| UK Corporate
Taxation for Multinationals |
Corporate Taxation
for Resident Multinationals
If
a multinational corporation (meaning, a company with subsidiaries
or affiliates in more than just one or two countries) needs
to be based in a high-tax country, for instance because it
must have a listing on a major stock exchange, then the UK
is often a good choice. As a member state of the EU, the UK
is within the EU parent-subsidiary directive, and in addition
the UK has 110 double tax treaties, more than any other EU
country, so that the UK is well-placed to receive dividend
income with the lowest possible amount of foreign tax deduction.
However,
this advantage has been somewhat compromised by measures in
successive Finance Acts to limit international tax planning
by multinationals.
Firstly,
the UK's Controlled Foreign Company rules have been tightened
to the point at which only marginal benefits can be obtained
by locating a subsidiary in a low-tax jurisdiction - most
types of income and capital gain in 40% offshore subsidiaries
are now caught for UK corporation tax whether remitted to
the UK or not.
An offshore company owned by several unrelated UK entities
would still escape the rules, but that does not accommodate
many business situations. In addition, enabling legislation
in the 2002 Finance Act allows the British government to alter
the tax treatment of controlled foreign companies in jurisdictions
which are considered to allow 'harmful tax practices'.
Further
changes were brought forward in the 2005 budget. The 2005
Controlled Foreign Companies (Excluded Countries) (Amendment)
Regulations aim to prevent CFCs from manipulating their profit
location in order to evade taxes, to stop them from secreting
income in non-corporate entities, and to exclude them from
receiving the benefits of the CFC regime if they are not liable
for tax in another country. The measures came into full force
on March 31st.
A
spokesman for the Inland Revenue explained that: "All of the
changes made are a reaction to schemes including some that
were identified via the disclosure rules. The government could
not have allowed significant amounts of tax to remain at risk."
The UK Finance
Bill, 2007, implemented changes to the Controlled Foreign
Company regime made in response to the previous year's high-profile
Cadbury-Schweppes decision by the European Court of Justice.
Although
CFCs were not mentioned in the Chancellor's March Budget speech,
the Treasury released a detailed response to the ECJ's decision,
which commentators said represented the minimum that the Government
could have done to comply with Cadbury; in fact, many consider
that the Treasury has not gone far enough and remains vulnerable
to a new ruling.
The
new provisions restrict the application of CFC rules to profits
arising from the activities of employees but not of capital,
meaning that they will only become significant in respect
of trading operations in a 'low-tax' EU or EEA territory.
The ECJ did not make such a distinction. To the disappointment
of many tax advisers, the Treasury has not provided for an
advance clearance mechanism for the CFC regime. In addition,
the Treasury has stiffened the effective management test,
making it more difficult for EEA-based companies to satisfy
the Exempt Activities exemption.
The
Government did however announce that it would publish a paper
in relation to CFCs before the end of May 2007, so that the
Finance Act measures (effective from 6th December 2006) may
have just been a holding operation.
Secondly,
the use of tax 'mixing' intermediate companies in such jurisdictions
as Holland and Denmark was severely pruned back by the Finance
Act 2000. Whereas it used to be possible to use, say, a Dutch
holding company to mix dividends from foreign subsidiaries
taxed at say 10% and 50% to achieve a blended rate of 30%,
thus ensuring that only a very small amount of UK corporation
tax would be payable, the rules have now changed.
Mixing
has been brought onshore by limiting the availability of tax
credits to directly-held subsidiaries only, and the maximum
'mixable' rate of tax is limited to 45%. Evidently this has
a substantial impact on the usefulness for UK companies of
Danish and Dutch intermediary holding companies.
One
improvement that should be noted, however, was the abolition
of the ACT (Advance Corporation Tax) withholding tax in 1998:
although corporation tax is now payable earlier than before,
the problem of excess ACT has disappeared.
Dividends
to both resident and non-resident shareholders are paid without
deduction of withholding tax.
Another
improvement, contained in the 2001 budget, was the abolition
of withholding tax on interest and royalty payments to companies
subject to UK corporation tax.
Gordon
Brown announced the extension of the abolition of withholding
tax on international bonds and intra-UK payments of interest
and royalties, to include non-bank entities, such as venture
capital companies.
While
this announcement was welcomed by British industry, there
was disappointment that the change was not more far-reaching.
The Chartered Institute of Taxation made the following suggestion
for further reform:
'We are disappointed that this will only apply where the recipient
company is within the charge to UK corporation tax. Gross
rental income may be received by non-resident landlords who
have undertaken to comply with UK tax obligations, and we
would suggest that consideration be given to the introduction
of such a scheme for the receipt of interest and royalty payments
by those outside the charge to UK corporation tax.'
