Tax traps and opportunities in Central and Eastern Europe

Pursuing transactions in Central and Eastern Europe (CEE) can present attractive prospects to investors, but it's important to understand that the acquisition and integration processes require local knowledge and compliance. 

The CEE region benefits from a strategic location, with developed economies of Western Europe on one side and the Middle East on the other. As a result, there are numerous investor benefits, but the region can be difficult to navigate. That’s why we have published Doing M&A in CEE Tax traps and structuring opportunities. We take a broad approach to the CEE region in the study and have included insight on the following countries: Albania, Austria, Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania, Russia, Serbia, Slovakia, Slovenia, and Ukraine.

What are the main tax traps?

When doing business overseas it is important to be aware of the main tax traps, incentives and exemptions encountered in the due diligence and tax optimisation processes. Some of these tax traps include financial expenses reduction, transfer pricing documentation, controlled foreign companies’ rules, dissuasive tax rates, tax treaties, stamp duties and finally the use of tax losses in case of a charge of control of the taxpayer.

Tax monitoring necessary to mitigate the ‘tax traps’

Companies planning to carry out mergers and acquisitions in CEE must consider the financial expenses deduction rules, which can determine what part of the expenses is considered as deductible for corporate tax income tax (CIT). To alleviate this matter, companies must monitor the level of their debt and financial expenses to achieve a full deduction of financial expenses. 

Meanwhile, transfer pricing and CFC (Controlled Foreign Companies) rules may vary from one country to another. Transfer pricing requires updated documentation available at the level of the corporate taxpayer to support all inter-company transactions. To address this situation, companies must deliver proper documentation to justify the transfer policy applied.

As for the CFC rules, several countries do not have such provisions or rules and should be able to monitor the level of taxation locally to prove the absence of abuse.

Appropriate structuring to minimise the tax impact

Capital gains tax rates may differ from local corporate tax income rates to limit the disposal of assets locally. Some applicable rates may discourage investors from selling their assets, in Albania, for example, capital gains on the sale of shares are taxable at 15%. To mitigate this effect, companies can minimise the tax impact by applying appropriate structuring. The same applies to the provisions of tax treaties, where companies can improve tax leakage on repatriation of profits by implementing proper tax structuring.

 Stamp duties as a cost in transactions

Structuring transactions such as asset deals, share deals, capital decreases and mergers usually involve stamp duties depending on the country. Companies should adopt the best routes that involve low stamp duty cost: take Austria for instance, while stamp duty has been reduced in most cases, it still stands in others.

Tax losses legislation

For corporate income tax purposes, most states enable the offsetting of past tax losses carried forward against the taxable income of the year to enable the determination of the corporate taxpayer’s corporate income tax basis. Therefore, tax losses may give rise to the recognition of deferred tax assets in consolidated accounts when it is likely that the losses will be used for offsetting tax purposes.

Countries such as Austria and Poland do not benefit from the total or partial forfeiture of tax losses carried forward in case of a change of control, making a potential impact on cash flows and on deferred taxes. In this case the risk can be reduced by acquisition price adjustments considering the amount of tax attributes lost.

CEE investor opportunities

Investors are becoming more and more attracted to the CEE region thanks to its unique combination of competitive advantages. Some of them involve tax structuring opportunities, including goodwill, corporate income tax, carry back-or-carry forward of tax losses, tax treaties, deduction of financial costs, group tax regime, tax exemption applied to mergers, de-mergers and local incentives supporting investments.

 Goodwill a tool for cost reductions

Goodwill and intangible assets are amortised in time and may lead to cost reductions. However, Poland is one example of a county where goodwill does not apply as a tax benefit. Accordingly, companies should carry out studies on the feasibility and the domestic tax treatment concerning amortisation in order to take advantage.

 Financial costs as a tax opportunity

Deduction of financial costs is another important tool to consider as a tax opportunity, enabling tax leveraging of investments abroad and allowing more flexibility in the repatriation of profits. The same occurs with the group tax regime (specific incentives that may apply to groups of companies) which enables a reduction of the tax basis through the offsetting of the losses incurred by tax group members by the profits earned by other tax group members.

 Tax exemption in mergers and de-mergers 

One of the main topics in doing business abroad is mergers and de-mergers and their tax impact. Some CEE countries, such as Russia and Slovenia, provide companies with tax-exemption due to the gains that could be secured from a merger, de-merger or assimilated transaction at the level of the absorbing company.

Lastly, local tax law may encourage the development of a sector or an undeveloped geographic area by granting various tax incentives allowing companies to reduce their tax burden and, as a result, expand their activity.

For CEE investors, it is important to consider the main ‘tax traps’ that appear in the due diligence processes which are related to thin capitalisation rules and tax losses when undertaking acquisition activity. However, these same transactions can also benefit from local tax incentives that support investments and exist alongside tax exemptions applicable to mergers and demergers.

To read the full study 'Doing M&A in CEE Tax traps and structuring opportunities' go here.