VAT in M&A transactions: When it is exempt and when the tax applies

When planning M&A transactions or corporate restructurings, attention is often focused on the direct taxation of capital gains, the availability of the special tax neutrality regime for mergers and demergers, and the tax treatment of shareholders, all of which are critical considerations when making strategic decisions. However, the indirect tax implications of a transaction must also be taken into account, as they frequently give rise to significant and unexpected costs.

Failure to anticipate the indirect tax consequences of a transaction may result in substantial cash-flow pressures arising from VAT liabilities, particularly where real estate assets are involved, the emergence of irrecoverable transfer tax costs, or even the application of the anti-avoidance provisions set out in article 338 of the Securities Markets and Investment Services Act.

Accordingly, before implementing any M&A transaction, it is essential to undertake a comprehensive analysis of the potential VAT implications, transfer tax exposure and any other indirect taxes that may affect the transaction.

Is the sale and purchase of a business subject to VAT?

The answer will, of course, depend on how the transaction is structured.

From a practical perspective, three main types of transaction can be distinguished:

• Acquisition of shares in a company

• Direct acquisition of assets or individual business assets.

• Transfer of an autonomous business unit or a going concern.

Although all of these alternatives may pursue the same economic objective, their tax consequences differ significantly.

Sale or contribution of shares

As a general rule, the sale of shares or other equity interests is exempt from VAT, primarily pursuant to article 338 of the Securities Markets and Investment Services Act.

The exception under Article 338 of the Securities Markets and Investment Services Act

One of the most common mistakes is to assume that every transfer of shares automatically falls outside the scope of indirect taxation.

In order to prevent real estate from being transferred indirectly through the sale of shares without bearing the corresponding tax burden, Spanish legislation includes a specific anti-avoidance rule, currently contained in article 338 of the Securities Markets and Investment Services Act.

Article 338 is an anti-avoidance provision that allows the Spanish tax authorities to tax the transfer of shares in real estate holding companies where, in substance, the transaction amounts to an indirect transfer of real property. Consequently, before acquiring or disposing of a company with a significant proportion of real estate assets, it is advisable to assess whether there is a risk that the transaction could be taxed as though the underlying properties had been transferred directly.

In general terms, and subject to a detailed analysis of the specific facts and circumstances of each case, concerns typically arise where:

• control of an entity is acquired or increased;
• more than 50% of the entity’s assets consist of real estate located in Spain; and
• such real estate is not used in the carrying on of an economic activity.

Although the practical application of this provision requires a careful case-by-case assessment, it is particularly relevant in transactions involving holding companies, family-owned groups with significant real estate assets, real estate investment vehicles and similar structures.

Accordingly, before proceeding with any share acquisition, it is essential to analyse the composition of the target company’s assets.

Asset sales: when VAT takes centre stage

The position changes significantly where, instead of shares, the assets comprising the business are transferred.

In such cases, each of the assets and rights being transferred must be analysed individually:

• Real estate assets.
• Inventory.
• Machinery.
• Trade marks.
• Software.
• Contracts.
• Licences.
• Customer portfolio.
• Etc.

Depending on the nature of the assets transferred, the transaction may be subject to VAT and not exempt, subject to VAT but exempt, or fall entirely outside the scope of VAT.

Accordingly, the structure chosen for the transaction may have a very significant economic impact.

The transfer of a going concern

One of the most important VAT provisions in the context of M&A transactions is the exclusion from the scope of VAT set out in article 7.1 of the Spanish VAT Act.

Under this provision, VAT does not apply to the transfer of a combination of tangible and intangible assets which constitutes, or is capable of constituting, an independent business undertaking capable of carrying on an economic activity by its own means.

The purpose of this rule is to facilitate the transfer of entire businesses by preventing VAT from becoming a financial obstacle to the transaction.

Accordingly, where a genuine independent business undertaking is transferred, the transaction may be completed without charging VAT.

However, whether a genuine independent business undertaking exists must be assessed on a case-by-case basis. Not every collection of assets qualifies as such under the criteria applied by the tax authorities. If the requirements are not met, the entire transaction may become subject to VAT, with the resulting financial consequences. This is a highly fact-specific area that requires careful analysis.