Some
further improvements to the withholding tax regime were included
in the 2002 Finance Act
.As
a result of the accumulation of negative measures imposed
by the Treasury, it was reported in December, 2004, that leading
tax advisers and accountancy firms such as PricewaterhouseCoopers
and KPMG were advising their international clients to avoid
establishing operations in the United Kingdom.
One
favourable development for existing UK-based multinationals
is the gung-ho attitude of the European Court of Justice,
which is rapidly tearing down national fiscal barriers inside
the EU. In 2002 it ruled against fiscal exit penalties on
corporate relocation.
In
a preliminary hearing of the Conseil d'Etat v de Lasteyrie
du Saillant case, the ECJ's Advocate General decided that
the French government had violated the freedom of establishment
provisions contained within EU law by levying a punitive residential
exit tax on an individual who wanted to transfer his tax residence
out of France.
Twelve
of the EU's 15 member countries impose company emigration
exit charges. They include the UK, France, Germany, Italy
and Spain. The huge tax penalties act as a deterrent on companies
wanting to relocate to other member states where running costs
are less.
Tax
charges vary from country to country, but most countries,
including the UK, levy a penalty of about 30% of the value
of a company's capital assets. Individuals must often pay
up to 40%.
The
ECJ has ruled against national governments in a number of
cases involving freedom of establishment, and in August 2003
the English High Court followed ECJ precedents in a test case
brought by Deutsche Morgan Grenfell, concerning EU 'freedom
of establishment' and anti-discrimination laws.
Mr
Justice Park's decision in the High Court was the conclusion
of a case first initiated when 50 companies submitted a group
claim in the English courts as the result of an European Court
of Justice precedent which ruled that the British government
had illegally imposed advance corporation tax.
Under
the rules which applied until the 2001 and 2002 reforms of
corporation tax, UK subsidiaries of European firms were wrongly
made to pay tax on dividends repatriated to their continental
parent companies.
Although
tax law in this area has since changed, the UK investment
banking arm of the German bank was attempting to establish
how far claims of wrongly paid tax can be backdated.
The
Inland Revenue (now HMRC) argued that the claims are restricted
to a six year period by the 1980 Limitation Act. However,
Justice Parks ruled otherwise, announcing that such claims
were not time-barred by the 1980 Act.
However,
he added that: "This is not a result which I reach with much
enthusiasm."
A
further blow for national treasuries came in September 2004
when the ECJ ruled that the Netherlands' domestic tax law
on 'exempt participations' was discriminatory and as a consequence,
unlawful.
The ruling relates to a case involving Bosal Holdings, a Dutch
manufacturer of car exhausts which acquired a number of European
firms during the 1990s, and was prevented from claiming tax
relief for interest paid on borrowings financing subsidiaries
which did not generate income taxable in Holland.
The
ECJ found that this breached Bosal's fundamental 'freedom
of establishment' rights, laid down in the founding Treaty
of Rome, and therefore upheld its claim against the Dutch
government.
The
ECJ decision was expected to benefit many firms elsewhere
in the union which had similar claims pending against national
governments.
One
such company was UK retail firm Marks and Spencer. M&S argued
that under Article 43 of the European Union Treaty, it should
be allowed to offset losses of around 160 million euros made
by its French, Belgian, and German subsidiaries between 1997
and 2001 against UK profits, claiming a tax refund of GBP30
million.
In
March, 2005, came the initial result of the much-followed
Marks and Spencer case, in which Advocate General Mr Poiares
Maduro agreed with the company.European Union finance ministers
however vowed to find a "defence mechanism" to counter the
likelihood of tax revenue shortfalls should the British retailer
ultimately be successful in its legal bid to offset losses
made by foreign subsidiaries against tax.
The
issue formed one of the main talking points during an Ecofin
meeting of EU finance ministers. "There is great concern about
this," remarked Jeannot Krecke, Economy Minister of Luxembourg,
which was holder of the rotating EU presidency at that time.
The
Advocate General's opinion was supported later that year by
the full ECJ.
In September, 2003, the ECJ ruled in favour of the UK Inland
Revenue in its dispute with Dutch copier firm Oce NV concerning
withholding tax levied on its UK subsidiary.
The
Dutch firm claimed that the 5% withholding tax it was required
to pay on the earnings of its UK subsidiary was unlawful because
it did not extend to British companies and was therefore discriminatory
under European law which stipulates such dividend income cannot
be taxed twice.
However,
the ECJ ruled that as the Dutch government allowed Oce to
deduct its tax payments made to the Inland Revenue, the withholding
tax did not constitute double taxation and as a result was
not discriminatory against other firms within the EU
.And
in February 2006 HM Revenue and Customs won an important legal
battle when the House of Lords ruled that companies which
claimed a tax credit on a dividend paid to a foreign parent
cannot claim a refund of advanced corporation tax.
