Norcous & Partners lithuania Lithuania

Asta Karpaviciute and Dmitrij Dolgin Norcous & Partners

The acquisition (from the buyer’s perspective) is subject to depreciation for tax purposes for 15 years applying the linear method. 1 What are the differences in tax treatment between an acquisition of stock in In cases of acquisition of other intangible assets, the deprecia- a company and the acquisition of business assets and liabilities? tion rules are as follows: From a corporate income tax (CIT) perspective governed by the • software – three years, applying the linear or double declining Law on CIT of 20 December 2001, no difference in tax treat- method; ment occurs between the acquisition of stock and that of business • rights acquired – three years, applying the linear or double assets and liabilities at the moment of acquisition itself. declining method; and However, the differences appear in cases of disposal. The • other intangible assets – four years, applying the linear Law on CIT sets an exhaustive list of income classes sourced in method. Lithuania by foreign companies having no business presence in Lithuania that are subject to Lithuanian withholding tax. Neither Goodwill created as a result of acquisition of stock and recorded capital gains earned by a foreign company on stocks nor move- in the accounts separately from other assets is subject to deprecia- able property are included in the above-mentioned list and there- tion for tax purposes only after the subsequent reorganisation of fore are not taxable in Lithuania. However, income from sales, such companies in the form of a merger or a transfer of assets. other transfers of ownership or leases of immoveable property Such goodwill can be depreciated for 15 years applying the linear located in Lithuania are subject to Lithuanian CIT. method. Moreover, foreign companies holding business assets or liabilities and performing economic activities in Lithuania might be recognised as operating through a permanent establishment 3 Is it preferable for an acquisition to be executed by an acquisition company in Lithuania. In such case, the tax base of the foreign company established in or out of your jurisdiction? for Lithuanian CIT purposes would be all income sourced in Although at the moment of acquiring the target company, the Lithuania through the permanent establishment, as well as place of establishment of an acquisition company does not cause income earned in foreign countries and attributed to the perma- any material difference, it might be of importance for further nent establishment in Lithuania. management of stock acquired. For differences in tax treatment from a value added tax (VAT) Concerning dividend distribution, participation exemption perspective, see question 6. (see question 13) is equally applied regardless of the country of establishment of the company receiving the dividends, except for companies organised in the low-tax jurisdictions. 2 In what circumstances does a purchaser get a step-up in basis in the Moreover, according to the Law on CIT, tax-free mergers business assets of the target company? Can goodwill and other intangibles and other forms of reorganisation may be performed only if com- be depreciated for tax purposes in the event of the purchase of those assets, panies participating in the reorganisation are established in the and the purchase of stock in a company owning those assets? European Union. If one of the companies participating in such In the event of a purchase of the business assets, the purchaser reorganisation is established outside the EU area, capital gains gets a step-up in basis. Pursuant to the Law on CIT, generally realised as a result of the reorganisation would be subject to CIT the acquisition price of assets comprises expenses incurred in the in Lithuania. course of acquiring the assets, including the commissions and With regard to disposal of stock, starting with the 2007 par- taxes (levies) paid, except for VAT, in connection with the acqui- ticipation exemption on capital gains will apply for Lithuanian sition of such assets. If assets are exchanged for other assets, the companies disposing of stock in companies organised in the acquisition price of the newly acquired assets is the acquisition European Economic Area or in the country with which Lithuania price of the assets exchanged. In the event that the acquisition has concluded a treaty for double taxation avoidance. In order to price of the assets exchanged cannot be determined, the acquisi- qualify for the participation exemption, the Lithuanian company tion price of the newly acquired assets is the fair market value should satisfy the following conditions: of such assets. • participation in stock capital exceeds 25 per cent; and Goodwill created as a result of the acquisition of one or more • stocks are held for at least two years. branches of activity of another company which, from an organi- sational point of view, constitute an independent business and Moreover, losses on disposal of stock compliant with the above which are recorded in the accounts separately from other assets, requirements may be used to offset income from disposal of secu-

