ABSTRACT: The complexity of the merger is reflected not only in its legal regime but also in its tax and accounting implications that must be taken into account before two or more companies decide to merge, in order to restructure their business. For this purpose, it is important to know the legal framework of the merger and the procedure of the merger that implies preliminary accounting operations, drafting and publicity of the merger report, approval of the merger by the shareholders and its registration based on a court decision with the register of commerce. The nullity of a merger is possible but only within certain limits and it still needs to be regulated as a merger from an accounting and tax point of view. The merger is neutral from a tax point of view and one of its recent beneficial consequences is that the financial loss can be recovered.
1. Preamble to the Legal Framework on Mergers in Romania
According to Romanian law the merger is an operation where one or more companies are wound-up without going into liquidation and transfer all their assets and liabilities to another company, in exchange of shares in already existing companies or in newly established companies and of cash payment (if the case), not exceeding 10% of the nominal value of the shares so allocated.
The Law on Companies no. 31/1990 and the Civil Code represent the general legal framework of mergers of companies in Romania. In addition to them there are other legal documents regulating mergers and acquisitions from an accountancy and tax perspective, as follows:
• Accounting Law no. 82/1991;
• Order of the Ministry of Finances no. 1376/2004 regarding the approval of the Methodological Norms regarding the Reflection in Accounting of the Main Operations of Merger, Spilt-up, Wind-up and Liquidation of Companies, as well as the Withdrawal and Exclusion of Shareholders from Companies and the Applicable Tax Treatment;
• Order No. 3055/2010 of the Ministry of Public Finances on the Approval of the Accounting Regulations in compliance with the European Directives;
• Fiscal Code.
In addition to the general provisions, in the case of mergers between credit institutions, banks, insurance companies, different special regulations are applicable. As in other countries, companies involved in a merger may be subject to certain restrictions, most frequently from a competition perspective. Thus, in case of a merger one should analyze whether, by meeting certain material thresholds (for establishing which financial figures of the merging companies are necessary), the respective merger falls under the provisions of Competition Law 21/1996, or even of the Council Regulation (EC) no. 139/2004 on the control of concentrations between undertakings.
The Romanian legislation underwent a major change in 2011, when a new Civil Code entered into force. Such Code contains specific information about the merger of legal entities that also apply to companies. The merger was explicitly recognized as a reorganization mean of the legal entity.
The New Civil Code provides just some general rules concerning the merger – most of them already set forth by the Company Law, but there are also some specific rules. As regards this category, we are referring to the provisions related to the termination of contracts on the occasion of mergers. In fact, in case of intuitu personae contracts (contracts that were concluded taking into account the quality of the contracting party) they shall not be terminated due to the merger unless the contrary is expressly stipulated in their content or that the continuation of the contract is based on the prior approval of the contracting party. This provision is important and must be taken into account when drafting such a contract and thinking in perspective. It is then to decide whether the contract should also continue in case of a merger or not. It is a long shot decision. For example, in case the transfer of the contract is conditioned by the obtaining of a prior approval of the other party and such condition is not fulfilled and covered and the shareholders discover it within 6 months after the merger, this could trigger the nullity of the merger; according to Romanian law, it can be ruled only by the court. We have encountered this aspect in our legal experience, as a lawyer to the trial during which the Bucharest Court ruled on such a case in November 2011 (court decision that was not published) and decided the nullity of a merger concluded under these circumstances. The result was the first nullity of merger to be implemented by the Register of Commerce and by the tax authorities in Romania. It was a bureaucratic and challenging experience for the shareholders, the companies involved in the merger, the judge, the lawyers and the authorities: it took several years and its accounting effects are still in progress.
In fact, as regards the nullity of the merger, except for one article referring to it in the Law on Companies no. 31/1990 the rest of the Romanian legislation is silent. So, it is more than necessary that the Romanian legislator also regulates this matter, including the registration, accounting and tax implications. As the law has the role of creating the instruments for the implementation of new situations occurring in practice, some based on a legal possibility materialized by a court decision and it is necessary to be implemented so that the parties involved benefit from the rights gained in justice.
