Tax issues are crucial in private equity transactions. Investors regularly require that the acquisition of the target is structured in a tax efficient manner and that financing costs in relation to the acquisition in a target company may be offset against any profit resulting from it. Further, the distribution of dividends as well as tax considerations with respect to future exit strategies are typically decisive in choosing the acquisition vehicle with respect to Austrian and non-Austrian target companies.
Financing of an Austrian acquisition vehicle
Equity contributions into an Austrian corporation are no longer subject to capital duty. Since 1 January 2016, the previously applicable capital duty of 1 per cent has been abolished and, according to EU law, cannot be reintroduced. This has simplified funding structures as multitier structures (grandparent contributions) are no longer used to avoid capital duty.
Debt financed acquisitions should be structured carefully in order to secure the general deductibility of interest as well as the offsetting of such interest expenses from business profits of the target company. In general, interest expenses on loans from unrelated parties are fully tax deductible. The same holds true for interest paid to related parties, if the following criteria are fulfilled:
- the terms are at arm’s length and properly documented;
- the debt is not requalified as equity; and
- there is no low taxation of group lenders.
With regard to the arm’s-length test, the Austrian tax authorities generally apply the comparable uncontrolled price method. However, a comparison of inter-company financing transactions to those with commercial banks is generally not accepted by the Austrian tax authorities (because of differing objectives and goals of an unrelated lender, as well as the different risk profile). As a result, the interest rates of banks can only be considered as the upper limit of the arm’s-length interest rate. In general, in determining the interest rate, factors such as currency, term, creditworthiness of the borrower and refinancing costs need to be taken into account. If the related-party lender has sufficient own liquidity, the tax authorities see the deposit interest rate as the appropriate interest rate for a related-party loan.
As to the requalification of debt into equity, it is worth noting that there are no statutory rules on thin capitalisation in Austria. From a practical perspective, tax authorities usually accept debt to equity ratios of around 3:1 to 4:1. Beyond that, interest deduction may be denied based on a requalification of shareholder loans into equity. Besides the non-deductibility, this would also result in the interest payments being treated as deemed dividends, which - unlike interest on shareholder loans - would be subject to withholding tax in Austria (see below).
Interest payments under a related-party loan of a foreign lender are not deductible in Austria if the interest payments are not taxed at an effective tax rate of at least 10 per cent at the level of the lender. According to the Austrian tax authorities, it is not relevant whether such low taxation is owing to the domestic law of the jurisdiction of the lender or the result of an applicable double taxation treaty.
Finally, it is worth noting that there is currently no interest barrier rule providing for a general limit on the deductible amount of interest expenses paid to unrelated parties. However, according to article 4 of Council Directive (EU) 2016/1164 (Anti-BEPS Directive), such limitation shall be implemented until 1 January 2024, at the latest.
Austrian group taxation regime
The use of an Austrian acquisition vehicle allows for the establishment of a tax group between the acquisition vehicle and the target. Such tax group allows for the offsetting of interest expenses at the level of the acquisition vehicle from business profits of the target.
The previously applicable goodwill amortisation regime on share deals (up to 50 per cent of the purchase price over a period of 15 years) is no longer available (it is only for acquisitions made by 28 February 2014).
In general, non-Austrian corporations may also be part of an Austrian tax group and their respective losses may reduce the Austrian tax burden. However, the group taxation regime was reformed in order to limit the inclusion of such non-Austrian subsidiaries (to corporations resident in EU member states or other countries with which Austria has concluded comprehensive administrative assistance procedures) and the attribution of their losses (which can only be offset by up to 75 per cent of the taxable income of such Austrian entities, with the balance being carried forward to future years).
Dividends and interest payments are generally subject to withholding tax of 27.5 per cent. However, limitations and exemptions apply under domestic law as well as applicable tax treaties. In particular, withholding tax on dividend payments to non-Austrian investors is typically subject to the limitations under the EU Parent-Subsidiary-Directive and applicable double taxation treaties. Interest payments on loans to non-Austrian lenders are, in principle, no longer subject to withholding tax, as the previously applicable withholding tax in the case of loans that were secured by real estate located in Austria has been abolished.
