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The cancelation/forgiveness of a loan and the tax interpretation in Albania and Europe

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The capitalization and/or forgiveness of loans by a shareholder to its wholly-owned subsidiary in Albania, generally qualifies as a shareholder contribution to the net equity of the subsidiary.

When this is the case, the subsidiary does not register income in its Profit and Loss (P&L) account and the shareholder increases the basis of its investment in such subsidiary. However, Albanian National Accountability Standards (NAS) provides that differences between the book value of the debt and its fair value must be registered by the subsidiary (the borrower) as income in its P&L account.

Forgiven amount is generally non-tax-deductible to the creditor. If debt is forgiven by a shareholder of the debtor (debt-for-equity swap), the forgiven amount does increase the cost of the shareholding for the creditor. In case of an insolvency proceeding, the creditor is entitled to entirely write-off its credit, and such a write-off is tax deductible. On the other hand, debt rescheduling has no tax implications.

In the absence of a tax provision, since Albanian income tax rules follows accounting, where income is registered by the subsidiary as a cancellation of debt, the argument may be made that it is taxable at the standard corporate income tax rate. The Albanian tax authorities have now issued a ruling stating that where income is recognized under Albanian NAS by the subsidiary in a capitalization or forgiveness of the loan by the shareholder, this income is not taxable if the following circumstances exist:

– The shareholder holds 100% of the Albanian subsidiary; and

– The tax value of the receivable held by the shareholder is equal to the tax value of the payable at the subsidiary’s level.

The debt that has been capitalized or waived by the shareholder had been purchased from a third party at a discount, the difference between the value of the liability in the subsidiary’s books and the tax basis of the receivable for the shareholder, if booked as income by the subsidiary, is fully taxable.

The interpretation made by our studio[1] we think that is relevant as it addresses situations that are fairly common under the current environment and facilitates the recapitalization of entities in need of additional shareholding funding with no adverse tax consequences. This notwithstanding, a caseby-case analysis must be carried out to ensure that the interpretation made in the ruling is applicable to particular situations. Cancellation or capitalization of debt may still give rise to the recognition of accounting and taxable income where the subsidiary has more than one shareholder or where the tax value of the receivable is different at the subsidiary’s and parent company’s level.

About this transaction there’s no VAT implications for debt forgiveness. In case of insolvency proceedings, the creditor is entitled to reduce the VAT taxable amount.

In cross-border transactions, the forgiveness of the debt relating to interest may trigger withholding tax.

Let’s see below some experiencies from european countries and the tax treatment they implement in this regard.

Cyprus

Forgiven amount is generally taxable income for the debtor. Related party transactions should be made at arm’s length. It is uncertain whether forgiven debt between related parties may be taxed all together or partly.

No VAT implications on issuance or exchange of “financial instruments” (such as a debt obligation).

Denmark

Forgiven amount is generally taxable income for the debtor, unless the creditor owns more than 50% of the debtor’s capital.

Assignment of debt without payment of consideration is treated as debt forgiveness for tax purposes. Debt restructuring within a group is generally tax neutral. However, if a group-related creditor can deduct a loss upon the forgiveness of a Danish debtor’s obligation, the debtor will be subject to capital gains taxation.

Special rules apply to debt conversions, amendments to terms and conditions, refinancing of old debt by new debt, waivers of debt and/or interest, suspension of payments and bankruptcy and assignments of loans, depending on whether you look at the creditor or the debtor and whether the parties involved are grouprelated. Special rules apply if the debt forgiveness is part of a “general scheme”. A general scheme is defined as a scheme including at least 50% of the unsecured debt and all major creditors.

No VAT implications on issuance or exchange of “financial instruments” (such as a debt obligation).

France

Forgiven amount is generally taxable income for the debtor.

If the debt forgiveness is motivated by commercial considerations, it is fully deductible. Debt forgiveness motivated by financial considerations is only deductible up to the negative equity of the subsidiary, and the excess is generally deemed to be a capital contribution.

If it only leads to a modification of the duration or the interest rate, the debt rescheduling or restructuring is tax neutral. If the principal of the debt is modified the debt forgiveness rules will apply.

Conversion of debt into equity capital is not a taxable event.

Loan interest is VATexempt. For the creditor this has an effect on input VAT deductions where interest is charged to EU or French debtors, but an input VAT deduction can be taken for a loan granted to a non-EU borrower.

Germany

Forgiven amount is generally taxable income for the debtor.

Debt forgiveness from shareholders is treated as contributions in the amount of the debt’s fair market value. To the extent the fair market value of the debt is lower than the amount of the debt forgiveness, the difference is treated as taxable income.

No VAT implications on issuance or exchange of “financial instruments” (such as a debt obligation).

Greece

Forgiven amount is generally taxable income to the debtor. Debt settlement pursued in the context of bankruptcy procedures is generally not considered debt forgiveness resulting in taxable income to the debtor. Assumption of debt without consideration triggers for the debtor/beneficiary the imposition of gift tax (at an average rate of 40%) rather than income tax.

In principle “bad debt” provisions at a percentage of either 0.5% of the total amount of sales and services invoiced to business clients or 1% on retail sales on credit of specific consumption goods and sales by natural gas companies, telephone companies and others, are tax deductible. In case the above bad debts for which provisions have been recorded have not been realised within a specific period they are subject to corporate income tax at the applicable rate. Additional bad debt amounts are tax deductible in case there is specific evidence for the realization of the bad debt (e.g. bankruptcy of the debtor). Special provisions apply to taxpayers operating in specific industries (e.g. banks, leasing companies, etc).

