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Tax authorities gearing up to increase field audits on tax-neutral restructurings

Whilst corporate restructuring transactions such as mergers, partial demergers, and contributions of a line of business are generally understood to be tax-neutral if they satisfy the relevant conditions, tax costs may still be incurred if the transaction is not adequately reported from an accounting or tax perspective. In recent months, Belgium’s Federal Public Service Finance has been expanding its dedicated restructuring workforce, which may lead to an increase in targeted field audits in the years ahead.

Common pitfalls

In Belgium, tax-neutral transactions may not in fact be entirely without a tax cost. A well-known example of this is the rule regarding the limitation of tax losses and dividends received deduction carried forward applicable to entities involved in a restructuring, that becomes increasingly complicated if the transaction does not take place either on the first day of the financial year, or with retroactive effect from that date, or if the restructuring entails successive tax-neutral operations.

In addition, taxpayers frequently overlook the fact that upstream mergers and (partial) demergers may require corrective accounting entries, e.g., for goodwill arising from the merger and other tax-free reserves, or may need specific adjustments in the corporate income tax returns of the year of the transaction—and sometimes subsequent years—to avoid unexpected tax leakages through the discovery of errors by the tax authorities.

The Belgian legislative framework and administrative guidance covering the practical effects of these transactions is often vague, meaning that ensuring the correct implementation may require expert advice. The reality is that tax-neutral restructurings are built around complex legislation, administrative commentaries and circulars, a thriving rulings system, jurisprudence, and academic theories. 

Circular letter concerning the tax-free reserve for social liabilities

Circular Letter 2023/C/40 (Dutch │ French) issued by the tax authorities on 3 April 2023 clarifying the impact of a tax-neutral restructuring on the tax-free reserve for social liabilities, resulting from the unified employment status between blue collar and white collar workers, illustrates these complexities.

As the applicable legislation only refers to the principle that the tax-free reserve for social liabilities should be treated as if no tax-neutral restructuring has taken place, many questions remain (e.g., with respect to the calculation of the seniority of qualifying employees, the reversal of previously recorded reserves upon termination of employment agreements in the year, and following the tax-neutral transaction, the transfer of the obligation to submit certificates, etc.).

Although the resulting clarifications provided in the circular are therefore welcome, they also highlight the fact that the regulatory framework for tax-neutral transactions is very fragmented.

How to prepare for a tax field audit

Despite the fact that many taxpayers seek an advance ruling to safeguard the tax-neutral character of a restructuring, these rulings do not provide any protection against additional tax costs resulting from inadequate accounting or tax reporting.

Therefore, taxpayers may wish to review the accounting and tax implications of the transaction carefully, as well as the supporting legal documentation, as the tax cost of errors or omissions discovered during a field audit covering transactions of this nature and size could be many times the expected corrections arising from a standard tax audit.

Although the nature of any examination depends on the specifics of the reorganisation (including any subsequent transactions), it typically includes a review of: (i) the reported result of the merger; (ii) the accounting entries to reinstate the tax-free reserves; (iii) the calculation of the post-transaction tax attributes; (iv) a roll-forward of secondary tax attributes to future years; and (v) a validation of the implementation steps in line with any relevant ruling.

If any deficiencies are identified, proactive remedial measures should be considered. 

Relevance for M&A transactions

These considerations are a fortiori relevant for taxpayers preparing the business for a sale, as there is a greater risk of items being uncovered by buy-side advisors, which may lead to discussions around tax indemnities, net financial debt adjustments, or the need to obtain specific tax risk insurance.