New practice on tax disregard of transactions

In the merger case, the Board ruled in favour of the taxpayer maintaining the tax position in question. The tax motive was not the predominant factor. The merger was based on genuine commercial purposes, supported by external documentation from the bank and the adviser, and the tax positions could in any event be utilised without the merger. In the receivables case, the actual purchase of the receivable below face value was deemed eligible for tax purposes, but the way the receivable was repaid proved decisive. The repayment was reclassified as a taxable dividend because it was in reality financed with capital from the taxpayer's wholly owned subsidiary.

We will examine the Tax Appeals Board's specific assessments of the two cases below, along with our own commentary.

Two group companies within travel and property sectors planned to merge their parent companies A and C. As the merger would accelerate the utilisation of disallowed interest deductions and loss carry-forwards, a BFU was requested to determine whether the merger could be carried out without triggering Section 13-3 of the Tax Act, which regulate lapse of general tax positions. Both the tax office and the secretariat to the Tax Appeals Board concluded that the tax positions would lapse pursuant to Section 13-3(a) of the Tax Act if the merger was completed.

The Tax Appeals Board was divided into a majority and a minority (4-1). The minority concurred with the secretariat's recommendation. The majority overturned the tax office's conclusion and upheld the appellant's appeal.

The majority emphasised that:

• Both groups consisted of active companies with day-to-day operations, employees and concrete plans for the future, and that the plan upon completion of the merger was to continue operations within all business areas.
   
• The intention was to coordinate the business areas within a single group with the expectation of more efficient operations, better returns and increased strategic and operational capacity.
   
• A merged group would entail a significant strengthening of the balance sheet with the potential for increased debt financing and more flexible financing solutions, which was confirmed in writing by the group's local bank.
   
• An external adviser's assessment further strengthened the business case, and it was pointed out that the two-tier structure could appear operationally inefficient.
   
• If the merger were not to go ahead, operations within the A Group would continue and the tax positions could be carried forward against future positive income even without a merger. There was therefore a realistic expectation of utilising the tax positions regardless of the merger.
   

Against this background, the majority found it difficult to agree with the secretariat's conclusion that the utilisation of the tax position appeared to be the predominant motive for the merger. The appeal was upheld.

In December 2016, a personal taxpayer purchased a receivable owed by company A AS at a significant discount, at the same time as his wholly owned company B AS purchased all the shares in A AS. At the time of purchase, A AS was effectively a shell company with no liquidity, assets or active business operations, and with negative equity. It was expressly stated in the share purchase agreement that the motivation for the share purchase was to recover the face value of the receivable.

The general rule is that gains on the realisation of a receivable outside the scope of business operations are tax-free under Section 9-3(1)(c)(1) of the Tax Act, as the Supreme Court held in the Øverbye judgment (Rt-1999-1347). The Court held that the purchase of a receivable below face value is entirely lawful, and that this may be done to shareholders with the same tax consequences as a sale to third parties. This means that the face value of the receivable including the discounted amount may, in principle, be repaid tax-free, as opposed to an ordinary dividend distribution, which would trigger taxation under Section 10-11 of the Tax Act.

The secretariat reiterated the principle from the Øverbye judgment, but pointed out that in this case it was not the same taxpayer who purchased both the shares and the receivable. The taxpayer purchased the receivable personally, whilst his wholly owned company B AS purchased the shares in A AS.

The secretariat further assessed the three transactions, (1) the purchase of the receivable, (2) the purchase of shares, and (3) the subsequent repayment, collectively, with reference to Supreme Court case law stating that transactions with a close internal connection that form an integral part of an overall plan must be assessed as a single whole. This fundamental condition was considered to be clearly met. The tax motive was assessed as decisive in the decision to purchase the receivable privately, rather than B AS securing the receivable itself or writing it off.

In the overall assessment, decisive weight was given to the fact that A AS was unable to service the receivable from its own funds, and that the payments to the taxpayer were in reality financed by loans from B AS. The secretariat considered that the repayment was in fact a transfer of funds earned in B AS to the taxpayer privately, without dividend taxation.

The Tax Appeals Board concurred with the secretariat's assessment and reclassified the repayments as taxable dividends. It is worth noting, however, that the receivable itself was not set aside. The Tax Appeals Board expressly confirmed that the receivable does not lapse, it was the repayments that had to be reclassified.

The penalty tax was waived by the Tax Appeals Board, as it had not been established on clear and convincing evidence that the taxpayer provided incorrect or incomplete information in the tax return.

The decisions illustrate that the Tax Appeals Board makes genuine and nuanced assessments, and that the outcome depends on a concrete overall assessment of the factual circumstances.

In the merger case, it is positive that a thorough and externally documented commercial justification is given weight. Also important is the majority's point that the tax positions could in any event have been utilised without the merger, which illustrates that the size of a tax position is not necessarily decisive on its own.

In the receivables case, it is confirmed that the purchase of a receivable below face value is, in principle, permitted, as established in the Øverbye judgment. The decision notes that the distinction lies in how the debtor company finances the repayment. Where the repayment effectively takes place through the creditor's own company continuously lending funds to the debtor company, which are immediately passed on to the creditor, the tax avoidance rule may potentially apply.

The overall message is that commercial justifications must be genuine and well documented. Transactions such as in Case 2 above, where the repayment of a discounted receivable is financed by funds from another business of which the creditor is the sole owner, should be avoided.