By Alan J. Turner, Head of UK Center of Excellence, KPMG LLP – New York
With recent and proposed changes to the UK’s taxation of foreign profits, the UK is increasingly being considered as a location in which to establish a holding company. The following article discusses the key reasons behind the UK joining the ranks of traditional holding-company jurisdictions, such as Ireland, Switzerland and the Benelux nations. However, consideration is also given to less competitive areas of UK tax law which could detract companies.
Participation Exemption?
The Benelux nations all offer a ‘participation exemption’ which, broadly, exempts a corporate shareholder from tax on dividends received and, potentially, gains arising on disposal of the shares. The UK does not have a defined participation exemption, but instead has two separate pieces of legislation which, subject to qualification, can achieve the same result.
Dividend Exemption
Until June 2009, dividends received by UK companies from other UK companies were exempt from tax. Dividends received from a foreign source were subject to corporation tax, albeit with the potential availability of a credit for taxes suffered overseas. Following a review of the UK’s international tax laws, the UK Government introduced a tax-exemption regime in Finance Act 2009 that applies to dividends paid on or after July 1, 2009.
From that date, all dividends received by UK companies will be subject to tax unless they qualify for exemption. Broadly, a dividend will qualify for exemption if it falls within one of the exemption categories (discussed further below), is not effectively a payment of interest which is treated as a dividend for tax purposes and is not tax-deductible by the payer.
The dividend exemption categories for large groups are:
- Dividends from ‘controlled companies’ – includes dividends from subsidiaries (over 50 percent shareholding) and joint venture companies where both partners hold at least 40 percent of the shares.
- Dividends paid in respect of non-redeemable ordinary shares.
- Portfolio dividends – applies to ordinary shareholdings of less than 10 percent.
- Motive test – applies where dividend is paid out of profits which have not been diverted from the UK, or where the diversion of profits was not one of the main purposes of the transaction gave rise to the profits.
- Shares treated as loans.
It is envisaged that the majority of dividends paid to UK companies will fall within at least one of the above categories. However, it should be noted that anti-avoidance legislation exists to restrict the availability of the exemption to situations involving tax avoidance.
Simplified rules have been put in place for small groups; the exemption will be available where the paying company is resident in a ‘qualifying territory,’ broadly one with which the UK has a double-tax agreement in place, which includes a non-discrimination article.
Where exemption is not available, the dividend received will be subject to tax, and a credit will potentially be available for foreign taxes suffered.
Substantial Shareholding Exemption
A disposal of shares by a UK company gives rise to a chargeable gain or loss for UK corporation tax purposes. However, any gain will be exempt from tax (and any loss disallowed) if it qualifies for the substantial shareholdings exemption.
To qualify for the exemption, a UK tax-resident company must be disposing of a substantial shareholding (broadly at least 10 percent of the ordinary share capital). The shares must have been held for at least 12 of the 24 months immediately prior to disposal. In addition, the disposing company and company in which the shares are being disposed of must satisfy a trading test that demonstrates they are active businesses or part of wider groups which conduct active businesses.
The effect of this legislation is that groups involved in active businesses may qualify for an exemption arising on disposals of shares by UK tax-resident companies.
Other Advantages in UK Tax Law
There are a number of other areas of UK tax legislation which may make the UK an attractive holding company location. They include the following:
Withholding Taxes
The UK does not operate a withholding tax on payments of dividends.
Under domestic law, a 20 percent withholding tax applies on payments of interest and royalties outside of the UK. Exemptions apply for payments of interest on Quoted Eurobonds and interest on short-term loans.
Membership of the European Union
As a member of the EU, UK taxpayers have access to EU Treaties and other laws. The Parent-Subsidiary Directive and Interest and Royalties Directive have been incorporated into UK domestic law. The latter applies to payments of interest and royalties and, broadly, exempts such payments from UK withholding tax where the payments are made between recognized EU companies.
Double Tax Treaty Network
The UK has one of the world’s most extensive Double-Tax Treaty networks which, subject to qualification, affords beneficiaries with the right to avoid double taxation and reduced rates of withholding on cross-border payments.
Clearance Procedure
The UK operates a number of statutory clearance procedures for specific items of tax law and a broader non-statutory clearance procedure for other areas, where taxpayers can contact the UK tax authorities, to get greater clarity on how a tax law may apply to their particular circumstances.
Taxation of Intellectual Property
In its Pre-Budget Report of December 2009, the UK Government announced that it is planning to introduce a ‘Patent Box’ to compete with other European jurisdictions.
Under the proposals, royalty income would be taxed at the lower rate of 10 percent (currently 28 percent). The regime would only apply to new patents granted after mid-2011, but only with effect from 2013.
The proposals are currently subject to ongoing discussion with interested stakeholders.
Less Competitive Aspects of UK Tax Law
Before establishing a holding company in the UK, consideration also has to be given to other areas of tax law which may be less attractive.
Controlled Foreign Companies
Where a UK tax-resident company holds a controlling interest in a foreign company, the Controlled Foreign Companies (CFC) rules apply such that, in certain circumstances, the foreign company’s profits will be subject to UK corporation tax on an arising basis.
A foreign company will only be regarded as a CFC if it is subject to a lower level of taxation in the country in which it is resident. A lower level of taxation is defined as less than 75 percent of the UK corporation tax that would be payable if the company was UK tax resident.
Various exemptions from the CFC rules exist including where the foreign company conducts exempt activities in its country of residence and a wider motive test. The UK tax authorities offer an advance clearance procedure in relation to the availability of these exemptions.
As part of the UK Government’s ongoing review of the taxation of foreign profits, the CFC legislation is currently the subject of an ongoing consultation. Legislation is expected to be implemented in 2010 or, more likely, in 2011.
Deductibility of Interest Costs
Within UK tax law, there are various rules designed to deny a tax deduction for interest costs where there is a perceived avoidance of tax. Applicable legislation includes transfer pricing (incorporating the UK’s thin capitalization rules) rules on anti-arbitrage and loans made for an unallowable purpose.
The latest addition to this body of law is the Worldwide Debt Cap rules which apply to accounting periods beginning on or after January 1, 2010. The rules apply to UK corporate taxpayers that are part of large groups and are aimed at denying a tax deduction where the UK’s burden of interest and financing costs exceeds the worldwide group’s.
These rules must be considered if it is intended that debt will be used in a corporate group which includes the UK.
Further Changes
In addition to the ongoing consultation on the UK’s CFC rules and proposals for reform to the taxation of intellectual property, there is increasing speculation that the next area for review will be the taxation of foreign branches.
Conclusion
The ongoing review and reform of the UK’s rules on the taxation of foreign profits has already brought some welcome changes (dividend exemption) and hopeful prospects (introduction of patent box, CFC reform) for UK tax-resident companies. While other aspects of UK tax law may detract some from establishing a holding company, this will be dependent on the specific facts and circumstances of each case.
However, with multinationals increasingly looking at the UK as a potential holding-company jurisdiction, this would seem to indicate that the UK is becoming increasingly competitive in the international tax arena.
About the author: Alan J. Turner is head of the UK Center of Excellence, KPMG LLP, New York. He can be reached at aturner2@kpmg.com.
This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG LLP.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
KPMG LLP, the audit, tax and advisory firm (www.us.kpmg.com), is the U.S. member firm of KPMG International Cooperative (“KPMG International”). KPMG International’s member firms have 140,000 professionals, including more than 7,900 partners, in 146 countries.
