The location of a holding company
International tax expert Parwin Dina, Managing Director of Global Tax Services, explains how a holding company can benefit corporate investors looking for a tax-efficient structure. She cites the UK as an example to explain the due consideration one needs to give to choosing the location.
Parwin Dina, Managing Director of Global Tax Services and international tax expert
For corporate investors, the choice of holding company location for European operations is receiving greater attention than it has for many years. Groups, particularly those based in Asia and the Middle East, are starting to take advantage of the relative absence of private equity competition to make strategic acquisitions at prices which might not be this low again for many years, and the Obama administration’s international tax reform proposals, some of which reappeared in February in the US budget request for 2011, may force US groups to restructure their international operations. These two developments are driving the need for a tax efficient holding structure for acquiring, holding, financing and – in the long term – exiting European investments.
Recent reforms to its tax law have made the UK a more attractive location for holding and financing other group companies, so the choice of holding company location is now much broader than the traditional favourites of Luxembourg and the Netherlands. The UK has some relative advantages, as well as some complex areas of tax law which require careful management.
Ensco International, a US multinational that is a global provider of offshore drilling services to the petroleum industry, has already announced plans to relocate from the US to the UK citing “the UK’s developed tax regime and extensive tax treaty network” to allow the group, potentially, to achieve “a global effective tax rate comparable to that of some…global competitors”.
The plan of action before considering a UK holding company is that one needs to look at the global structure of the various locations in which they operate, and analyse the various tax exposures and see whether a UK holding company would achieve an efficient tax structure globally.
What to consider
The key tax considerations when deciding the location of a holding company include:
Tax impact for the shareholder (withholding tax on dividends paid by the holding company, for example)
The applicable tax rate in the holding company
Taxation of capital gains
Controlled foreign company (CFC) legislation
Double tax treaty network
Other taxes such as capital taxes, stamp duty and transfer taxes
Of course, the selection of a holding company location will not be driven solely by fiscal motivations, but these are undoubtedly important. A variety of other commercial considerations will also be involved in the final decision – London’s reputation as a preeminent global financial centre, the English legal system which is the model for many other jurisdictions, the ability to set up a new company rapidly, digital bandwidth for communications, London’s status as a hub for many airline networks, the English language, and the UK’s time-zone (which is midway between Asia, the Middle East and the Americas) are all factors which make the UK an attractive location.
All of these points undoubtedly contribute to the UK being, by some margin, the top destination for foreign direct investment into Europe, but this has not been mirrored historically in fiscal structuring.
Withholding tax on dividends to shareholders
The UK does not apply domestic withholding tax on dividend payments to individual or corporate shareholders. Some competing holding jurisdictions such as Jersey and Malta similarly apply 0% rates, but others such as the Netherlands, Luxembourg and Switzerland apply dividend withholding tax at rates of up to 35%. Even where mitigation of the tax is possible, it may require structured planning. In the international fiscal climate, using companies based in perceived tax havens such as Jersey may bring other tax complications for the ultimate parent.
Holding company tax rate
The UK’s headline corporate tax rate for large companies is 28%. This is broadly comparable to the Dutch rate of 25.5% and the Luxembourg rate of 28.59% (including municipal business tax). It is appreciably higher than the headline Irish rate of 12.5%, but this only applies to trading income and certain types of income such as dividends from subsidiaries in EU territories and treaty countries. Otherwise, the Irish rate for investment income is 25%.
Other low-tax locations such as Jersey or Dubai offer significantly lower headline rates, but often this must be weighed against their comparative disadvantages, such as their limited treaty networks or status for CFC purposes in the jurisdiction of the ultimate group parent company.
Taxation of dividends received by the holding company
Many of the traditional European holding company locations such as Luxembourg, the Netherlands and Switzerland have offered participation exemption for dividends as a key feature of their tax systems for a number of years.
The UK was always at a historical disadvantage as dividends received from foreign subsidiaries were fully taxed, with credit generally given for withholding taxes and underlying tax (that is, overseas tax on the profits out of which the dividend was paid) against the UK corporation tax liability. As well as the risk of a cash tax liability if a dividend came with insufficient credits, the administrative burden for companies in calculating the credits under the highly complex double tax relief (DTR) rules was widely recognised as a key disadvantage of the system.