Getting the Deal Through – tax on inbound investment 2008  Norcous & Partners lithuania

rities and derivatives during the same tax period. However, no ity) provided the receiving company continues the acquired activ- loss carry-forward for these losses will be allowed. ity for at least three years. After the three-year period expires, such losses can be carried forward by the receiving company only while it is engaged in the acquired activity. 4 Are company mergers or share exchanges common forms of acquisition? The Law on CIT’s loss carry-forward rules distinguish The way companies are managed and reorganised is rather a sub- between losses from operating activities and losses incurred as jective issue depending on the business model selected, the aims a result of transferring securities or derivatives. Losses from of the companies, etc. The most tax-efficient way of acquiring the operating activities can be carried forward for five consecutive target company should be carefully analysed given the purpose fiscal years and can be used to cover income received from both and circumstances of the transaction itself. In Lithuania, compa- operating activities and trading in securities or derivatives. Losses nies more often choose mergers rather than stock exchanges for incurred as a result of transferring securities or derivatives can be individual business reasons. carried forward for three consecutive fiscal years and can be used only to offset the income received from the transfer of securities or derivatives. 5 Is there a tax benefit to the acquirer in issuing stock as consideration rather than cash? 8 Does an acquisition company get interest relief for borrowings to acquire the Lithuanian tax laws do not provide for any specific tax benefits target? Are there restrictions on deductibility where the lender is foreign, a to the acquirer issuing stock as consideration rather than cash. related party, or both? Can withholding taxes on interest payments be easily Still, if the acquirer issues stock as consideration, the acquisition avoided? Is debt pushdown easily achieved? of either stock or business assets of the target company might fall under the provisions of the Law on CIT regulating tax-free Lithuanian tax laws do not provide for any interest relief for mergers and acquisitions. As a consequence, this would result in borrowing to acquire the target. a different estimation of the acquisition price of either stock or Moreover, Lithuanian tax laws do not provide for any restric- business assets which is important for the acquirer in cases of tions on the deductibility of interest payments where the lender subsequent disposal. If stock or business assets are acquired for is foreign. However, all loans received from the foreign lenders cash, the acquisition price is considered to be the price paid and should be registered with the Bank of Lithuania. other related expenses incurred. However, if the acquisition falls Deductibility of interest where a lender is a related party under the above-mentioned Law on CIT rules, the acquisition despite its place of residence might be subject to several restric- price of stock received is considered to be the emission value of tions. Lithuanian thin capitalisation rules restrict the deductibility stock issued for consideration and the acquisition value of busi- of interest paid on loans granted by a controlling Lithuanian or ness assets is considered to be the price for which the assets were foreign company, except if it is proven that such a loan could acquired by the seller. be perfectly granted by an independent company. According to Lithuanian thin capitalisation rules, interest incurred on the amount of the loan granted by the controlling company exceed- 6 Are documentary taxes payable on the acquisition of stock or business ing the permitted debt-to-equity ratio (which is currently 4:1) is assets and, if so, what are the rates and who is accountable? Are any other not deductible for CIT purposes. transaction taxes payable? Loans received from other related parties regardless their Lithuanian law does not provide for any stamp duties payable on country of residence should comply with the arm’s-length prin- the acquisition of stocks or business assets. However, pursuant cipal. Otherwise, the Lithuanian Tax Authority can recalculate to the Civil Code of the Republic of Lithuania certain transac- taxable profits of the Lithuanian companies engaged in the trans- tions are subject to the confirmation by notary. As a consequence, action. parties to such transactions would suffer notary expenses, for Taxation of interest payments is outlined in question 13. example transfer of real estate or transfer of the company as a Except for reduced tax rates, there is no possibility of avoiding going concern is subject to the notary fee of 0.5% of the sale withholding taxes. price. Lithuanian laws do not provide for notary confirmation Debt pushdown in the form of an upstream or downstream requirement for the transfer of stocks. merger may be achieved only in case of pre-approval of the Pursuant to the Law on Value Added Tax (Law on VAT) of other shareholders and creditors. However, after the acquisition 5 March 2002, the sale of stock and liabilities of a company is company and target company are merged, the interest payments not subject to VAT. The sale of business assets might be subject on loans taken to finance the acquisition of the target company to 18 per cent VAT, depending on the type of business assets sold, are no longer treated as allowable deductions for CIT purposes. the deduction of input VAT of the assets disposed of and other Moreover, Lithuanian law does not provide for a possibility of circumstances. consolidating for CIT purposes, therefore such a debt pushdown strategy is not possible.

