One of the adverse consequences of Brexit for UK registered companies will be possible disqualification from benefit under EU Directives. Two particularly significant Directives for UK holding companies within multi-national groups are the Parent/Subsidiary Directive and the Interest & Royalties Directive.
The overall effect of the Parent/Subsidiary Directive is that:
1. withholding tax on dividends paid to a UK company is abolished in the “source” Member State; and
2. the “residence” State (in which the dividend recipient is registered and resident) must give double taxation relief, either by exempting the dividend from taxation altogether; or by crediting against the recipient’s tax liability for the dividend income an appropriate proportion of the foreign tax paid on the profits representing the dividend, together with any withholding tax. The purpose of the Directive is to tax cross-border dividend flows comparably with dividends paid and received by companies resident in the same State.
To benefit from the Directive i.e. to receive the dividend “gross” , without French withholding tax, the main conditions are:
- UK Co must be effectively managed in the UK or another EU Member state and liable to corporate income tax in the State of effective management
- UK Co must be the beneficial owner of the dividend
- UK Co must own not less than 10% of the voting power of the French Co
- Recent changes to the Directive require France and other Member States not to grant the benefits of the Directive to arrangements one of whose main purposes is obtaining a tax advantage that defeats the object and purpose of the Directive and are not “genuine “ ie not put in place for valid commercial reasons which reflect economic reality
- French law also requires the French shares to be held for at least two years without interruption , and that the UK company is not directly or indirectly controlled by non-EU legal or natural persons ( however both these conditions of French law have been significantly modified and mitigated from the taxpayer perspective by rulings of the European Court of Justice).
Fortunately for the UK and its resident companies , any loss of eligibility for Parent/Subsidiary Directive relief is unlikely to be economically damaging , because UK companies have the option of obtaining comparable benefits under UK double taxation conventions , which are not governed by EU law . The relevant article of the UK’s tax treaty with France is the dividend article (article 11). Article 11(c) provides that France shall not tax the dividend (i.e. shall not impose withholding tax) provided that:
- the UK company (which must be UK resident) is the beneficial owner of the dividend
- the UK company is “liable to UK corporation tax” (there is a general consensus in the OECD and among leading commentators , that a company is “liable to tax” in its country of residence even if exempt from tax on certain sources of foreign income such as foreign dividends, if that exemption is subject to specific conditions of the national taxation law)
- the UK company holds directly or indirectly not less than 10% of the capital of the French company
- the anti-treaty shopping provision in article 11(6) is not applicable . Article 11(6) denies the benefit of the 0% withholding tax rate in France , if it was the main purpose or one of the main purposes of any person concerned with the creation or assignment of the shares in respect of which the dividend is paid, to take advantage of the dividend article of the tax treaty. However this rule should not affect UK companies with appropriate substance and commercial strategies
- Fortunately for the UK, the tax treaty with France is not an isolated example of a UK tax treaty matching the benefits of the Parent/Subsidiary Directive. Other examples of UK tax treaties providing UK companies with the possibility of a 0% treaty rate of foreign withholding tax include:
- Switzerland (Switzerland is not an EU Member state but has successfully negotiated eligible party status to the benefits of the Directive. This may be instructive to the UK’s Brexit negotiating team)
Of course, the zero rates of dividend withholding tax provided in the UK tax treaties are not unconditional, and the detail of the dividend article of any particular tax treaty needs to be considered on a case by case basis.
It is also important to bear in mind that UK tax treaties provide for dividend withholding tax rates where none exist under national law. This is always the case concerning the UK (which does not levy withholding tax on dividends to non-UK residents under any circumstances) but the national law of the other Contracting State which is the source of the dividend may not in fact impose a withholding tax under its law if certain conditions are met. Ireland and The Netherlands are two examples of this. In these circumstances, the treaty rate specified is otiose (a tax treaty cannot levy taxation, its main function is to apportion taxing rights between the contracting states who retain sovereignty over direct taxation).
Interest & Royalties Directive
The EU Interest & Royalties Directive exempts cross-border payments of interest and royalty from source withholding tax. As with the Parent/Subsidiary Directive, the principle is that cross-border interest and royalty flows within the EU should be taxed comparably with interest and royalty payments taking place within the same State.
In one respect the Interest and Royalties Directive differs from the Parent/Subsidiary Directive. The point of difference is that the Interest and Royalties Directive is only concerned with the elimination of withholding tax in the State of the paying entity. The Directive is without prejudice to the ability of the residence (recipient) State to tax the interest of royalty (whereas under the Parent/Subsidiary Directive the recipient of the dividend must grant exemption or credit relief from double taxation).
The conditions for relief from withholding tax under the Interest & Royalties Directive include a requirement that the payer and payee must be associated by the holding of rights or shares (with a minimum holding of 25% currently required); and that the recipient company must be the beneficial owner of the interest or royalty. There is also an anti-abuse rule contained in the Directive focussing on excessive royalties, and a general anti-avoidance rule or GAAR drafted in the same terms as the Parent / Subsidiary Directive GAAR.
It is interesting to review the same UK tax treaties that appear to match the benefits of the Parent/Subsidiary Directive in relation to dividends, in order to compare the UK tax treaty rates of withholding tax on interest and royalties paid to a UK resident company.
Ireland and The Netherlands were mentioned as Member States of the EU that would in appropriate circumstances grant a 0% rate of withholding tax on dividends paid to a UK company. The UK/Ireland and UK/Netherlands tax treaty rates of withholding tax on interest and royalty payments are set out below:
International groups with UK Headquarters companies are understandably concerned about Brexit.
Where dividends, interest and royalties are being received from EU Member States, it will be important firstly to determine with the payer whether relief from source withholding taxes is being obtained via the relevant EU Directive or the UK double tax treaty. UK companies can choose whether to claim Directive or tax treaty relief from withholding tax on such payments.
Whilst future relief under the EU Directives may be of short-term duration, the UK’s double tax treaty network is extensive and includes treaties with all the EU Member States. In principle, the UK’s tax treaty reliefs are largely equivalent to the Directive reliefs, so if the Directive reliefs do fall away, UK companies should not suffer economically as a result, as they will have the option to claim comparable reliefs under the dividend, interest or royalty articles of a double taxation convention. As has been noted, the UK’s tax treaty reliefs are not unconditional, and the various conditions for treaty relief will need to be carefully reviewed.
The ability to benefit from tax treaties is extremely fact sensitive, and independent tax advice on the specific circumstances of each case should always be taken.