The underestimated role of tax law in promoting asset partitioning ánd discouraging selective de-partitioning

Asset partitioning refers to limited liability (or: owner shielding) and entity shielding. In both cases a pool of assets is allocated to a pool of liabilities.

The economic justifications of limited liability and entity shielding typically refer – sometimes implicitly – to the situation of many shareholders in a business. Hansmann and Squire refer to this type of asset partitioning as external asset partitioning (“External and Internal Asset Partitioning: Corporations and Their Subsidiaries, The Oxford Handbook of Corporate Law and Governance (Forthcoming)”; Yale Law & Economics Research Paper No. 535, 2.). Asset partitioning is also used within a business to make separate pools of assets and liabilities; this is internal asset partitioning (ibid.). A typical example is a corporate group, where the business as an economic unity is internally, through affiliates, divided in separate pools of assets.  We also consider a company owned (or primarily owned) by a single shareholder as internal asset partitioning, even if that shareholder is a physical person. The economic unity between the single shareholder and the business of her company is similar to, if not stronger than, that between the separate entities of a corporate group.

Asset partitioning builds walls between pools of assets and liabilities. Sometimes the insiders themselves disregard the asset partitioning which they have set up themselves. This is referred to as selective de-partitioning. A crude example is the single shareholder or the parent company extracting assets from its company or subsidiary or shifting liabilities towards it. A more sophisticated example is a guarantee of one entity of a group towards another entity of the group. Often legal rules provide the creditors of the shareholders of a company with remedies against selective de-partitioning. In such a case the law reinforces the walls of asset partitioning.

We will use Belgian law as an example of how an entity-focussed tax law can favour asset partitioning and discourage selective de-partitioning.

Belgian tax law favours internal asset partitioning 

Belgian tax law is one of a handful modern European tax systems which focuses primarily on separate entities and persons to establish the taxable base and levy taxes.

Two examples:

  • A single-shareholder company and the shareholder of such company will be separately taxed. As a principle a legal person is not transparent from a tax perspective. The income of a single-shareholder company is taxed at the level of that company and not at the level of the shareholder; the shareholder only gets taxed on income she gets from the company. This results in a widespread use of management companies with a single shareholder. Many directors of Belgian companies are for instance legal persons. This practice is not so much driven by a desire to enjoy the benefits of asset partitioning as by a desire to optimize the tax situation of the shareholder. The result is, however, an increased use of asset partitioning through single-shareholder companies (which we consider to be a type of internal asset partitioning).
  • In a corporate group, the corporate income tax is assessed and levied at the level of the individual entities of the group and not at a consolidated level. This implies that the same business reality can, through the use of separate legal entities, be structured in many ways with different tax consequences. In practice, this gives an incentive for internal asset partitioning through the use of subsidiaries and other affiliated companies.
Belgian tax law enforces prohibitions on selective de-partitioning

The entity-driven approach of Belgian tax law implies that Belgian tax law and tax authorities are very much concerned about intra-group transactions which are not at-arm’s-length.

Belgian tax laws have important provisions that tackle artificial profit shifting. The main example are the provisions on so-called abnormal or gratuitous benefits (‘abnormale of goedgunstige voordelen’).

These provisions have a severe punitive character. An abnormal or gratuitous benefit will be added to the taxable basis of the benefit’s beneficiary. The benefit should be added back to the taxable income of the grantor as a disallowed expense unless the benefit was taken into account to determine the taxable basis of the beneficiary. Even if the abnormal or gratuitous benefit was taken into account to determine the taxable basis of the beneficiary, the benefit can be added (e.g. as a disallowed expense) to the taxable basis of the grantor of the benefit. A benefit received from an affiliate cannot be offset by the beneficiary against its current or carried forward tax losses or other tax deductions.

As a consequence, Belgian tax law and the enforcement by tax authorities (which have dedicated transfer pricing investigation units) serve as an important safeguard against selective de-partitioning through shifting with assets and liabilities within a corporate group. While both company and tax lawyers will insist on the autonomy of their respective tests, the notion of ‘abnormal or gratuitous benefit’ will in practice overlap with related-party transactions which fail a ‘corporate benefit’ test. The tax authorities care more about asset-shifting than secured creditors who benefit from selective de-partitioning. The tax authorities have a stronger incentive to monitor intra-group relations than unsecured creditors (who suffer from rational apathy) and can use the full force of the tax investigation and enforcement apparatus.

Few other creditors have the right to force an unannounced ‘visit’ upon their debtor.

This post is base on J. Vananroye, A. Van Hoe, G. Lindemans, “Curb your opportunism: limits to group structures and asset partitioning in insolvency”, in Reports to the Netherlands Association for Comparative and International Insolvency Law, 2019, forthcoming

 Joeri Vananroye

Author: Joeri Vananroye

Professor of economic analysis of law (KU Leuven), attorney (Quinz)

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