However, a full participation exemption system for dividends has now been introduced into UK law by the Finance Act 2009 and is contained in part 9A of the Corporation Tax Act 2009. Any dividend paid on or after 1 July 2009 to a UK company, if it is not a capital dividend, is exempt from UK corporation tax if it falls into one of the five exempt classes as set out in the legislation. These are:
Distributions from controlled companies (broadly using the same definition of control as under the CFC rules)
Distributions from non-redeemable ordinary shares. Most dividends paid on ordinary shares should be capable of falling into this class, although dividends on preference shares or on other shares which are redeemable in nature would not qualify under this heading
Distributions from portfolio holdings (a specific exemption for holdings of less than 10% in the company paying the dividend)
Dividends derived from transactions not designed to reduce tax (a fallback exemption if, for technical reasons, a dividend does not fall into one of the other exempt classes, but is not related to transactions designed to reduce UK tax. This exemption includes a grandfathering for profits arising before the introduction of the dividend exemption regime)
Dividends from shares accounted for as liabilities (for certain preference shares which can be accounted for as liabilities of the issuing company under IFRS)
To qualify for any of the exempt classes, it must also be the case that no deduction is allowed in the relevant foreign territory for the payor for that distribution (which could, for example, have an impact on certain repo transactions where a deduction may be available in the paying company because it is classified as interest payable under its local tax law).
The legislation also contains a number of targeted anti-avoidance rules which can deny the benefit of the exemption, but these are unlikely to apply to the vast majority of dividends.
In comparing this new system to other dividend participation exemption regimes, it should be noted that the UK rules do not have any minimum shareholding or minimum holding period.
Taxation of capital gains
The UK also has a participation exemption system for capital gains. In force since 1 April 2002, the substantial shareholding exemption excludes disposals of qualifying shareholdings from UK corporation tax on chargeable gains. Three main conditions must be met:
The disposing company must have held at least 10% of the ordinary shares of the company being disposed of for a continuous 12 month period within the two years before disposal.
The disposing company must be part of a trading group (that is, the worldwide group of which that company is a member) during the period starting with the latest point at which the first condition is met (typically 12 months before disposal) and ending with the point immediately after disposal.
The company being disposed of must be a trading company or the holding company of a trading sub-group for, broadly, the same period as that outlined in the second condition.
Taxpayers do have to undertake some analysis of their worldwide group and the company or subgroup being disposed of to ensure that the conditions are met for the exemption to be available, but it is also possible in cases of doubt to seek advance clearance from Her Majesty’s Revenue & Customs (HMRC).
The UK has detailed and comprehensive CFC rules which must be taken into account in designing and implementing a holding/financing structure involving a UK company, but in the vast majority of cases it is possible to prevent an attribution of offshore income to the UK, either through being able to claim one of the exemptions available, or through appropriate structuring.
Profits of a foreign company can be apportioned to the UK under the CFC rules where the actual tax suffered overseas is less than 75% of the tax that would have been due had the company been UK tax resident. The CFC rules apply, broadly, where UK residents have control (either by votes or by value) of more than 40% of a non-UK resident subsidiary. In the context of inbound corporate groups, it is, therefore, possible to preclude the application of the UK CFC rules by means of de-control arrangements.
The exemptions available include an exempt activities test which applies, broadly, to activities of a trading nature; a white list of territories; and a motive test, which is available where a taxpayer can show that the main purpose of the existence of the offshore company, and the transactions it enters into, are not to divert profits which would otherwise arise in the UK.
Grace periods of up to two years are also available for taxpayers undertaking new acquisitions. This gives such taxpayers time to restructure their affairs, if required, to take advantage of one or more of the available exemptions.
After some minor amendments in 2009, a more comprehensive reform of the CFC rules is scheduled to take place in the Finance Act in 2011. The CFC rules have also been challenged under EU anti-discrimination rules.
Double tax treaty network
The UK has one of the most comprehensive, if not the most comprehensive, networks of double tax treaties anywhere in the world. For many inbound investors, this is a key criterion in determining the location of their holding company as it allows repatriation of funds (dividends, interest and royalties/licence fees) through structures while minimising tax leakage by taking advantage of treaty provisions.
The UK does not apply capital duty to any issue of shares.
The main UK transfer tax is stamp duty which is levied at 0.5% on the transfer of shares of a UK incorporated company. However, this is normally only of concern in third-party transaction situations, as the stamp duty regime contains a broad group relief provision, which essentially exempts all intra-group transfers of shares from the duty.
Stamp duty does not apply to the issue of shares.
Extra favourable aspects of the UK tax regime
The UK applies withholding tax on interest, but in the vast majority of cases this is eliminated or substantially reduced either by application of the EU Interest and Royalties Directive, through the relevant double tax treaty or appropriate structuring.
The UK group relief system allows losses to be surrendered between UK companies in a worldwide group to offset taxable profits. The system is not a full fiscal unity, but the economic effect is largely the same.
