Guidance on the tax treatment of debt push down financing structure finally published by Estonian tax authority

Discussions around the tax treatment of the debt push down financing structure have been at the forefront of M&A and tax advisors’ attention over the past two years, as the tax authority actively worked on developing the guidance. The final version of the guidance was completed and published on the tax authority’s website in December 2024. Although the publication of the guidance was overshadowed by widely publicized tax increases and the approaching long Christmas Holidays, the importance of the guidance for the transaction market and the Estonian economy cannot be underestimated, especially since the final version contains several changes compared to previous drafts.

Background of the debt push down guidance

The debt push down financing structure is widely used in M&A transactions, where an acquisition loan is granted to a holding company established specifically for this purpose, which is later merged with the target company. The loan is, therefore, transferred to the target company, and is served from its business cash flow. Although the structure offers significant flexibility in financing, the tax authority has seen it as problematic from a taxation perspective.

Years ago, the financing structure was not seen as an issue, and the tax authority had even issued a binding ruling, considering the structure economically justified if the adoption of the structure (merger of the holding and target companies) was due to the financier’s requirement.

About 10 years ago, however, the Estonian Tax and Customs Board took a more critical stance on debt push down structures, which led to the removal of the previous positive binding ruling summary from the website and the issuance of negative responses to new clarification requests from market participants. Due to the lack of actual tax proceedings, market participants continued using debt push down structures and taking a conscious risk.

A significant development occurred in 2023 when the tax authority brought to attention the draft guidance on the taxation of debt push down structures and arranged several roundtables on the topic with stakeholders (banks, funds, tax consultants, etc.).

According to the initial version of the guidance, the debt push down financing structure was subject to corporate income tax without exceptions, as a non-business-related expense, which caused serious opposition among market participants. In addition to questions about the legal interpretations in the guidance, it received much criticism for its clearly negative impact on the Estonian M&A market and the overall investment environment.

Based on the feedback, the tax authority changed the legal basis for taxation in the draft guidance and allowed considering of corporate income tax paid on loan servicing upon later distribution of dividends. The softened guidance also mentioned the tax authority’s waiver from taxing historical transactions, i.e., those before the publication of the guidance.

Final version of the debt push down guidance

The final version of the guidance, published on the tax authority’s website, contains several changes compared to previous drafts.

The most significant change is that the tax authority has abandoned the automatic taxation of debt push down structures. Instead, the guidance includes a reference to the general anti-avoidance rule, according to which the structure is subject to taxation only if it is aimed at obtaining a tax advantage and there are no other economic reasons for its use. This makes the guidance more consistent with both tax laws and court practice.

Since the potential abuse of the structure is seen by the tax authority as hidden profit distribution (if the merger did not take place, the target company would have to distribute dividends to finance the holding company’s loan payments), the corporate income tax paid on loan servicing (both principal and interest payments) can be considered by the taxpayer when distributing dividends in the future.

The guidance includes examples of situations where the use of the structure can be considered tax-neutral by the tax authority, as well as a list of circumstances that may indicate abuse. Positively, the guidance considers the structure to be for business purposes if it is used by a person whose main business activity is investing in companies, i.e., acquiring and disposing of holdings. Therefore, the use of debt push down structures by investment funds and companies should generally not entail tax risks.

The guidance also helps to substantiate the business purpose if the requirement for the merger of the holding and target companies comes from the financier, as it is necessary to secure the loan (the collateral is usually in the target company) or to meet other requirements of credit institutions. However, the financier’s requirement alone may not be sufficient to substantiate the business purpose, and other circumstances surrounding the transaction (e.g., the buyer’s availability of own funds for the transaction) also play an important role.

A completely new aspect introduced in the latest version of the guidance is the potential taxation of the so-called equity push down structure, similar to the debt push down. The equity push down differs from the debt push down transaction in that instead of taking a loan, the parent company makes a capital contribution to the holding company or converts a previously granted loan into equity, with the other transaction steps, i.e., the merger and subsequent capital distribution, taking place similarly to the debt push down transaction. Therefore, in the case of such capital contributions being deemed abusive, the tax authority may prohibit the declaration of the taxation rights related to the capital contribution and thus exclude tax-exempt return of capital in the future.

Since the new version of the guidance does not entail automatic taxation of debt push down and equity push down structures, leaving some flexibility, the tax authority has not considered it justified to exclude historical transactions from the scope of the guidance, and this principle has been removed from the guidance. This means that the tax authority has reserved the right to review debt push down transactions that took place before the publication of the guidance if they are deemed abusive by the tax authority.

Future perspectives

Despite the fact that the debt push down guidance has become significantly more flexible compared to its initial versions, market participants need to be cautious when adopting loan and equity financing structures. Before adopting a debt push down or equity push down financing structure, it is advisable to carefully analyze the perspective of substantiating its economic substance. If the use of a debt push down or equity push down structure turns out to be too high-risk in view of the tax authority’s guidance, alternative transaction structures should be considered, if possible. 

This article was written by our counsel Dmitri Rozenblat and also published in Äripäev.