Insolvency proceedings: Which taxes affect the purchase of a productive unit?

The purchase of a productive unit within insolvency proceedings, regulated in Articles 200 et seq. of the Consolidated Text of the Insolvency Act, is a fairly common way of preserving economic activity and employment.

However, this type of transaction raises significant tax issues that the buyer must analyse carefully before making its offer and during the negotiation of the terms of the transfer.

Succession to tax obligations during insolvency proceedings

Article 42.1.c) of the General Taxation Act provides for the joint and several liability of the acquirer for the transferor’s tax debts arising from the business acquired.

Nevertheless, in the context of insolvency proceedings, case law and insolvency legislation itself have gradually shaped the so-called ‘clean purchase’ regime, which makes it possible to limit or exclude that liability when the acquisition takes place within the proceedings, with court authorisation and following a request for a certificate of debts from the insolvency administrator and the competent tax authorities.

It is advisable to include specific clauses in the contract that hold the acquirer harmless against undetected contingencies. A retention of part of the price may also be agreed until any doubts regarding possible outstanding debts with the Tax Authorities and Social Security have been cleared.

VAT and ITP/AJD in the purchase of a productive unit in insolvency proceedings

When the transfer includes a set of assets capable of operating autonomously, such as property, machinery, contracts, employees or client portfolio, the non-taxable event provided for in Article 7.1 of the VAT Act applies, provided that the acquirer continues the business activity using those means.

This prevents VAT from accruing on the transaction, although it requires adequate documentation, within the insolvency proceedings, showing that a genuine autonomous economic unit is being transferred and not isolated or scattered assets.

The concept of ‘productive unit’ in the insolvency context does not necessarily coincide with that of ‘autonomous economic unit’ in the VAT context, in accordance with the definition contained in the legislation governing this tax and its interpretation by administrative doctrine and by the contentious-administrative chambers of the courts.

The core provision from which the definition of autonomous economic unit derives is the aforementioned Article 7.1 of the VAT Act.

This article provides that the following, among other transactions, shall not be subject to VAT:

‘The transfer of a set of tangible and, where applicable, intangible elements which, forming part of the business or professional assets of the taxable person, constitute or are capable of constituting an autonomous economic unit in the transferor, capable of carrying out a business or professional activity by its own means, irrespective of the tax regime applicable to said transfer in the context of other taxes.’

Should the Tax Authorities challenge this classification, or should certain elements be excluded from the sale, for example where the buyer acquires only the properties without the associated business, the transaction could become subject to VAT in respect of those specific assets.

It could also be subject to Transfer Tax, under its Onerous Property Transfers category, in the case of second transfers of property.

Likewise, the possible application of Stamp Duty should be reviewed, particularly when the transaction is executed in a public deed registrable at the Land Registry or the Companies Registry.

Corporate Income Tax: goodwill and badwill in insolvency proceedings

The difference between the price paid and the fair value of the identifiable assets and liabilities acquired gives rise, for accounting purposes, to goodwill, when the price exceeds that net value, or to a negative difference on business combination, known as badwill, when the price is lower.

This difference is recognised in the profit or loss for the year in accordance with the applicable accounting rules, specifically Recognition and Measurement Standard 19 of the Spanish General Accounting Plan, with a direct impact on the buyer’s taxable base.

In this type of transaction carried out within insolvency proceedings, the acquisition method will apply. This means that the acquiring company will recognise, at the acquisition date, the identifiable assets acquired and the liabilities assumed in the business combination at their fair values at that date, provided that these can be measured with sufficient reliability.

Recognition will take place irrespective of the consideration agreed, defined as the cost of the business combination. Therefore, differences may arise, whether positive or negative, between the cost of the business combination and the fair value of the assets acquired and the liabilities assumed.

In this regard, it is essential to have a report prepared by an independent expert or an audit of the annual accounts for the financial year of the purchase.

This report should serve as support from a third-party opinion and indicate the fair value of the productive unit and, where applicable, the amount of any resulting goodwill or badwill.

In this way, the acquirer will have backing to justify the correct accounting of the transaction carried out in the insolvency proceedings and its tax implications in the event of a review by the Tax Authorities.

It should also be analysed whether the insolvent company’s tax loss carryforwards, pending deductions or other tax credits can be transferred to the acquirer.

As a general rule, these tax credits are not transferred, unless the transaction involves the continuity of the legal personality of the insolvent company, for example through certain restructuring transactions. This situation is different from the simple purchase of the assets and liabilities that make up the productive unit.

Practical example of the purchase of a productive unit in insolvency proceedings

Let us assume that company ‘A’ acquires, within the insolvency proceedings of company ‘B’, the productive unit corresponding to its industrial plant.

The productive unit consists of a property, machinery, inventories and a client portfolio, without the acquiring company assuming the financial liabilities.

The transaction data would be as follows:

In this case, the price paid, of €3,000,000, exceeds by €200,000 the net fair value of the identified assets, which stands at €2,800,000.

This difference is recognised as goodwill, an asset that is not amortisable for accounting purposes but which, under certain conditions and limits provided for in Article 12.2 and related provisions of the Corporate Income Tax Act, may be tax-deductible from the buyer’s taxable base.

The deduction may reach, at most, one twentieth of its amount per year, that is, 5%. In this example, the maximum amount would be €10,000 per year, subject to the limits and requirements in force.

If, on the other hand, the price paid had been €2,500,000, that is, lower than the €2,800,000 net fair value, a negative difference or badwill of €300,000 would arise.

In accordance with accounting rules, this difference would be recognised directly in the profit and loss account for the year of acquisition, increasing the accounting profit and, consequently, the Corporate Income Tax base for that year, unless off-book adjustments were applicable.

As regards VAT on this same transaction, since it involves an autonomous economic unit capable of operating by its own means, made up of the property, machinery, inventories and client base transferred together, the transaction would, in principle, not be subject to VAT pursuant to Article 7.1 of the VAT Act.

Consequently, company ‘A’ would not bear any VAT charged on the €3,000,000 acquisition price.

Conclusions on the taxation of the transaction in insolvency proceedings

Before submitting an offer to acquire a productive unit in insolvency proceedings, it is advisable to request from the insolvency administrator a detailed report on the tax and Social Security debts linked to the productive unit.

Guarantee clauses, mechanisms for retaining part of the price and specific representations regarding possible tax contingencies should also be included in the contract.

In short, a comprehensive tax due diligence, combined with a review of the other legal, corporate, employment and other issues, exhaustive drafting of the contractual clauses and proper accounting planning of the transaction is essential.

This analysis will make it possible to weigh up the risks, anticipate contingencies and apply the appropriate tax treatment to the purchase of a productive unit within insolvency proceedings.

FAQ on the purchase of a productive unit in insolvency proceedings

Do you need advice? Visit our areas related to the productive unit in insolvency proceedings:

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Insolvency Law