Another aspect clarified by the New Civil Code in connection to the merger regards the transfer of real estate following a merger. Thus, in order for the ownership right of the real estate of the absorbing company or the new company created by merger, be recognized it is necessary that the merger report is authenticated by the notary and after the merger is registered with the Register of Commerce the transfer of the real estate must also be registered with the Land Register. It should be noted that from the previews of the provisions it did not result that the merger report had to authenticated if between the assets transferred through merger from a company to another there was also real estate and the practice of the authorities as regards the form of the merger report was different for the authorities from a county to another. Now, the practice is unified.
The New Civil Code was mainly inspired from the Quebec Civil Code, but also the Swiss Civil Code, the Brazilian Civil Code and other European Civil Codes (Spanish, French and Italian). Meanwhile, the corporate, tax and accounting provisions regarding mergers are most of European influence. In fact, an important part of the Romanian legislation regarding mergers of companies is harmonized with the European provisions in the field.
It was in the spirit of harmonization with the European provisions that Law no. 31/1990 was also changed in 2012 by the Government Ordinance no. 2/2012 on mergers. The main change regarded the simplification of procedure and publicity of the merger. Thus, , the obligation of information of the shareholders was limited under certain conditions, the formalities of publicity of the merger were simplified, offering companies the possibility to use their websites to publish the merger project instead of the publicity in the Official Journal. We are witnessing the way the law is continuing to adapt to the new means of communication, accepting and recognizing the importance of the internet and indirectly encouraging companies to create and use their websites not only for commercial, but also legal publicity.
2. General Presentation of the Accounting Preliminary Procedure of Merger - Overview
In Romania, as in almost all the Member States of the European Union, any merger implies two or more companies and there are two types of merger: the merger by absorption of one or more companies by another company, or the merger of one or more companies by creation of a new legal entity. The most frequent case of is the one of merger by absorption, therefore our article shall refer to such merger and only if there are certain particularities to the merger by formation of a new legal entity.
The procedure of merger implies several stages, after the representatives of the two or more merging companies meet and discuss the aim of the merger and the steps to be taken.
Thus, the next one is the stage of preliminary accounting and financial organization in view of the merger. The Order of the Ministry of the Finances no 1376/2004 provides as mandatory the following phases of merger:
a. Inventory and evaluation of all assets, liabilities and net assets of the merging companies
There are specific legal provisions about the performance of inventory and evaluation, in accordance with the Law no. 82/1990 and other legal deeds referring to these operations. They are well-known by the accountants of the each of the companies involved in the merger.
b. Drafting the financial statement for the merger
The same Law no. 82/1990 provides that in case of merger the financial statements of the merging companies to be drafted on this occasion and submitted to the tax authorities. Still, it is to be noted that it is possible to also use the annual financial statements of the companies concerned, if the financial situation of the companies at the time of the merger process did not change significantly compared to the annual ones. From this point of view, it is advisable to perform a merger at the beginning of the year, after the annual financial statements were approved by the shareholders.
The financial statements to be used as reference for the merger are very important as they contain the accounting net assets (that is equal to the difference between the total assets and the total debts of the company), as that shall be used for the computation of the exchange ratio of the shares of the merging companies, later.
c. Auditing the financial statements of the merger
According to Law no. 82/1990 in case of merger the financial statements of the merging companies must be audited, if such companies have the legal obligation to have the financial statements audited. If the annual financial statements are used for the merger then the audit report for them can also be used for the merger.
d. Global evaluation of the merging companies; determination of the net participation
Each of the companies involved in the merger must be evaluated by one of the following methods:
(i) the patrimonial or the net assets method;
(ii) the stock market method;
(iii) the methods of the outcome (such as the payoff method, the output method or the estimated profits value method);
(iv) mixed methods, or the
(v) cash flows method.
