Out-Law Legal Update
Individuals advised to check whether they can still claim entrepreneurs' relief
Out-Law Guide | 03 Aug 2011 | 12:55 pm | 9 min. read
This guide considers the tax implications of using a UK holding company to hold shares in other UK or overseas companies. The general principle is that a UK resident company is subject to UK corporation tax on its worldwide profits and gains. The main rate of UK corporation tax is currently 20% and is due to be reduced further to 19% from April 2017 and then to 17% from April 2020.
There are a variety of exemptions potentially available to a UK holding company which makes having a UK holding company an attractive prospect in certain circumstances.
Some of the general considerations which may apply to UK holding companies are set out below. Whether a UK holding company is the appropriate solution for a company or investors very much depends on the particular circumstances and the other jurisdictions involved, so this guide only gives a brief indication of the issues that may be relevant.
Tax treatment of payments made by a UK holding company to investors
Investors can invest in a UK holding company through a mixture of two methods:
The UK holding company is likely to make returns to investors either by way of interest, in the case of debt funding, or dividends, in the case of equity funding.
Debt and interest
A corporation tax deduction may be available to the UK holding company on the payment of interest to investors, although these payments may be subject to anti-avoidance provisions - for example, transfer pricing which is discussed below. These anti-avoidance rules are very complicated and may apply to deny any tax deductions for the UK holding company.
The UK government intends to introduce a general rule restricting the ability of a company to deduct interest expenses from its taxable profits. The new rule is expected to be introduced from April 2017 and will restrict tax deductions for interest by reference to a fixed ratio constituting a percentage of a company's earnings before interest, taxes, depreciation and amortization (EBITDA).
In May 2016 the government published details of how the new rule would operate. It is currently proposed that the rule will have a fixed ratio of 30% of tax EBITDA and will include a £2 million de minimis threshold and a narrowly drawn exemption for third party interest expenses on certain public benefit infrastructure projects.
The new interest limitation rule is being introduced as a result of the Organisation for Economic Cooperation and Development's (OECD) project to prevent "base erosion and profit shifting" (BEPS). The BEPS project aims to combat the artificial shifting of profits of multinational groups to low tax jurisdictions and the exploitation of mismatches between different tax systems, so that little or no tax is paid. The OECD considered that the tax deductibility of interest created a BEPS risk, and in October 2015 recommended the introduction of a general interest limitation rule.
Withholding tax on interest
Generally, a UK holding company has a duty to withhold tax (currently at a rate of 20%) on UK source payments of interest to investors. Where tax is withheld, it will have to be paid to HM Revenue & Customs (HMRC) to account for the investor's liability for UK tax. In certain circumstances investors can then claim a repayment from HMRC of the tax withheld.
There are a number of exemptions to this general rule regarding withholding tax. For example, there is currently no withholding tax on payments of interest to UK banks and UK corporation taxpayers.
Quoted Eurobonds also benefit from an exemption from UK withholding tax. A quoted Eurobond is a debt security issued by a company that carries a right to interest and is listed on a recognized Stock Exchange.
From January 2016, a new exemption has been available for certain qualifying private placements. A private placement is a type of unlisted debt instrument that is sold by way of a private offering to a small number of investors.
For non-UK resident investors, there may be no requirement to withhold tax if the investor is based in a country which has a double tax treaty with the UK, which provides that no UK tax is payable on interest paid to a resident of that country. A double tax treaty may also provide for a lower rate of withholding tax. Even if a double tax treaty does apply, the holding company cannot make the payments without deducting tax or with tax withheld at less than 20% unless it has received clearance from HMRC to pay investors without withholding tax.
Shares and dividends
No tax deduction is available for the holding company for dividends paid to investors.
There is no withholding tax on dividends paid by a UK company.
Tax treatment of payments received by the UK holding company from its subsidiaries
Dividends received by the UK holding company from other UK companies or from overseas companies should benefit from an exemption from corporation tax, called the dividend exemption. If available this means that the UK holding company does not have to pay corporation tax on the dividends it receives.
Whether the UK holding company gets the benefit of the dividend exemption will depend on whether it is a 'small' company. Generally a company will be a small company if it has fewer than 50 employees and its annual turnover or annual balance sheet is less than €10 million. If there are any linked enterprises, such as subsidiaries of the holding company, their employees, turnover and balance sheet will need to be added to that of the UK holding company for the purposes of these limits.