The
group litigation was brought by more than 60 companies and
led by Pirelli, the Italian tyre manufacturer, which claimed
that the obligation to pay advance corporation tax (ACT) in
the UK on dividends it paid to its Dutch parent was in breach
of European Union law concerning taxes levied on dividends.
Although
the Dutch parent had received a repayment of 50% of the tax
credit attached to the dividend under the tax treaty between
the UK and the Netherlands, it claimed that the parent's right
to receive the credit was legally separate from any obligation
of the subsidiary to pay ACT.
However,
in overturning judgments by the High Court and the Court of
Appeal, Lord Nicholls, one of the five judges on the panel,
said that Pirelli was looking to obtain "the best of both
worlds."
In
February, 2006, the ECJ seemed set to confirm the House of
Lords ruling, when Advocate General Leendert Geelhoed stated
that whilst the UK tax authorities were required to treat
non-UK firms fairly, there was no pre-requisite for equal
treatment.
Consequently
the UK was entitled to enter into different tax treaties with
different countries and did not need to offer the same benefits
to everyone.In his opinion, Mr Geelhoed noted that this was
an area where "predictability and legal certainty are crucially
important, so that Member States can plan their budgets and
design their corporate tax systems on the basis of relatively
reliable revenue predictions.”
Following
up on the M & S case, the United Kingdom government announced
in February, 2006, that it would introduce legislation in
the Finance Bill 2006 to amend the UK loss relief rules.
According
to the UK government, the ECJ considered that the country's
group loss relief rules are in principle compatible with European
law, meaning that the system of group relief can be kept broadly
as it is now, although the Court also held that, in some very
limited circumstances, relief should be available in the UK
for the otherwise unrelievable losses of some group companies
resident in other States.
However,
the government fears that groups with loss-making companies
resident in another state could "engineer" their circumstances
so as to preclude the possibility of a loss making company
obtaining relief in its state of residence by, for example,
liquidating that company whilst transferring its business
to another company.
In
response, the government introduced legislation to deny loss
relief where there are arrangements which either: result in
losses becoming unrelievable outside the UK that were otherwise
relievable, or; give rise to unrelievable losses which would
not have arisen but for the availability of relief in the
UK, if the main purpose or one of the main purposes of those
arrangements is to obtain UK relief.
The
legislation was to be effective from Monday, February 20 of
that year.
Then
in April, 2006, the European Court of Justice Advocate General,
Leendert Adrie Geelhoed, gave an opinion in favour of four
UK companies who had claimed that corporation tax charged
on dividends received from EU subsidiaries was illegal under
EU free movement of capital rules.Between 1973 and 1999, when
the UK scrapped its Advanced Corporation Tax system, which
allowed UK companies to pay up dividends domestically at a
favourable rate, dividends from non-UK EU subsidiaries of
UK companies were charged at higher rates.
Although
the four companies in the case, British American Tobacco,
British Petroleum, Aegis Group and Imperial Chemical Industries,
were claiming refunds of 'only' some hundreds of millions
of pounds, the UK government warned during court proceedings
that the total cost of an adverse ruling might be as high
GBP7 billion if many companies applied for refunds, and that
the ECJ should therefore reject the companies' case on the
grounds that the UK's financial stability could be affected.
Mr.
Geelhoed denied this reasoning.
In
December 2006, the European Court of Justice followed his
opinion, and ruled that ACT operated illegally between 1973,
when the UK acceded to the EU, and 1999, giving rise to the
prospect of substantial rebates to companies which have paid
this tax in the past.
The
Treasury warned that such a ruling could leave it open to
repay claims totalling GBP9 billion, although draft blocking
legislation which would limit a company's claims to six years
would reduce this to about GBP2 billion, the government has
estimated. However, this legislation itself is to be challenged
in the courts, and while accountants say that the ECJ's decision
is a boost for companies, the full consequences won't be known
until the next legal battle is resolved.
“In
principle, today’s decision is good news for companies
hoping for an ACT rebate. However, they are unlikely to receive
anything until the UK and European courts reach a decision
as to the legal status of the blocking legislation –
a process that is likely to take some time," observed
Jonathan Bridges of KPMG’s EU law group at the time.
The
Court referred the matter back to the UK courts to determine
whether the UK rules operate to achieve this parity.
“It
is disappointing that the ECJ has stopped short of ruling
that the UK should apply the same rules to both UK and foreign
sourced dividends," Bridges noted.
He
continued: “Achieving equality of treatment via a credit
system may, on the face of it, sound reasonable but it is
not straightforward."
"The
ECJ’s ruling today fails to fully appreciate the fact
that not all profits in the UK are taxed at the corporate
tax rate of 30%. For example those deriving from share sales
are completely exempt."
Bridges
concluded:
"What
today’s ruling does is potentially introduce yet another
layer of complexity into the UK’s already overly cumbersome
corporate tax system.”
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