A radical change in United Kingdom (UK) corporation tax may make the it an attractive location for tax-efficient structuring within a multinational group.
With effect from 1 July 2009, foreign (as well as UK) source dividends are exempt from UK corporation tax.
Alongside the benign treatment outbound dividends receive and the exemption for gains realized on disposals of trading subsidiaries, this makes the UK tax neutral for many international investments. When combined with other tax and legal benefits, the United Kingdom becomes a competitive jurisdiction for certain international holding and joint venture structures.
Tax-Efficient Dividend Flows
Dividends Received
From 1 July 2009, most dividends received in the United Kingdom are free of UK corporation tax.A number of "classes" of dividend payment are now tax exempt, provided the dividend payment is not tax deductible in the source jurisdiction (and certain specific anti-avoidance exclusions do not apply). The most relevant classes of exempt dividend, none of which have a minimum holding period, are:
- Dividends paid on shares of any kind where the UK recipient controls (or jointly controls) the payer, in terms of powers or economic rights;
- Dividends paid on non-redeemable ordinary shares – there is no minimum shareholding size;
- Dividends paid on shares of any kind where the recipient (together with connected persons) holdsless than 10 per cent of the issued share capital of the paying company (or less than 10 per cent of the class of shares held, where there is more than one class in issue); and
- Dividends paid on shares of any kind where the profits are not derived from transactions designed to achieve a reduction in United Kingdom tax.
The introduction of this dividend exemption has been widely welcomed as a replacement for the complex regime formerly in place – the foreign tax credit rules.
The credit rules have not been removed entirely, and remain in place as the default regime, applying where dividends are not exempt. The credit rules render foreign dividends liable to UK tax (currently, at 28 per cent), but with credit for foreign tax – subject to conditions, both withholding tax and local tax on the profits out of which the dividend is paid. The rules will often give complete relief from UK tax on dividend receipts, but are relatively complicated and administratively burdensome.
Importantly, it is possible for a UK dividend recipient to elect out of exemption treatment so that the credit rules will apply – and there are circumstances where this may be beneficial.
For instance, a number of the United Kingdom's tax treaties (including, for example, those with Germany, Israel and Russia) only reduce withholding tax on dividends paid from those jurisdictions, if the dividend is subject to tax in the United Kingdom. Where dividends are to be received from these treaty jurisdictions, and where it is necessary to rely on the treaty for withholding tax reduction (rather than, for instance, intra-EU exemption), the credit rules may give a better overall outcome than dividend exemption.
Reduced Withholding Tax on Dividends from Foreign Jurisdictions
UK companies can receive dividends from foreign subsidiaries free of local withholding tax if those subsidiaries are located within the European Union, in accordance with the EU Parent/Subsidiary Directive.
For subsidiaries outside the EU, withholding tax on dividends can be reduced, often to nil, by the United Kingdom's excellent tax treaty network. The relative advantages need to be assessed on a case-bycase basis, depending on the detailed provisions of the relevant treaties. But, in terms of the sheer size and range of its treaty network, with around 112 active tax treaties, the United Kingdom compares favourably with other well-known holding company jurisdictions, including (for instance) the Netherlands, Luxembourg, Cyprus, Singapore, Mauritius, Ireland, Malta and Switzerland.
No UK Withholding Tax on Outbound Dividends
The United Kingdom does not levy withholding tax on dividends, or liquidation distributions, paid by UK companies.
This combination of extensive relief from foreign withholding tax, exemption from UK tax on dividend receipts, and the absence of UK withholding tax on outbound dividends, means that it is possible for distributions of profits from operating subsidiaries in many foreign jurisdictions to flow through the United Kingdom with no, or minimal, incremental tax cost.
Controlled Foreign Company Regime
Unlike the participation exemptions offered by some other jurisdictions, the exempt dividend classes cover dividends from low taxed/passive subsidiaries.However, instead, the UK "controlled foreign company" (CFC) regime may tax a 25 per cent plus UK corporate shareholder on the undistributed income profits of a foreign company, which is taxed at less than three-fourths of the equivalent UK tax charge and which lacks genuine local substance or whose business is "passive" and/or largely conducted with affiliates.
So, depending on the nature of the group's activities, the UK CFC regime in its existing form may mean that the United Kingdom is more suitable as a location for an intermediate holding/JV company, owning operating subsidiaries, rather than an ultimate parent company.
However, a consultation process is currently underway that may result in a fundamental reform of the CFC regime. The stated aim is to ensure that the CFC regime does not catch profits genuinely earned overseas, but still protect the UK tax base from erosion by the artificial diversion of profits abroad. This is in the context of a general move, already evidenced by the introduction of the tax exemption for foreign dividends, towards a more territorial system for taxing foreign subsidiaries. A consultation document is expected to be published towards the end of 2009 with a view to any resulting reform coming into force in 2011.
The hope is that the outcome of the CFC consultation process will further enhance the competitiveness of the UK tax system.
No United Kingdom Tax on the Sale of Operating Subsidiaries
The so-called "substantial shareholding exemption" provides a tax exemption corresponding to the capital gains tax component of the "participation exemption" in some other jurisdictions.Where a UK company sells a trading subsidiary, it will not normally be subject to any UK corporation tax on the realised gain, provided the UK company has owned at least 10 per cent of the ordinary shares of the trading subsidiary for at least 12 months and is itself either a trading company or a member of a trading group (and will remain so immediately following the disposal).
Deductible Interest Costs
Interest costs on borrowings incurred to purchase or fund (both UK and overseas) subsidiaries are, in principle, tax deductible (subject to certain anti-avoidance rules).The level of debt taken on, and the interest rate payable, will need to meet arm's length standards.
It will also be necessary to consider whether the worldwide debt cap could impact upon the deduction of debt financing costs.
The worldwide debt cap is a new measure which will come into effect from 1 January 2010.
Put simply, this rule can apply where a group puts a greater amount of debt into the UK than it has borrowed externally. Interest costs on the excess are not tax deductible. However, the regime is subject to gateway and de minimis tests, and contains important exemptions – including, in particular, for treasury companies and certain companies in the financial services sector.
No United Kingdom Tax on the Sale of Shares in a UK Company by a Foreign Shareholder
The United Kingdom does not tax any capital gain realised on a sale of shares in a UK holding company by a non-resident shareholder (unless the shares are assets of a UK permanent establishment).Other Advantages
- In addition to the UK's extremely wide tax treaty network, the UK has entered into well over 100 bilateral investment treaties. These exist to give fair and equitable treatment to foreign investors in the counterparty state, protecting, in particular, against expropriation (without compensation) of business assets in that state.
- The tax treatment described here is based on the general UK corporation tax regime applicable to all companies, whatever their ownership or activities, and whether the subsidiaries are located in the UK or abroad, and hence may be less vulnerable to attack from anti-avoidance rules in other countries compared with a special holding company regime.
- English company law and contract law is robust and flexible, and company formation procedures in the United Kingdom are simple, fast and cheap.
- There is no capital duty payable on share capital subscriptions and no minimum capital requirement; however, sales of UK company shares do incur stamp duty at 0.5 per cent of the sale price.
- London provides excellent access to the international financial and capital markets.
- The UK, especially London, remains an attractive work base for many executives, for reasons of language, lifestyle, transport links and the (still) favourable tax treatment of resident but non-domiciled individuals.
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