Private equity investors will usually seek a structure that allows for a tax-free exit. As there is no tax exemption for capital gains realised from the sale of shares in an Austrian company (as opposed to shares in a foreign company), foreign investors will now more often choose an acquisition vehicle in a foreign country with which Austria has concluded a double taxation treaty that provides that only such other jurisdiction is entitled to tax the capitals gains.
Further, it is worth noting that Austrian tax law provides for a sophisticated exit taxation regime under which capital gains taxation is - simplified - triggered under any circumstances that result in Austria losing its taxation right with respect to assets subject to taxation in Austria. However, if such taxing right is lost in relation to EU/EEC countries providing for comprehensive mutual assistance, the taxpayer may apply for payment of the exit tax in instalments over a period of up to seven years (unless the capital gain is actually triggered beforehand).
For real estate deals a recent tax reform brought significant changes for companies owning Austrian real estate directly. First, the taxable event, ‘unification of shares’, that once required a unification of all shares in a company that directly owns Austrian real estate by one shareholder, now foresees a lower threshold of 95 per cent. Furthermore, shares held by trustees shall be attributable to the trustor in determining this and other similar thresholds. Second, if within five years in total 95 per cent or more interests in a partnership that directly owns real estate are transferred (also if in different transactions and to different purchasers), this now also triggers real estate transfer tax.
Management incentive packages
Management incentive packages usually take the form of share options, restricted stock, profit participation rights or phantom stock (see question 8).
An important aspect is whether, upon the investment by the management members, economic ownership in the shares (or other instruments) actually transfers. In relation to shares this mainly depends on the management members’ entitlement to dividends (if any), voting rights and the applicability of transfer restrictions. From a tax perspective, management incentive packages are typically structured to ensure such transfer. In the case where economic ownership transfers and the management members receive the shares without paying an arm’s-length consideration, the grant will be taxable as employment income at the fair market value of the shares received. Otherwise, the full return received at exit may be subject to taxation as employment income.
In the case of stock options, non-transferable stock options are not taxed at the time of the grant, but upon exercise of the option based on the difference between the (discounted) acquisition cost and the fair market value of the shares received based on the option. In contrast, transferable stock options are considered an asset for tax purposes and, consequently, are already taxed at the time of the grant.
Income from shares received by individuals resident in Austria is taxed at 27.5 per cent. Such income includes dividends as well as capital gains. Former models that granted shares to the management relied on an exemption for capital gains (if the percentage of the shareholding in the Austrian company was below 1 per cent and was held for more than one year) are no longer applicable as realised capital gains are generally subject to tax. However, in the case of non-resident individuals, capital gains are only subject to tax in Austria at a rate of 27.5 per cent if the percentage of the employee’s (weighted) shareholding in the Austrian company amounts to at least 1 per cent during the previous five years. Double taxation treaties, however, usually restrict Austria’s right to tax such capital gains (article 13, paragraph 5 of the OECD Model Tax Convention on Income and on Capital), whereas dividends are subject to withholding tax at a rate of 27.5 per cent (which is usually reduced by double taxation treaty).
Recurring income from profit participation rights that classify as equity at the level of the company is taxed similar to income from dividends, at a rate of 27.5 per cent. If, owing to its features, profit participation rights qualify as debt at the level of the company, income is taxed similar to interest at a rate of 27.5 per cent. Regarding the exit, profit participation rights generally give more room for a tax-optimised structuring than other incentives, such as stock options or restricted stock.
Income from phantom stock (not qualifying as profit participation rights) is generally taxed similar to ordinary income from employment at the progressive income tax rate.
As well as the developments mentioned above, tax audits in relation to M&A deals are becoming more common and burdensome. In particular, transfer pricing issues, for example, in relation to interest on shareholder loans or certain fees payable to related entities, are under scrutiny. Accordingly, tax rulings are also becoming more popular.
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