7 Do net operating losses survive a change in control of the target? If not, are there techniques for preserving them? 9 What forms of protection are generally sought for stock and business asset acquisitions? How are they documented? A change in control of the target company does not impact on the possibility of carrying forward operating losses for tax pur- To protect an acquirer of stock, sellers’ representations and war- poses. ranties are used. In the form of a statement in the stock purchase Different rules on loss carry forward are applied in case of agreement, the seller confirms that the target company does not the tax free reorganisations of the companies. In such case, losses have any overdue tax debts, has filed all tax returns by their due attributed to the branch of activity may be carried forward by the dates, has paid, withheld and collected all taxes required by law receiving company (ie, the one that acquires the branch of activ- to be paid, withheld or collected, no tax administration institu-

 Getting the Deal Through – tax on inbound investment 2008 Norcous & Partners lithuania tion has filed or threatens to file any demands or claims related the transfer can no longer be carried forward and the Lithuanian to tax or other obligations of the target company, etc. company would be subject to taxation of capital gains realised on the transfer.

Post-acquisition planning 13 Are interest and dividend payments made out of your jurisdiction subject to 10 What post-acquisition restructuring is typically done and why? withholding taxes and, if so, at what rates? Are there domestic exemptions from these withholdings or are they treaty-dependent? Post-acquisition restructuring very much depends on the business model selected by the acquirer and a typical practice in Lithuania Interest payments made by Lithuanian companies to foreign cannot be outlined. companies are subject to a 10 per cent withholding tax. Dividends distributed by Lithuanian companies to foreign companies are subject to a 15 per cent withholding tax. The 11 Can tax neutral spin-offs of businesses be executed and, if so, can the net Lithuanian Law on CIT also provides for participation exemp- operating losses of the spun-off business be preserved? tion which allows for distributing dividends without triggering Pursuant to the Law on CIT, the following types of business spin- taxation in Lithuania. To be qualify for participation exemption, offs do not trigger taxation of capital gains: the foreign company must satisfy following requirements: • A company, without being dissolved, transfers one or more • the recipient holds (or intends to hold) stock for an uninter- branches of its activity to one or more existing or new com- rupted period of at least 12 months, including the moment panies, which results in a reduction of its authorised capital, of dividend distribution; and in exchange for the pro rata issue to its members of stock in • the recipient holds more than 10 per cent of voting stocks the receiving companies. (interests, member stocks). • A company, without being dissolved, transfers all or one or more branches of its activity to another company in exchange However, it is not possible for foreign companies established for stock of the receiving company. or otherwise organised in low-tax jurisdictions to apply for • A company, without being dissolved, transfers a portion of participation exemption. its assets, rights and obligations to one or more new com- Double taxation avoidance treaties may establish more panies and divides the stock of transferring and receiving favourable tax rates for interest payments and dividends. companies in proportion to the stock held by the members Currently, Lithuania has concluded more than 40 double taxa- prior to the reorganisation. tion avoidance treaties.

