Change in Practice Regarding Business Transfers

For several years now, the State Revenue Service (SRS) has been actively recovering companies’ tax debts from the transferees of these companies. Specifically, in cases where it can be established that a company (tax debtor) has been acquired, i.e., everything necessary for the continuation of the respective economic activity without significant changes has been transferred to another company (e.g., employees, assets, client base, supplier network, trademark, etc.), the SRS recovers tax debts from the transferee of this company.

The previous practice in determining a business transfer was largely based on case law developed by interpreting the European Union VAT Directive and the relevant provisions of the Value Added Tax Law. Decisive importance was given to whether the acquirer had received a set of business elements that was necessary and at the same time sufficient for the continuation of independent and autonomous economic activity in the existing manner and profile without significant changes.

To conclude that the transferee continues the debtor’s economic activity without significant changes, it was usually necessary to establish that the acquirer had received the most substantial part of the assets, clients, or employees, and that the company’s accumulated know-how and the identity of its economic activity had been preserved.

However, a significant turning point has recently occurred, which may change the current practice and approach to determining when a business transfer can be established.

Section 20 of the Commercial Law

The Commercial Law stipulates that if an undertaking or its independent part is transferred to the ownership or use of another person, the acquirer of the undertaking is responsible for all liabilities of the undertaking or its independent part. In turn, regarding liabilities that arose before the transfer of the undertaking or its independent part and whose performance deadline or condition occurs within five years after the transfer of the undertaking, the transferor and the acquirer of the undertaking are jointly and severally liable.

The purpose of this regulation is to prevent situations where a capital company is effectively “emptied” of assets, leaving its creditors with no real possibility of receiving their due performance. This means that along with the assets included in the undertaking – both tangible and intangible values – the acquirer of the undertaking also assumes responsibility for the undertaking’s liabilities. Thus, the regulation ensures the protection of the interests of creditors, as well as the undertaking’s employees, against the potential negative consequences of a business transfer.

Business Transfer Criteria to be Assessed Holistically

Recently, the Senate of the Supreme Court re-analyzed the regulation of business transfers and its purpose, concluding that to determine whether a business transfer has occurred (i.e., whether the identity of the undertaking has been preserved), all circumstances of the specific case must be assessed holistically and in their mutual interrelation.

Namely, the following circumstances must continue to be assessed:

1. type of commercial activity,
2. whether tangible assets have been transferred,
3. value of intangible assets at the time of transfer,
4. whether the majority of employees have been taken over,
5. whether the client base has been transferred,
6. degree of similarity of activities performed before and after the transfer,
7. period, if any, during which these activities were interrupted.

However, the importance attributed to each of these criteria may differ depending on the specific type of economic activity or even on the production or management methods used in the respective economic unit, undertaking, or part of an undertaking.

For example, in sectors where activity is primarily based on labor (i.e., when specific tangible assets are not required for economic activity), the identity of the economic unit can only be preserved if the acquirer takes over the most significant part of the personnel of that unit, in terms of number and skills, employed by the predecessor for the performance of the respective activity. In such a case, the labor criterion itself may be given decisive importance, even if the transfer of other elements is minimal.

Conversely, in cases where economic activity is primarily based on equipment, the fact that the acquirer has not taken over the most significant part of the personnel in terms of number and skills does not, by itself, preclude the possibility of establishing the transfer of an identity-preserving economic unit. In such situations, decisive importance may be given precisely to the transfer of tangible assets or equipment, even if the transfer of other elements is minimal.

Furthermore, importance is attached not to the preservation of a specific organizational structure, as defined by the transferor for the various production elements, but to the functional link between these elements – their interdependence and ability to complement each other. The preservation of such a functional link allows the acquirer of the undertaking to use the transferred elements even if, after the transfer, they are integrated into a new or different organizational structure to carry out the same or a similar economic activity.

Criterion “without significant changes” – will not be applicable

Henceforth, to establish a business transfer within the meaning of Section 20 of the Commercial Law, it will no longer be of decisive importance whether the acquirer has received a set of business elements that is necessary and at the same time sufficient for the continuation of independent and autonomous economic activity in the existing manner and profile without significant changes.

Such a decisive criterion is provided for in the VAT Law to determine cases where an exemption from VAT payment is applicable, and it will continue to be applicable in this context.

It is expected that with this significant turning point, the number of cases in which a business transfer is established may increase in practice.