Audit of Mergers, Demergers and Acquisitions

Merger and acquisition

Audit of Merger and Acquisition

In our professional work we frequently encounter situations where Companies, departing from their normal course of business, must take decisions on corporate steps such as a change of company form, merger or demerger. In today’s rapidly changing and inherently unpredictable economic environment, events may occur at any time which, having a far-reaching impact on the Company’s business environment, may compel the Company to undergo a transformation.

With this in mind, we would like to briefly present the main types of transformation procedures and their legal background, which can serve as a guide for Companies considering such steps.

Concept and types of transformation

The concept of transformation covers changes of company form, mergers and demergers.

1. Change of company form: This occurs where the legal successor company continues its operations in a different company form and under a new tax number, taking over the assets and liabilities of the legal predecessor (e.g. a limited partnership – Bt. – becomes a limited liability company – Kft.).

2. Merger: Within mergers, two types of transformation are distinguished: beolvadás (absorption) and összeolvadás (consolidation).

  • Absorption (beolvadás) Under absorption, the legal successor Company “B” continues to operate in unchanged form and with unchanged tax status, while taking over the assets and liabilities of the legal predecessor Company “A”, which ceases to exist.
  • Consolidation (összeolvadás) In a consolidation, Companies “A” and “B” both cease to exist and their assets are transferred to Company “C”, a newly established entity.

3. Demerger: Under the applicable legislation, demerger may take place in two forms.

  • Division (különválás) In a division, two new companies, “B” and “C”, are created from Company “A”, sharing between them the assets and liabilities of the legal predecessor.
  • Spin-off (kiválás) In a spin-off, Company “B” is separated from the legal predecessor Company “A”, taking over a portion of its assets, while the legal predecessor continues its operations.

Procedure for transformation and applicable legislation

The transformation process essentially consists of steps laid down in the Civil Code and in the Act on Transformations.

It is important to understand that Hungarian rules on transformations provide for a so-called two-step legal procedure, in contrast to the single-step transformations commonly used elsewhere in Europe.

1.First step:
All legal and accounting documentation must be prepared, including the draft statement of assets and liabilities (vagyonmérleg-tervezet), which is required for the Court of Registration to make its decision.

2. Second step:
This covers the approval of the documents containing the substantive decisions regarding the transformation, which are then submitted to the Court of Registration.

In the next section we discuss in more detail the corporate law rules on preferential transformation, as this is the most commonly chosen tax regime in the context of transformations.

Preferential transformation

The rules on preferential transformation are laid down in Act LXXXI of 1996 on Corporate Tax and Dividend Tax (hereinafter: the Corporate Tax Act). Preferential transformation offers several tax advantages, which we outline below.

Due to the fair value remeasurement of assets performed in the course of the transformation, the taxpayer that remeasures its assets to market value is not required to pay tax on the resulting revaluation differences at the time of the transformation. In substance, this constitutes a tax deferral, because the tax base reducing items of the legal successor must be determined after the transformation as if the transformation had not taken place.

Accordingly, tax base reducing items are derived from the values before the market value remeasurement (depreciation based on the pre-revaluation values), while tax base increasing items are derived from the revalued carrying amounts (depreciation based on the new gross values).

An additional significant tax advantage of a preferential transformation is that, in the case of a revaluation, the real estate contributed by the taxpayer into the new company is exempt from transfer tax on onerous transfer of property, even if it has been revalued.

However, an important documentation requirement is that the Articles of Association must include an undertaking that, following the transformation, the taxpayer will determine its tax base as if the transformation had not taken place, and this must be reported to the tax authority in the final tax return for the tax year of the transformation.

Absorption (beolvadás) – Act on Transformations

In the case of an absorption, only the assets and liabilities of the company being absorbed may be revalued; there is no possibility to revalue assets at the receiving company.

In an absorption, when determining the registered capital of the legal successor, the nominal value of the participation held by the absorbed company in the receiving company may not be taken into account and must be eliminated.

Until the date of receipt of the court order on the registration application relating to the transformation, the company being absorbed is required to include the term “átalakulás alatt” (“under transformation”) on all invoices and simplified invoices it issues. This requirement does not apply to the receiving company, as it continues to operate in unchanged form.

In an absorption, from the date on which the legal successor is entered into the company register, the right to deduct input VAT arising at the absorbed entity is exercised by the legal successor (receiving) company.

Spin-off (kiválás) – Act on Transformations

In a spin-off, the first step is to allocate the assets of the legal predecessor between the continuing company and the company created through the spin-off. We would like to emphasize that, in the course of this allocation, the statements of assets and liabilities should present sources (equity and liabilities) that can be linked to the related assets, taking into account that the companies created by the demerger are jointly and severally liable.

In a spin-off, it is reasonable to transfer those assets that are necessary for the future operation of the company, together with the related liabilities directly connected to those assets.

The allocation of assets and liabilities should preferably already be set out in the demerger (split) agreement.

In a spin-off, as many statements of assets and liabilities must be prepared for the legal successors as the number of companies into which the assets of the legal predecessor are divided.

From a valuation perspective, the continuing company presents its assets only at carrying amount (market value remeasurement is only possible in the case of a division – különválás). In the case of a spin-off, the accounting treatment is specific for the continuing company, as in addition to the transfer of assets, it must also account for the differences arising from the final statement of assets and liabilities and the data in the adjustment column.

Audit of transformations

The statement of assets and liabilities and the supporting inventory of assets must be reviewed by an auditor. This requirement also applies to the draft statements of assets and liabilities where the Company is subject to a statutory audit obligation.

The auditor must state the maximum amount of the registered capital of the company resulting from the transformation, given that the equity may not exceed the amount accepted by the auditor.

An important restriction is that the Company’s permanent statutory auditor is not permitted to audit the statements of assets and liabilities and the inventories. Another restriction is that the auditor of the legal successor may not be the person who audited the statement of assets and liabilities for a period of three years from the date of registration.

Why choose us?

The Central Audit team regards client satisfaction as its highest priority, and we design our services in a way that delivers the greatest possible added value to our clients.

For the audit of annual financial statements, consolidation packages, statements and inventories of assets relating to transformations, as well as contributions in kind (apport), please request our quotation using any of our contact details.

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