Cross-border conversions and ex-ante control of ‘artificial arrangements’: is this an adequate reaction to Polbud?

On 25 April the Commission published its proposal for a directive amending Directive 2017/1132 as regards cross-border conversions, mergers and divisions (Proposal). One of the aspects of the Proposal, which will undoubtedly cause debate in relation to intracommunity cross-border conversions is the need to assess whether the conversion processes constitute ‘artificial arrangements’, requiring, in certain circumstances, an independent expert report. This post critically assesses the ex-ante procedure for controlling artificial arrangements introduced in the Proposal.

Polbud and the Proposal

The judgment handed down by the Court of Justice of the European Union (ECJ) in the Polbud case, widely discussed in this blog (here; here; and here), confirmed the right of companies to carry out cross-border conversions on the basis of freedom of establishment ‘even though that company conducts its main, if not entire, business in the first Member State [that is, the departure Member State]’ (Polbud, para 38), but provided the requirements applicable in the destination Member State are fulfilled.

The fear that the implications of the Polbud judgment will facilitate situations in which cross-border conversions are used for abusive purposes has influenced the final approach adopted by the Proposal.

The ex-ante control procedure for ‘artificial arrangements’

Article 86c.3 of the Proposal establishes that the departure Member State shall not authorize the cross-border conversion where it determines that such conversion constitutes an artificial arrangement aimed at obtaining undue tax advantages, or at unduly prejudicing the legal or contractual rights of employees, creditors or minority members. 

The competent authority of the departure Member State shall analyse this matter within a one-month term. However, if the competent authority has serious concerns that the cross-border conversion constitutes an ‘artificial arrangement’, it may decide to carry out an in-depth assessment which will last a maximum of an additional two months (Articles 86m 7 c) and 86 n)).

The Proposal also establishes that in the event the company that is being converted is not a ‘micro’ or ‘small enterprise’ it will be necessary to obtain a report from an independent expert (Article 86g 6) which will be analysed by the competent authority in the departure State before taking a decision. The report will include a description of all the factual elements necessary to ascertain whether the cross-border conversion implies an artificial arrangement including, at the minimum, certain specified elements (as the ones mentioned in Article 86g 3), but it does not need to assess expressly whether the cross-border conversion in fact implies an artificial arrangement.

Critique of this ex-ante control procedure and the independent expert report

I agree with Segismundo Álvarez when he criticizes the practical difficulty of examining in advance whether a cross-border conversion implies a purely artificial arrangement. Let us have a look, for example, at the case of arrangements designed to obtain ‘undue tax advantages’, that probably will be the most problematic in practice. From reading the OECD report on the BEPS project, one can clearly deduce that the analysis of the issues underlying artificial arrangements must essentially be carried out a posteriori taking into account different tax periods and the different functions, activities and risks of each activity to see if tax is paid correctly.

The proposed system of ex-ante control could also not generate the legal certainty that the Proposal is clearly seeking to achieve for cross-border conversions. To talk about the prohibition of artificial arrangements means talking about the prohibition of abuse of law. As was already highlighted by advocate general Maduro in his conclusions in the Cartesio case (para 29), certain tensions can be detected in the ECJ’s case law in relation to the concept of abuse. On the one hand, we have ECJ case law in relation to company law matters (eg Centros, paras 27, 39; Inspire Art, paras 39, 98, 138; and now Polbud, paras 62 and 63) where the concept of abuse is left devoid of meaning, although it can be alleged in theory. Meanwhile, mainly in tax matters (eg Cadbury Schweppes, paras 51, 55, 64–68), the position of the ECJ has been far more cautious and the concept of abuse and artificial arrangement has played a key role. Conjugating all these subtleties will be far from easy in practice, and it can be a source of conflict and a tool used by the departure Member States to unduly restrict corporate mobility.

The implementation of the ex-ante system of control designed in the Proposal is also going to be a challenge for those Member States in which the control of the legality of these types of transactions is not performed by a judge but by other authorities (eg notaries or commercial registries) which are not as well-placed as courts to assess whether a certain conversion implies an artificial arrangement.

It is also worth mentioning that cross-border conversions are not regulated consistently in European law which could create incentives to use alternative routes for cross-border conversions.

For example, the regime under Regulation 2157/2001 on the Statute for a European company (SE) (Regulation 2157/2001) for the transfer of the registered office of an SE to another Member State does not include this ex-ante control of artificial arrangements. Perhaps it was not deemed necessary to modify it because Regulation 2157/2001 requires that an SE have its registered office in the same Member State as its head office. But, as we see in practice, complying with the criterion of situating the head office in the same State/place as the registered office is not a major problem for companies and does not necessarily imply preventing artificial arrangements.

There is no similar control of artificial arrangements for cross-border mergers either. Therefore, companies could try to continue to use cross-border mergers to carry out a cross-border conversion. Many cross-border conversions are implemented by means of the incorporation of a new entity in the destination State which subsequently absorbs the company that wants to transfer its registered office. Whether this continues to be possible after the approval of the Proposal will also be a matter for debate.

Final comments

Looking at what we have discussed thus far, it is clear what the answer to the question posed in the title of this post will be. The introduction of the ex-ante control mechanism for artificial arrangements (enhanced with an expert report) seems to me to be an over-reaction to the implications of the Polbud case law, which is also unlikely to achieve its stated objective; it might hinder the cross-border conversion procedure and it could provoke arbitrage between different routes to carry out cross-border conversions.

Jaime Sánchez Santiago is a Spanish lawyer (‘abogado’), attorney at law (NY), and an associate professor of EU corporate law and cross-border M&A at the ICADE University (Spain).

This post draws on a more extensive work published in Spanish by Almacén de derecho on 15 June 2018 with the title: ‘El control ex-ante de montajes puramente artificiales: ¿una reacción adecuada frente a Polbud?’.