Reduction in corporate tax rate may not be good news for international groups, says expert

Speaking at a Pinsent Masons Budget briefing, Eloise Walker said that although the announcement was good news for UK companies, there are two potentially negative effects of a low rate of UK corporation tax for multinational groups.

Firstly, she said that the UK holding company of an international group may find that the lower rate hinders its ability to set off tax deducted by foreign jurisdictions on interest and royalty payments made to it by its subsidiaries. She said that this is because offshore subsidiaries can only set off withholding tax credits against the amount of their UK tax, so if their UK tax rate falls, so does their ability to set off. She explained that this in turn could mean that the overall tax bill of the group may effectively be increased.

Secondly, she said that an international group with UK subsidiaries and a parent company located in a foreign jurisdiction could also be adversely affected. She explained that many jurisdictions, especially those in well developed countries, have controlled foreign company regimes. These are rules designed to stop local business from migrating offshore to low tax jurisdictions. This is achieved by effectively taxing entities resident in tax heavens as if they were resident in the jurisdiction of their parent company. Reducing the UK corporation tax rate too far relative to others in the G20 may therefore have adverse effects, she said.

Walker said that Japan's anti-tax haven regime is a good example. She explained that where a Japanese company holds 10% or more in a controlled foreign company (CFC), the Japanese entity may become taxable on its proportionate share of the subsidiary's income whether or not distributed. A CFC for these purposes is, broadly, one which is more than 50% owned by Japanese residents and either has its head office in a country which does not impose corporate income tax or is subject to an effective tax rate of 20% or less.

Walker said that unless Japan changes its domestic law, any Japanese holding companies owning UK subsidiaries may find themselves owning CFCs from April 2015. A 1% cut in UK tax from 21% to 20% could result in an extra 5.5% tax bill in Japan, so that the total cost is the Japanese rate of 25.5% she said.

Walker said that the change was “a classic example of how a small welcome domestic change can have a wide adverse international impact."

"This won’t be an easy one for HMRC to fix, either, unless they want to negotiate with Japan and any other territories where this is a problem," she said. "It would be ironic if the UK, as host of the G8 summit this summer and one of the parties putting pressure on the OECD to produce a comprehensive action plan on base erosion and profit shifting, found itself under attack as a tax haven.”

Ray McCann, a tax expert at Pinsent Masons, said at the Pinsent Masons budget briefing, that the reduction in the corporation tax rate will undoubtedly be welcomed by many UK companies. However, he questioned the "placebo effect" of measures which are announced more than two years before they are introduced and bring no immediate benefit.

At the same event, James Bullock of Pinsent Masons said that "a company cannot operate without individuals, and for those individuals, the rate of income tax remains punitively high". This is exacerbated by the fact that many benefits have been taken away from non-domiciled individuals. He said that for many, relocation to the UK may therefore not be an appealing option, despite the "much advertised" low corporation tax rate.