Moreover, to qualify for tax-free reorganisation, a company 14 What other tax-efficient means are adopted for extracting profits from your should not sell or otherwise dispose of stock received as a conse- jurisdiction? quence of the reorganisation performed for three years. Other- wise, the capital gains realised after reorganisation are taxed and The most common means of extracting profits from Lithuanian the taxable amount is considered to be the difference between the companies is through distributing dividends as in certain cases fair market value of the stocks received and the acquisition price (see question 13), they are not subject to Lithuanian withhold- of the stocks before the transfer was effected. ing tax. Concerning preservation of losses, losses attributed to the Another tax-efficient way to take out free funds from Lithua- branch of activity may be carried forward by the receiving nian companies is by decreasing authorised stock capital. company (i.e. the one which acquires the branch of activities) Pursuant to the Law on CIT, in case the authorised stock provided the receiving company continues the acquired activity capital formed exclusively from the contributions made by the for at least three years. After the three-year period expires, such members of the company is reduced, funds distributed as a con- losses can be carried forward by the receiving company only sequence of such reduction are not subject to CIT. However, if while it is engaged in the acquired activity. part of the authorised stock capital was formed otherwise than from members’ contributions, funds paid out to the members attributable to the part of the stock capital formed otherwise 12 Is it possible to migrate the residence of the acquisition company or target than from members’ contributions are treated as dividends and company from your jurisdiction without tax consequences? are subject to CIT in the same manner as dividends distributed. According to Lithuanian law, the possibility of migrating the Currently, all funds paid out as a result of stock capital reduction place of residence of a Lithuanian company is only provided for which are treated as dividends are subject to a 15 per cent with- a company registered as European Company (SE) or European holding tax, regardless of the amount of stock held or the holding Cooperative Society (SCE). period. However, from 1 January 2007, participation exemption The status of SEs and SCEs are governed respectively by the for taxation of dividends will also be applicable. Law on European Companies of 29 April 2004, enacted in rela- tion to the Council Regulation on the Statute for a European Company; and the Law on European Cooperative Societies of Disposals (from the seller’s perspective) 15 June 2006, enacted to ensure the application of the Council 15 How are disposals most commonly carried out – a disposal of the business Regulation on the Statute for European Cooperative Society. assets, the stock in the local company or stock in the foreign holding If a Lithuanian company, without being dissolved, transfers company? its registered office to another EU member state, no tax conse- quences arise provided that the company continues to perform The most tax-efficient form of disposal should be analysed its activities through a permanent establishment in Lithuania. separately in each specific case. In any case, the drawback of Otherwise, losses of the Lithuanian company incurred before disposing of business assets rather than stock is the subsequent

Getting the Deal Through – tax on inbound investment 2008  Norcous & Partners lithuania

Update and trends

In general, there are no major changes to tax legislation losses from the operating activities to be carried forward planned with regard to tax on inbound investment. for an unlimited period provided the company continues Several changes currently being considered, though yet the activities due to which such losses were incurred and to be accepted, cover calculation of the taxable base of CIT. to expand the period of loss carry-forward for the losses In particular the possible expansion of the list of allowable incurred as a result of transferring securities or derivatives to deductions is being considered. Also suggested is to allow five years.

extraction of funds from the company if needed. any relief to defer or avoid taxation. Still, capital gains realised by Lithuanian companies on the disposal of both stock and business assets are subject to CIT in the same manner. For the taxation of capital gains, in case the seller is a foreign company with no permanent establishment in Lithuania, see question 1. With regard to disposal of stock, starting with the 2007 par- ticipation exemption on capital gains will apply for Lithuanian companies disposing of stock in companies organised in the Euro- pean Economic Zone or in the country with which Lithuania has concluded a treaty for double taxation avoidance. In order to qualify for the participation exemption, the Lithuanian company should satisfy following conditions: • participation in stock capital exceeds 25 per cent; and • stocks are held for at least two years.

16 Where the disposal is of stock in the local company by a non-resident company, will gains on disposal be exempt from tax? Are there special rules dealing with the disposal of stock in real property, energy and natural resource companies? As was previously mentioned (see question 1), the Law on CIT provides an exhaustive list of income classes received by for- eign companies operating in Lithuania without a fixed place of business that are taxable in Lithuania. Capital gains realised on the disposal of stock are not included in the list. There are no special rules regarding the disposal of stock in real estate, energy and natural resource companies.

17 If a gain is taxable on the disposal either of the shares in the local company or of the business assets by the local company, are there any methods for deferring or avoiding the tax? Capital gains on a disposal of stock or business assets are taxed immediately after realisation. Lithuanian laws do not provide for

Norcous & Partners

Contacts: Asta Karpaviciute e-mail: [email protected] Dmitrij Dolgin e-mail: [email protected]

A Gostauto 12 A Tel: +370 5268 3620 01108 Vilnius Fax: +370 5268 3621 Lithuania Website: www.norcous.lt

 Getting the Deal Through – tax on inbound investment 2008