The UK retains a comparatively generous regime allowing the offset of interest expenses for tax purposes. A holding company can be leveraged with arm’s-length debt, and advance thin-capitalisation agreements of up to five years are available with HMRC lasting for up to five years. A worldwide debt cap has been introduced with effect from 2010, but this brings opportunities as well as restrictions. Tax relief for interest is generally on an accruals basis and restrictions which forced taxpayers into a paid basis for deductions in certain circumstances have been relaxed recently.
The UK can also be used as a location for outbound financing of overseas subsidiaries or operations in a way that does not generate taxable income in the UK, particularly where the UK has not borrowed to fund this financing. Otherwise, the avoidance through arbitrage anti-abuse provisions could apply.
UK companies can also acquire intangible assets, such as brands, from third parties and license them to overseas subsidiaries, while obtaining tax relief in the UK for amortisation expense through the accounts, or 4% cost on a straight line basis.
There has been a recent expansion in opportunities for taxpayers to obtain upfront confirmation of the tax consequences of transactions from HMRC through applying for advance clearances. This has been driven by the desire of HMRC to provide more certainty to business and to compete more effectively with some of the other holding company locations which have more established ruling processes.
Code of Practice 10 (COP 10) provides an opportunity for informal rulings on issues of uncertainty related to legislation in the last four Finance Acts (that is, new and recent legislation). A number of other statutory and non-statutory clearances exist for various aspects of the UK tax regime, particularly where the tax position has a significant commercial impact or where taxpayers wish to confirm the bona fide commercial nature of transactions.
Potential complexities and downsides
Along with its benefits for holding companies, the UK tax regime, like most developed tax systems, has complexities of which inbound investors should be aware.
From 1 July 2009, a post-transaction reporting requirement (which replaces the old Treasury Consent rules) applies to transactions where overseas subsidiaries controlled by the UK issue or transfer shares or debentures. Such transactions should be reported to HMRC within six months. There is a de minimis transaction value of £100 million ($150 million) and a number of exemptions are available (for example, for certain same country transactions).
The relatively benign interest deduction regime will be restricted somewhat for accounting periods beginning on or after 1 January 2010 with the introduction of a worldwide debt cap regime. The aim of this legislation is to prevent the relative over-gearing of the UK compared to the overall worldwide group. Many countries now have, or are considering, similar restrictions, so the UK is not unusual in this regard. It will still be possible to introduce acquisition and internal group debt at arm’s length into the UK, but over-gearing may become more difficult.
However, the debt cap regime can bring some opportunities. Disallowed interest expenses can be used to frank financing income. Groups suffering tax on cross-border financing income could consider transferring some of these receivables into the UK, where they would benefit from this relief.
Avoidance through arbitrage rules target complex cross-border financing schemes using hybrid instruments or entities, which aim to create tax arbitrage and can deny UK interest deductions or create taxable interest income. An advance clearance regime is available to obtain confirmation from HMRC that they will not seek to apply the rules to a particular structure.
A general unallowable purpose rule for interest deductions exists in the UK, but this should not apply to most commercially-driven situations.
Several years ago, HMRC introduced the disclosure regulations, a set of rules which obliges taxpayers to disclose certain classes of structured tax planning schemes before the filing of the relevant tax return.
Finally, the tax authorities recently announced the introduction of the senior accounting officer regime, which is intended to oblige the senior finance professional for the UK operations to certify the effectiveness of a company’s financial reporting systems for tax purposes. The finer details of this regime are still being worked through by HMRC in conjunction with taxpayers and advisers.
Benefits in moving
Recent reforms to the UK’s taxation of offshore income have made the UK a much more attractive choice for multinational groups looking at regional headquarter locations. US groups considering restructuring out of tax haven holding structures because of potential US tax reforms, and inbound corporate investors making acquisitions in Europe, will be giving serious thought to the UK’s relative advantages.
Parwin Dina is the Managing Director of Global Tax Services. In her previous positions she has been an International Tax Principal, MENA Region at Deloitte & Touche; Tax Manager at PWC, Mauritius; Group Tax Manager at National Australia Bank, UK; and Tax Accountant at CitiGroup, UK.
Dina has advised prominent clients on tax structuring for investments across the world. Her clients have spanned, among others, real estate, oil and gas and related services in various Middle East and Far East jurisdictions, and financial services and telecommunications players wishing to expand in the Middle East – such as Qtel and Zain.
She has provided tax planning and implementation for the International Cricket Council; and tax due diligence in the Middle East for investors such as Versace hotel, Movenpick hotel, Millenium hotel, and Rosewood hotel. Dina co-ordinates the tax planning of individuals including tax returns. For more information, visit www.global-taxservices.com.