Various corporate groups have recently relocated or announced that they are considering relocating their holding companies from the UK to places such as Switzerland and Ireland. Talk of tax moves has become common place. Does this mean the UK is an undesirable place to base a global corporate group’s operations? This article suggests that the UK may not be such a bleak place to be located, but each group must consider its own circumstances.
HOLDING COMPANY JURISDICTION
Multinational groups can be complex structures, often with a plethora of subsidiary companies encompassing operations in many countries around the world. Key to the overall group tax liability can be where the group’s holding company – that is, the company in the group that owns the subsidiaries – is located.
Holding companies can have a wide variety of roles depending on the business model of the group. They may be functional management companies that actively control their subsidiaries or they may be passive tax shells – owning and occasionally selling shares in their subsidiaries, but having little other involvement. The best location for a holding company depends on the role it is intended to play.
UK COMPANY TAX OVERVIEW
UK companies pay corporation tax at 27% (from April 2011) on their worldwide profits. The headline rate is higher than in some jurisdictions (such as Jersey or Switzerland), but is similar to others (such as the Netherlands or Luxembourg). The headline rate of corporation tax is expected to fall to 26% in 2012, reaching 24% from April 2014.
BENEFITS OF THE UK
From 2012 there may be a UK tax exemption available for foreign branches of UK companies. Further, the UK can be a good place from which to provide debt finance to a group, due to deductions being available covering the interest paid on loans. The introduction of the ‘debt-cap rules’ in 2010 has reduced this advantage for some groups.
When a UK company sells an asset – such as shares in a subsidiary – it may have to pay corporation tax on any gain. However, the substantial shareholding exemption means that there is no tax on the sale of group trading companies provided certain conditions are met.
Dividend income from shares is, in theory, subject to corporation tax. However, the UK has exemptions for dividends paid to the holding company from group subsidiaries (subject to certain restrictions), and there is no withholding tax on dividends paid out of the UK. In many other jurisdictions a holding company may be based in charge withholding tax on dividend payments in certain circumstances. This means that, broadly speaking, it is possible for a UK holding company to receive tax free dividend income from global subsidiaries and pay-out dividends without withholding tax. This ease of repatriation of profits has always been a key feature of the UK as a holding company location, and the dividend exemption has been a welcome addition to UK tax law since its introduction in 2009.
If a subsidiary and a holding company are located in different countries, and if those countries do not have a double tax treaty, then it is possible that both companies will pay tax on the same profits. The UK has one of the most developed treaty networks in the world, which makes it attractive in comparison to some of the traditional tax havens, such as Jersey or Bermuda, whose treaty networks are limited. The UK also offers an economically and politically stable environment to do business, and is an ‘acceptable face’ for investors. Tax havens are becoming subject to increased scrutiny and pressure to conform. For example, anticipated US law changes will soon be encouraging US groups to move away from tax haven corporate structures. The UK is potentially a positive alternative location and there have already been moves, such as the offshore drilling company Ensco plc in 2009.
Despite the above, it is, arguably, non-tax reasons that weigh most heavily in the UK’s favour as a holding company location. If a holding company is to have very hands-on involvement in the day-to-day management of subsidiaries, then it helps for its directors and other executive staff to be resident in the jurisdiction. The UK, and London in particular, is a very attractive location for global business, enjoying Europe’s central location between America and Asia. As a global financial centre, London has a great concentration of banks, financial institutions, and legal and business advisors, supported by a legal system that is highly regarded for business.
While the increasing complexity of the tax system is a general negative factor, HM Revenue & Customs are increasingly willing to pre-clear transactions, and are offering informal rulings on recent tax legislation. This provides a degree of assurance for groups thinking of relocating.
DRAWBACKS OF THE UK
Controlled Foreign Companies (CFCs)
A major drawback of the UK as a holding company location has long been its CFC rules. These require the profits of certain UK-owned overseas companies to be included in the UK holding company’s taxable profit. These rules are intended to prevent tax being avoided in the UK, but they also have the effect of making the UK a much less attractive holding company jurisdiction. However, quite broad exemptions are available, for example for trading activities that take place in a white list of territories and where there is not a motive to avoid tax. There is also a two-year grace period for new acquisitions, easing the initial compliance burden.
Even with these exemptions, the CFC regime is overly complex and adds to the administrative burden on companies. Reform aimed at simplifying the CFC regime has been discussed for many years, but this has just led to uncertainty. However, during 2011, changes are anticipated that should remove the uncertainty and focus the attention of the regime on certain high-risk sectors. Importantly, the new regime promises to be less burdensome to comply with.
These changes form part of a general shift in the UK and other jurisdictions away from taxing global profits and towards a focus on taxing profits created in the UK.
Worldwide debt cap
Another negative feature of the UK’s regime is the worldwide debt cap, which provides limits on interest deductions that can be claimed where too much of a group’s debt is held in the UK. This may limit a group’s debt financing flexibility, and is intended to prevent companies taking advantage of the UK’s otherwise attractive interest deduction rules.
Although the UK offers a high standard of living – and London in particular is widely perceived to be a desirable place for executives to live – the income tax rate can be a deterrent for individuals following the introduction of a 50% additional higher rate for earnings over £150,000.
The UK tax system can be very complex indeed. However, the variety of exemptions and reliefs available and the UK’s extensive double tax treaty network may make the UK very tax efficient for some groups, and it is hoped that it might become increasingly attractive from a tax perspective. This, combined with the attractiveness of the UK as a place to live, means the UK may become a more desirable holding company location. However, only time will tell. This article was drafted prior to the UK’s Budget announcement on 23 March 2011.