Companies can have diverse activities nowadays. The example below related to a business division transfer describes a company originally involved only in manufacturing that extended its activity to the service sector. If a company is involved in various activities, a potential investor may decide that instead of acquiring the whole company, it would prefer to buy only the business division that fits its profile.
Such cases raise the question of how a business division can be separated from the other activities, what costs are involved, how long it takes for a business division transfer, and what opportunities the Hungarian tax regime offers to carry out such transactions under beneficial taxation conditions.
Asset sale instead of a whole business division transfer
In relation to the example mentioned above, let us assume that the investor is a large group involved in manufacturing that wants to acquire the manufacturing division of the target company. Of course the target company may sell its assets or even its properties one by one to the investor.
The advantage of this method is that such transactions are simple and obvious so there is no need for long preparations. It should be considered, however, that a VAT liability may arise in Hungary when selling assets, as in the case of transferring properties. Sales can also be subject to corporate tax, while local business tax liability needs to be considered as well.
Handing over business divisions
From 2013, the VAT Act in Hungary introduced the concept of transfer of going concern which has long been used in international taxation. Accordingly, under certain conditions, handing over a separate business division is out of scope of VAT.
If the package to be sold complies with the concept of transfer of going concern set out in the VAT Act in terms of each detailed rule, for example, it is suitable for long-term independent business activity, then a VAT invoice does not need to be issued and no VAT is payable on the transaction .
This solution can be a favourable option as the buyer does not need to finance the VAT related to the transaction, even for a short period. Before a business division transfer it must be examined in detail whether the delivered assets and liabilities fulfil the conditions set for transactions out of the scope of VAT.
Preferential transfer of assets
This type of transaction – a preferential transfer of assets – is regulated by the Hungarian Act on Corporate Tax and is very similar to the notion of a business division mentioned above and regulated by the VAT Act. However, one significant difference is that while a business division can be sold in return for cash, a preferential transfer of assets actually means that the business division becomes a contribution in kind, where the company granting the asset gains ownership in return for delivering the independent organisational unit.
The main advantage of this option is that the business division transfer is regarded as a neutral transaction for corporate tax purposes for the delivering party, and so no corporate tax payment liability occurs. In return, however, the delivering party gains partial ownership for the organisational unit delivered, so the construction itself is not flexible and there are various rules to comply with. Yet it can still be an optimal solution for those who wish to place their independent organisational unit into a separate company under neutral conditions for corporate tax purposes.
A preferential transformation (spin-off or separation) can be an option in such cases. As the first step of a preferential transformation, the organisational unit can be placed into a separate company, which, under certain conditions, is neutral for corporate tax purposes for the delivering party (preferential). Another important benefit is that such transactions are duty-free, provided that the conditions are fulfilled. As transformations require complicated legal, accounting and tax measures, such transactions should definitely be undertaken with care.
Key aspects to be considered for a business division transfer
Besides the favourable tax aspects, there are a number of other factors to be considered when selecting the final framework, two of which are highlighted below:
- Loss: Whether the company has any loss carry forward is crucially important, and if so, to what extent the company wishes to use them in the future. In the case of a preferential asset transfer, for example, the loss carry forward belonging to the independent organisational unit handed over must also be transferred to the target company, so it may not be used in the future to reduce the tax base.
- Timeline: Another aspect not to be underestimated is the duration of the sales transaction. While a simple asset sale transaction can be concluded in a few days, the legal, accounting and tax tasks related to a transformation may take half a year.
To ensure successful long-term operations on the market, it is crucial that a company redefines its structure and operation from time to time, either entirely or focusing on certain elements. Within the framework of our restructuring management services, WTS Klient is at your disposal to give advice regarding the transformation of your company or on any business division transfer.