No special rules apply for intra-group debt restructuring, given that there are no tax consolidation rules in Greece.

No VAT implications on debt forgiveness. Assumption of debts against consideration falls within the scope of VAT, as a supply of service, however it is VAT exempt.

Italy

Forgiven amount is generally taxable income to the debtor, including trade debt forgiveness, except where the debt forgiveness takes place within an insolvency proceeding or in a debt-for-equity swap.

Forgiven amount is generally non-tax-deductible to the creditor. If debt is forgiven by a shareholder of the debtor (debt-for-equity swap), the forgiven amount does increase the cost of the shareholding for the creditor. In case of an insolvency proceeding, the creditor is entitled to entirely write-off its credit, and such a write-off is tax deductible. Rescheduling: Debt rescheduling has no tax implications.

In cross-border transactions, the forgiveness of the debt relating to interest may trigger withholding tax.

No VAT implications for debt forgiveness. In case of insolvency proceedings, the creditor is entitled to reduce the VAT taxable amount.

Netherlands

Forgiven amount reduces: (i) losses in the current year, and (ii) losses carried over from past years. Remainder is generally exempt from taxation, although forgiveness of a related-party debt may lead to the recognition of: (i) an informal capital distribution, or (ii) a disguised dividend distribution which is subject to dividend withholding tax.

Debt parking does not have any corporate tax consequences for the debtor. However, if the new creditor is a related party whereas the old creditor is not, the thin capitalization rules may restrict the deductibility of interest. The old creditor may have to recognize foreign exchange and other results on the corresponding receivable. If the terms of the debt parking are not arm’s length, the debt parking may have dividend tax consequences.

The tax consequences of debt rescheduling or restructuring have to be determined on a case-by-case basis. Debt rescheduling may constitute a taxable event. The characterization of the debt as equity or debt for tax purposes may have to be reviewed upon rescheduling.

Special rules apply to transactions involving receivables on subsidiaries of which the shares qualify for the participation exemption at the level of the creditor. In the event that such receivables have been depreciated, the aforementioned transactions may lead to a mandatory recapture of the depreciation.

Examples of these transactions are: (i) assignments to a related person, (ii) allocations to foreign permanent establishments, and (iii) conversions into share capital. In the event that the creditor and the debtor are within the same tax group for corporate tax purposes, these transactions are neutral for tax purposes.

No VAT implications for debt forgiveness.

Poland

Forgiven amount is taxable income to the debtor.

Forgiven amounts may be treated as tax deductible insofar as they have been previously recognized as taxable revenues. A creditor may recognize a loss on the sale of receivables under the same conditions. There is also a possibility for the creditor to write off debt in the amount previously recognized as taxable revenue, provided that there is certain formal, documentary proof that the debt is not collectible.

Issuance of “financial instruments” (such as a debt obligation) may be viewed as VAT-exempt activity in specific circumstances. Debt collection services and factoring are subject to 22% VAT. As of 1st December 2008, amended VAT regulations allowing for adjustment of output VAT on uncollectible commercial receivables came into force, which ease the conditions applied to bad debt relief.

Romania

Forgiven amount is generally taxable income to the debtor.

If the creditor is a Romanian tax resident company, the forgiven amount may result in a nondeductible loss, depending also on whether bad-debt provisions have been previously created or not. Bad-debt provisions are deductible within certain restrictive limits / conditions and are fully non-deductible in related-party debts. Assignment of receivables can also be performed and does not result in major adverse tax consequences.

Debt-for-equity swaps are allowed and trigger limited tax implications (possible withholding tax on interest capitalized).

No VAT implications for debt forgiveness.

Russia

Forgiven amount is generally taxable income to the debtor. No tax arises if the creditor is a parent which owns more than 50 % of the debtor’s capital.

Assignment of debts without payment of consideration is treated as debt forgiveness. Rescheduling: Debt rescheduling or restructuring is generally tax neutral, provided that the new liability does not significantly deviate from the previous one.

No VAT implications for debt forgiveness.

Sweden

Forgiven amount is not generally taxable income of the debtor, although the debtor will lose a corresponding portion of its tax loss carry-forward. However, if the debtor and creditor are in the same group of companies and the debtor is not insolvent, debt forgiveness may be considered a dividend to the debtor. There is therefore a risk of withholding tax if the debtor is not resident in Sweden.

Forgiven amount is generally deductible for a creditor, if made for a sound business reason and the debtor is insolvent.

VAT charged on services related to the issuance of debt is generally fully recoverable, unless the creditor’s business activity is only partly subject to VAT.

United Kingdom

Forgiven amount is generally taxable income to the debtor, unless the debt is between connected persons, in which case the forgiven amount is non-taxable. Trade debt forgiveness will be taxable to the debtor.

Forgiven amount is generally deductible to the creditor, unless between connected persons in which case the forgiven amount is not deductible. Trade debt forgiveness will be deductible to the creditor, unless between connected persons, in which case the forgiven amount is not deductible.

No VAT implications for debt forgiveness.

[1] altaxstudio.com

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