The principal VAT exclusion risk: transfer tax

However, caution is required. The exclusion from VAT described above may give rise to an unintended indirect tax consequence.

Where an independent business undertaking includes real estate assets, the application of article 7.1 of the VAT Act may trigger liability to transfer tax (Transferencias Patrimoniales Onerosas – TPO) in respect of those properties, owing to the rules governing the interaction between VAT and transfer tax. Under these rules, where the transfer falls outside the scope of VAT and includes real estate, transfer tax becomes chargeable on the transfer of the properties. The purchaser is liable for the tax, which is generally charged at rates ranging from 8% to 10% of the property’s value, depending on the autonomous community in which the property is located.

This distinction is particularly important because, whereas VAT incurred by a business is generally recoverable through deduction, transfer tax usually represents a final and irrecoverable cost for the purchaser.

Consequently, a transaction structured to avoid VAT may ultimately result in a substantially higher effective tax burden.

Consider, for example, the acquisition of an independent business undertaking that includes several properties used in a property-letting business.

If the transaction falls outside the scope of VAT but is subject to transfer tax, the purchaser may incur a significant tax cost that cannot subsequently be recovered.

Corporate reorganisations: VAT as a financial challenge

Another common scenario involves transactions such as contributions of assets to subsidiaries, the segregation of real estate activities or the reorganisation of assets within a corporate group.

In many cases, these transactions may qualify for the special tax neutrality regime applicable to mergers, demergers, asset contributions and share-for-share exchanges for corporate income tax purposes. However, this treatment is separate from their indirect tax treatment and, in particular, from their VAT treatment.

A common example: contributions of plots of land, developments under construction or land undergoing urbanisation

One of the most sensitive situations involves non-cash contributions of standalone real estate assets which, in many cases, may be subject to VAT without the possibility of applying the reverse charge mechanism. This may require the recipient entity to pay the VAT charged by the transferor, although the VAT may subsequently be recoverable where the assets are intended to be used for activities that are subject to and not exempt from VAT.

Examples include: development land; land undergoing urbanisation; real estate developments under construction; and real estate inventory.

Where the acquiring entity is entitled to deduct VAT in full, the VAT charged should ultimately be recoverable. Nevertheless, the transaction may still generate significant cash-flow pressures.

Consider the example of a contribution of land valued at €20 million as part of a corporate reorganisation. The VAT payable by the recipient entity could exceed €4 million.

Although that amount may ultimately be recovered through the VAT deduction mechanism, the group will need to finance the VAT liability until the relevant deduction, offset or refund is obtained.

In certain sectors, particularly real estate and hospitality, this temporary funding requirement may seriously affect the financial viability of the transaction.

The VAT group regime

To mitigate these issues, it may be advisable to consider the application of the VAT group regime, which broadly operates by allowing the offsetting of VAT payable and VAT recoverable among entities belonging to the same group

Where the statutory requirements are satisfied, following an appropriate analysis, the regime can significantly reduce the cash-flow impact of certain intra-group transactions and improve the financial efficiency of corporate reorganisations.

Although it is not a universal solution, it can be an extremely useful tool for real estate groups, holding structures and business groups that regularly transfer assets internally.

The importance of planning before implementing the transaction

One of the most common mistakes is to consider the VAT implications only after the corporate structure of the transaction has already been determined.

In practice, relatively minor changes to the way in which a transaction is implemented can fundamentally alter its indirect tax treatment.

The choice between a share sale, an asset sale, the transfer of an independent business undertaking, a demerger, a non-cash contribution or another transaction structure may result in substantial differences both in terms of the effective tax burden and the financing requirements of the transaction.

Accordingly, careful advance planning can often generate significant tax and financial savings.

Conclusion: VAT can determine the financial success of a transaction

The indirect tax treatment of M&A transactions is considerably more complex than is often assumed.

For this reason, before implementing any acquisition, restructuring or corporate reorganisation, it is essential to undertake a comprehensive review of the VAT implications, transfer tax exposure and any other tax considerations arising from the transaction. In our experience, careful planning not only reduces tax risk but can also prevent significant financial costs and play a decisive role in the overall success of the transaction.

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