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Brexit: Withholding taxes ahead for businesses

Withholding tax

Multinational enterprises are considering whether to move their UK headquarters to one of the remaining 27 EU nations, as withholding taxes could be charged once EU laws cease to apply.

The Parent-Subsidiary Directive and the Interest and Royalty Directive prohibit withholding taxes on intra-group interest, dividend and royalty payments. Cross-border payments of dividends, interest and royalties between entities in the UK and other EU member states can qualify for the withholding tax exemption under the directives.

"The inability to continue to be able to rely on such directives could result in a UK holding company ceasing to be as tax effective as currently, although in most cases (but not all) bilateral treaties [may help companies] avoid withholding taxes. UK subsidiaries could also incur additional withholding tax on certain types of royalty or interest payments to EU parent companies or affiliates," law firm Dechert said in a statement.

If the UK fails to complete agreements with EU countries that provide equivalent benefits, "UK companies receiving dividends, interest or royalties from EU entities will need to rely on double tax treaties, where applicable, to reduce or eliminate the rate of withholding tax in the payer jurisdiction. In some cases, this could cause an increased withholding tax exposure as compared with the position under the Directives. Fund structures should be reviewed with this in mind," law firm Akin Gump Strauss Hauer & Feld said in a tax alert.

However, KPMG UK told International Tax Review that companies "shouldn't lose sight of the fact that a number of EU countries don't levy dividend withholding tax", and for a good number of others the UK has an agreement for the avoidance of double taxation (DTA) which eliminates the levy. "However, there does remain a small number of countries where withholding tax will need to be considered – including Germany and Italy (both 5%) and Portugal (10%)."

"There will be similar considerations for those groups with material cross-border payments of interest and royalties, although arguably there is greater flexibility for a group to restructure its funding or licensing arrangements," the firm added. "Again, Portugal is an example of a country where the DTA does not fully eliminate withholding tax and it would be charged at 5% (on royalties) and 10% (on interest)," KPMG said in a statement responding to questions from International Tax Review.

Nevertheless, the firm said that it is possible the UK may negotiate an arrangement similar to the one Switzerland has with the EU to eliminate such charges.

Law firm Clifford Chance added that businesses may wish to start identifying the extent to which their existing group structure will be subject to these withholding taxes, and then "give consideration as to whether those taxes can be mitigated".

"In the past, it might have been thought this could be achieved by as simple a step as inserting, for example, an Irish holding company between a UK parent and an EU group. However, in light of modern views of beneficial ownership, the ongoing implementation of the OECD BEPS Project and the anti-avoidance rule written into the Parent-Subsidiary Directive last year, a restructuring of that kind may not be effective," Clifford Chance said in a briefing paper.

Transactions between UK and EU subsidiaries

"UK-headquartered groups with significant European subsidiaries which expect to be materially hit by withholding taxes on intra-group dividends, may need to consider taking radical measures," Clifford Chance said. The firm suggested that it was likely the only way to maintain the benefits of being an EU-headquartered group would be to shift the parent company and headquarters from the UK to another EU member state.

"That could be achieved, for example, by 'inverting' the group so that it becomes headquartered in (say) Ireland, with shareholders owning the new Irish parent, and the UK and EU subsidiaries held directly by the Irish parent," Clifford Chance said. However, it warned that a plan of this kind "would need careful consideration because it might for example have adverse US tax consequences if there are US tax subsidiaries or if a future US merger is planned".

It is possible that many EU directives would not apply to the UK post-Brexit, which would likely have an adverse effect on EU-based businesses.

"When the UK leaves the EU, subsidiaries based in EU member states would not be able to rely on these directives to make payments to their UK holding companies free from withholding taxes," said Ted McGrath, partner at law firm William Fry in Ireland. For Ireland, however, this risk is comparatively low because Ireland and the UK are party to a comprehensive double tax treaty, he said.

Portuguese law firm Rogério Fernandes Ferreira & Associados, pointed out that the DTA between the UK and Portugal does not offer the same withholding tax elimination effect as the EU's direct tax directives.

"Therefore, companies with cross-border investments may like to revise their current strategy and determine the potential risk and impact of this change, in order to eliminate or mitigate international double taxation. On the other hand, Portugal remains an attractive investment location, as a company may benefit from the participation exemption regime, which nevertheless would be applicable to cross-border flows of income and capital gains between the UK and Portugal because the existing double tax convention also enables the use of such regime. Furthermore, with or without Brexit, a Portuguese-based company may elect to exclude profits and losses from a permanent establishment that it has abroad, thus segregating the foreign and domestic income for taxation purposes."

EU Mergers Directive

Another beneficial piece of legislation for businesses is the EU Mergers Directive, which provides corporations with relief on restructuring. On leaving the EU and European Economic Area (EEA), UK resident companies would no longer be eligible for such relief.

"Companies locate their headquarters based on a multitude of factors, from availability of talent to local infrastructure, and the prevailing tax rate is just one part in this decision-making process," KPMG said.

"If companies do decide to restructure in light of Brexit, they will no doubt be considering the timing carefully – there will be a careful balancing act between allowing sufficient time such that the full details of the Brexit deal are known, but not before the closing of the Article 50 period so that relief under the Mergers Directive (for example) can be claimed if necessary," KPMG said.

What should companies be doing now?

According to KPMG, it is "quite possible there will be no material change in the amount of tax payable by corporates, depending on what is finally negotiated" between the UK and EU nations and which trading model the UK adopts.

Nevertheless, KPMG recommended that companies "undertake a review to identify 'hotspots' within their business and to the extent possible, quantify the future exposure of EU exit".

"Those groups which expect to be materially affected are likely to start to investigate restructuring options", KPMG said, adding that it "would encourage clients to weigh up the full range of alternatives available".

Before choosing to emigrate to an EU member state, KPMG said groups should consider whether smaller scale changes can be made to the existing structure. For example, a branch structure may reduce withholding tax exposures while allowing the company to continue to enjoy the wider benefits of the UK environment, the firm said. "Alternatively, it may be possible (and easier) to restructure finance or licence agreements to manage post-Brexit tax costs," KPMG said.

"Any move from the UK will require corporates to think carefully about the wider consequences, and so is unlikely to be the 'easy' answer it might first appear," the firm added. "For example, US inbounds will need to consider the consequences on their wider group, in particular, the tax impact on the repatriation of funds through a different (territorial) chain of ownership."

Non-UK businesses

Where the UK is used as an operational headquarters for multinational businesses, the issues are different, but that doesn't necessarily mean a higher tax burden.

If the UK chooses to implement a corporation tax rate below 15% and introduce further incentives, then "the UK's tax competitiveness may even improve", said KPMG.

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