If the holding company is a small company then the dividend exemption should prevent UK tax being payable in respect of dividends paid to it by UK companies or companies resident in most places where the UK has a double tax treaty, provided a few additional conditions are satisfied.
If the holding company is not a small company, then the dividend exemption may still be available if the dividend is paid by a company which the holding company controls provided certain other conditions are satisfied.
Controlled Foreign Company rules
Anti-avoidance rules, called the controlled foreign company (CFC) rules, prevent the artificial diversion of a UK company's profits to subsidiaries/other corporate entities in low tax jurisdictions to avoid UK corporation tax.
A CFC is a company that is tax resident outside the UK and controlled by one or more UK resident persons. In certain circumstances, the rules will impose a corporation tax charge on a UK resident company in relation to certain profits of the CFC.
There are certain exemptions that prevent a CFC charge applying. For example, subject to certain conditions there is an exemption for CFCs resident in a jurisdiction with a headline rate of corporation tax that is more than 75% of the UK corporation tax rate (currently 20%). The UK's CFC rules are complex and tax advice should always be sought where they may be relevant.
The transfer pricing anti-avoidance rules apply where services or transactions take place between connected parties for a price calculated to provide a UK tax advantage. The rules also apply to the terms of loans between connected parties. The effect of the rules is to treat goods or services as supplied to or by UK companies for their "arm's length price", rather than the price actually charged.
A UK holding company may need to consider the impact of these rules when it enters into transactions with other companies in its group. Depending on the circumstances, the rules may also prevent a tax deduction being available or restrict the tax deduction in respect of interest paid by the holding company to its investors.
The rules only apply to large companies – small and medium-sized companies are exempt. They apply to transactions which are cross-border, and to transactions which are between UK residents.
Diverted Profits Tax (DPT)
DPT is a new UK tax aimed at multinationals operating in the UK, who are considered to be diverting profits from the UK, to avoid UK corporation tax. DPT was introduced in April 2015. It does not apply to small and medium sized companies.
The current rate of DPT is 25% of the diverted profit. Broadly, DPT applies in two circumstances:
There are specific exemptions from a DPT charge where in a 12 month accounting period, UK-related sales are below £10,000,000, or UK-related expenses are below £1,000,000.
No DPT charge should arise if in the relevant transactions, the company has made transfer pricing adjustments that put it in the same tax positions as if arm's length pricing had been used.
Calculating a DPT charge is complex and there are various rules that need to be considered. Specialist tax advice should always be obtained if a UK holding company considered that DPT might be relevant to its operations.
The UK's patent box regime for the taxation of intellectual property was introduced in April 2013.
Broadly, the regime allows certain companies liable to UK tax to elect to apply a lower rate of corporation tax for their profits earned from their patented inventions (and certain other innovations). The relief was phased in over 4 years leading to a corporation tax rate of 10 per cent by 1 April 2017.
For further details of this regime see Out-law guide to the patent box regime.
However, the patent box will be closed to new entrants from 30 June 2016 and will be abolished for existing claimants by 30 June 2021. In December 2015, HMRC published drafted legislation to change the design of the patent box to comply with recommendations from the OECD as part of the BEPS project outlined above.
From 1 July 2016, a new UK Patent box will be available that will be based on the "modified nexus" approach. This approach looks more closely at where the research and development expenditure incurred in developing the patent or product actually takes place.
Sale of subsidiaries by the UK holding company: the UK holding company may wish to sell its shares in its subsidiaries and pass the money onto the investors by way of a dividend. On the disposal of the shares, this is likely to trigger a capital gain on which corporation tax will be payable. The UK holding company may benefit from a relief called the substantial shareholding exemption (SSE), which would have the effect of making the entire gain exempt from capital gains tax.
In order to benefit from this exemption various conditions need to be satisfied. These conditions are fairly complex but they include that the company has to have held at least 10% of the shares continuously for at least one year. The UK holding company and the subsidiary it is selling must both be trading companies, and their activities cannot include to a substantial extent activities other than trading activities. These conditions must be satisfied both before and after the disposal of the shares. There are a variety of other requirements which must also be satisfied, meaning that each transaction needs to be carefully checked to see whether the SSE would be available.
Where the SSE is available, the gains will not be taxed in the hands of the holding company and consequently, there should be more funds available to return to investors.
Sale of UK holding company by investors: if the investors decide to sell their shares in the UK holding company, any chargeable gain will be subject to capital gains tax unless the person disposing of the shares is not resident in the UK.
Out-Law Legal Update
Individuals advised to check whether they can still claim entrepreneurs' relief