According to Order no 1376/2004 the global value of each company established based on one of the above mentioned methods represents the net value of the merger participations of every company involved in the merger. The exchange ratio of the shares of the merging companies shall be determined based on this value of participation in the merger.
It is to be noted that Order no 3055/2009 changed the regime of the evaluation and stated that the evaluation on the occasion of merger does not represent a reevaluation with an accounting impact, as it is performed only for the purpose of establishing the exchange ratio. In this case, the results of the evaluation shall not be registered in the financial statements for the merger. The exception to this rule is the situation in which the annual financial statements are used for the merger.
e. Computation of the exchange ratio in order to cover the capital of the absorbed company and determination the number of shares to be issued for the net participation
Computed based on the global value of the merging companies, the exchange ratio means the number of shares to be issued by the absorbing company for the shareholders of the absorbed company.
In order to calculate the exchange ratio, the accounting value of the participation of every participating company must be calculated. Such value is established by dividing the net participation of the company to the number of shares issued by the company.
It is to be noted that based on the value of the net participation the amount of the merger premium (number of newly issued shares x (book value of one share - nominal value of one share) and the new shares that can be issued shall also be established.
The Law on Companies no. 31/1990 provides that in certain cases companies must chose an expert to examine the merger report, and that the conclusions of their analysis will be mentioned in a written report (to be presented to the judge). This report must specify whether the exchange ratio is correct and reasonable, as well as: the method or methods used to determine the exchange ratio, whether the used methods are appropriate for the case, and the opinion of the experts concerning the accuracy of the methods used to determine the exchange ratio. The report must also describe all special difficulties met during the process of evaluation.
After the above mentioned accounting and financial operations are finished, their results must be communicated to the directors of the merging companies, who must draft a merger report that shall be submitted to the Register of Commerce in order to be published in the Official Journal or on the website of the each of the merging companies. In certain cases, the shareholders of the merging companies gather in order to approve the initiation of the merger process, appointing the directors as attorney-in-fact for these operations and if all the shareholders are present it is possible to waive to the appointment of an expert to check the merger report.
Within 30 days after the publication of the merger report, any creditors may appeal the merger if it breaches their rights. If the merger is not appealed in court, than the merger report shall be submitted for approval to the shareholders of the companies. Afterwards, a file with the merger report and the resolutions of the shareholders of the merging companies approving the merger is submitted to the Register of Commerce that and it shall send it to the Court. A judge shall rule regarding the merger. If he considers that the merger was legally performed, he shall issue a decision regarding this and the merger shall be registered with the Register of Commerce.
The merger can be effective from the date of registration with the Register of the decision of the last general meeting having approved the operation or on the date decided by the shareholders of the merging companies. In the last case, two conditions must be fulfilled: (i) the conventional date must not be after the closing of the current financial exercise of the absorbing company and (ii) the conventional date cannot be previous to the closing of the last financial exercise of the absorbed company. Choosing a conventional date for the merger can create several problems in practice, therefore the merging companies must have particular diligences as:
a. ”Informing the creditors of the companies involved in the merger about the date when the merger becomes effective;
b. Adopting certain measures and/or offering warranties aimed at protecting the interests of the social creditors as well as the continuity of the business relationships, and
c. Harmonizing the data in the financial, accounting and tax documents of the companies participating to the merger”.
The difficulties regarding this conventional date are mainly of an accounting nature and in order to simplify them it is advisable that this conventional date be established after the date of the merger report and after the date of the resolutions of the shareholders approving the merger, more specifically at the end of the month estimated for the registration of the merger.
It is to be noted that as an exception due to the complexity of the operation, the merger can be declared null by but only within a period of 6 months since the merger becomes effective, no matter what grounds are invoked. Unfortunately, as presented in the introductive part of the paper, the Romanian legislation is lacking important provisions regarding the accounting and tax applications of such nullity.
