising decision rendered in 2001, the Austrian Administrative Court (Verwaltungsgerichtshof) ruled that losses generated by foreign permanent establishments may be deducted by an Austrian taxpayer even if the relevant double taxation treaty applies the exemption method, the effect of this being that only positive foreign income is exempted while negative foreign income may be set off against other domestic income. The Tax Reform Act of 2005 incorporates the main principles of the decision into the statute. In particular, the following will now be stipulated:
- Foreign losses are to be calculated pursuant to Austrian (rather than foreign) tax rules.
- Such foreign losses may be deducted from Austrian income if they cannot be utilized abroad.
- As soon as foreign losses are utilized abroad, the Austrian tax base is increased correspondingly (recapture).
The rules for calculating taxable income may be different in Austria and in the country in which the permanent establishment operates (such discrepancy may, for example, result from different depreciation rules), which may lead to the possibility of achieving "double-dips". The following example may serve as an illustration: an Austrian corporation has a permanent establishment in Austria and a permanent establishment in a country with which Austria has concluded a double taxation treaty providing for the exemption method. The Austrian permanent establishment earns a profit of EUR 2m. The foreign permanent establishment, on the other hand, earns a profit of EUR 1m pursuant to local tax law and a loss of EUR 1m pursuant to Austrian tax law. The consequence of this would be that the Austrian corporation could deduct the loss of its foreign permanent establishment (EUR 1m) from the taxable profit of its permanent establishment in Austria (EUR 2m). Yet in subsequent years the amount deducted would not have to be recaptured, the reason being that no losses were incurred under local law.
6. Deductibility of Interest Payments
Under current Austrian tax law, expenses may not be deducted if they were incurred in connection with tax-free income. Thus, in cases in which dividends from a participation are received tax-free in Austria under the national or international participation exemption (as described directly below), interest on loans for the acquisition of such participation are considered to be related to tax-exempt income and are therefore not deductible.
- Under the national participation exemption, dividends resulting from participations in Austrian corporations are tax-exempt, regardless of the extent of the participation and regardless of the length of time that the participation was held.
- Under the international participation exemption, dividends resulting from participations in foreign companies that are either comparable to an Austrian corporation (as opposed to a partnership) or that have a legal form listed in the annex to the EC Parent/Subsidiary-Directive are tax-exempt if the participation amounts to at least 10% of the share capital and if the participation has been held for an uninterrupted period of at least one year.
Even if interest in a given situation is not tax-deductible, deductibility may be achieved – albeit with a number of limitations – through certain types of corporate restructurings, e.g. through the transformation of an Austrian corporate subsidiary into a partnership, through a statutory merger or demerger, or through the establishment of a fiscal unity (as discussed supra 3.1).
The statutory rule regarding the non-deductibility of expenses incurred in connection with tax-free income has been widely criticized – not only because its consequences can be avoided, but also because of the difficulty of earmarking funds. In this respect, the Tax Reform Act of 2005 introduces (beginning with tax years ending in the calendar year 2005) the general deductibility of interest payments made in connection with the acquisition of shares of an Austrian or non-Austrian corporation. Thus, the benefits of both the national and international participation exemption no longer entail the drawback of the non-deductibility of interest.
The changes set out above will certainly further enhance Austria’s status as a holding company location and provide interesting tax planning opportunities for Austrian and non-Austrian enterprises alike.
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.