3. Tax Implications
3.1 General Tax Implications
As expected, the Fiscal Code contains most of the provisions with a potential impact on the taxation of mergers. Generally, it is intended that mergers be neutral for tax purposes. This means that mergers are expected neither to give rise to taxation, nor to give rise to additional tax advantages, which would not have arisen in the absence of the merger. In fact, this tax regime is the common system of taxation applicable to mergers provided by Directive 90/434/EEC and codified and published in an updated version, respectively Directive 2009/133/EC.
There are some general tax rules that apply to merger, as follows:
a. The transfer of assets and liabilities is not subject to taxation;
b. The tax value of an asset or liability that shall be taken by the absorbing company shall be equal to the pre-merger base cost of the asset in the absorbed company’s books;
c. The fiscal loss incurred by the company absorbed by merger shall be recovered by the absorbing company.
Government Ordinance no. 15/ 2012 amending the Fiscal Code published in August 2012 changed the treatment of fiscal losses recorded by taxpayers which cease to exist following a merger. Thus, fiscal losses may be recovered by newly established taxpayers or by the absorbing company, proportionally to the assets and liabilities transferred to this company, according to the merger report.
In the case of cross border mergers asset transfers and share exchanges involving companies from two or more EU Member States, if the transferring company registers a fiscal loss, this loss may be recovered by the permanent establishment of the receiving company situated in Romania.
This change regarding the recovering of losses is very important as previously it was provided that the fiscal losses could not be recovered by merger, reason for which many companies that had losses did not choose to reorganize their activity by merger.
d. Tax depreciation for any assets transferred is determined in accordance with the rules provided by article 24, that would have been applicable by the absorbed company, if there had not been a transfer;
e. The transfer of a provision or a reserve is not considered a decrease or annulment of such provision or reserve, if another taxpayer takes and maintains the value it had before the transfer.
These main rules are also partially repeated by the Order no. 1376/2004, in a different manner, from the point of view of the absorbing company and of the absorbed company.
It is to be noted that the neutral tax treatment shall not be applicable if a merger has as main objective tax evasion or tax avoidance and it is very important that the companies prove to the tax authorities that the merger was determined by commercial and management strategically reasons, not by tax reasons.
3.2 Specific Tax Implications
a. Corporate income tax
The Fiscal Code provides that the merger is treated as a non taxable transfer from a corporate income tax point of view. This implies that the income of the absorbing company is non-taxable and the expenses are non-deductible.
The transfer by a company of all or part of its assets, through operations such as merger, is not considered supply of goods or services if the beneficiary of the assets is a taxable person (which is the case of all persons participating in the mergers), therefore the transfer of the assets from the absorbed company to the absorbing one shall be VAT free.
The preparation for the merger starts from drafting the contracts establishing its regime in case of reorganization of the contracting parties. During the life of many companies there comes a moment when the decision of merging with one or more companies it taken. It is then the time to prepare such a merger not only from a legal point of view, but also from an accounting and tax approach. Such operation can be simplified by using well trained professionals familiar with the particularities of this process, as: (i) the value of an evaluation of the merging companies – that cannot be written in the financial statements of the merger, unless the annual financial statements are used; (ii) when the annual financial statements and auditors’ annual report can be used for merger – if the merger is started after the approval of the annual financial statements or even later, but on condition that important financial events did not occur; (iii) how to prevent situations that could lead to the nullity of merger – transferring the contracts by observing their provisions and ensuring the legitimacy of the merger and of the resolution of the shareholders of the merging companies; (iv) how to choose the conventional date – by the end of the month estimated for the finalization of the registration or a month later; (v) that it is possible to recover the losses in a merger - and which are the limits of the neutrality of the merger –merger is not just a real reorganization, just a simulation in order to benefit from its neutral tax treatment.
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Based in Romania since 1990 and having a strong team of about twenty French and English speaking Romanian lawyers, GRUIA DUFAUT Law Office assists foreign investors through all the stages in setting up their business in Romania and provides them with a local follow-up service covering tax and legal issues pertaining to the development of the company. GRUIA DUFAUT Law Office offers counsel and legal assistance to all foreign companies intending to export to or to enter the Romanian market. “