UK multinationals with significant overseas profits (particularly in the pharmaceuticals/IP sectors) are recognising the importance of undertaking a cost-benefit analysis in relation to the migration of their tax residency; non-UK multinationals with UK intermediate holding companies may consider it prudent to do likewise.

Following the recent announcements by Shire Pharmaceuticals Group plc and United Business Media plc (UBM) that they intend to migrate the tax residence of their ultimate holding companies from the United Kingdom to Ireland, several other major UK corporates have publicly indicated that they are actively considering similar moves.

Particularly within the European Union (with no internal trade barriers and good communications), corporates can increasingly locate their holding companies wherever they wish, and there is a growing perception that the traditional reasons for maintaining a corporate headquarters in the United Kingdom may be weakening. An important factor in this is the increasing complexity and instability of the UK tax system in comparison with those of its competitors in Europe. Particular concerns have been raised about proposed new changes to the United Kingdom’s controlled foreign companies (CFC) rules.

Reasons to Consider Migrating Tax Residency

The stimulus for the departure of Shire and UBM is not simply the headline rate of corporation tax of 28 per cent in the United Kingdom (which compares unfavourably with the 12.5 per cent rate in Ireland, and similarly low rates in many Eastern European countries). UK multinationals are also pre-empting anticipated changes from April 2009 to the UK taxation of companies’ foreign profits. Ironically, these proposals were originally brought forward in June 2007 in part to simplify that regime and make it more competitive internationally, but as currently framed, they could increase the amount of tax that UK corporates pay on profits they make overseas. Although the Government has, on 19 May 2008, reaffirmed that the proposals are intended to be revenue neutral and are not intended to extend the taxman’s reach to tax profits arising from intellectual property held and exploited abroad, concerns are likely to remain until the details of any new exemption are announced.

If a UK company controls a foreign subsidiary which pays a low amount of tax, the CFC rules subject the foreign subsidiary’s income to tax in the United Kingdom. There are a number of exemptions in place at present which have benefited UK multinationals: most importantly if the subsidiary’s income consists primarily of trading income, is distributed to the United Kingdom, is derived from a “white-listed” jurisdiction or where there is no UK tax avoidance motive. However, the Treasury’s proposals indicated that these exemptions may be withdrawn. Revised proposals are expected in a Treasury paper to be released before the UK Parliament summer recess after conclusion of a consultation exercise.

The main elements of the Treasury’s new proposals are as follows:

  • To move away from the current system of taxing foreign dividends and relieving double taxation through crediting foreign tax, towards an exemption from taxation on dividends derived from substantial (10 per cent) shareholdings in foreign companies
  • To replace the existing CFC rules with a “controlled company” (CC) regime, which would be an income-based regime under which the “mobile” or “passive” income of all 10 per cent subsidiaries of large and medium-sized UK-resident companies would be taxed in the United Kingdom (so as to enable the United Kingdom to tax “artificially located profits that are effectively within the control of the UK parent”)
  • To change the current regime in respect of interest relief for the costs of funding foreign activities and profits; specifically, it is proposed to restrict the amount of interest claimed by the UK members of a multinational group by reference to the group’s total consolidated external finance costs and to strengthen the existing unallowable purposes rules for loan relationships and derivative contracts

Specific concerns have been raised in relation to the impact of the proposed CC rules on overseas licensing activities. Currently a subsidiary carrying on pure licensing activity may fall within one of the exemptions. The CC proposals sweep away most of the exemptions and are income-based rather than entity-based. Income derived from intellectual property (IP) will generally be presumed to be mobile or passive in nature, and thus caught by the new rules.

HMRC’s concern is that, without the strengthened CC regime, it would be relatively easy for UK-based multinationals to divert profits out of the United Kingdom (through loan or royalty payments) which could then be brought back to the United Kingdom by tax-free dividend. However the provisions are potentially extremely wide in application and may capture, in particular, royalty payments of a wholly commercial nature with no UK nexus that are currently outside the scope of the CFC rules. The revised proposals to be issued later this year are expected to try to address this concern and provide a suitable exemption.

Whilst the prospect of a tax exemption for foreign dividends has been widely welcomed, there is growing concern that its benefit may be outweighed by a CC charge on profits generated from the exploitation of IP abroad, whether or not those profits are repatriated to the United Kingdom. Given the uncertainty surrounding the treatment of such profits, it is unsurprising that a number of the companies planning or considering relocating their holding companies out of the United Kingdom are IP-rich groups that derive a large part of their revenues from exploitation of their IP outside the United Kingdom.

Other Relevant Factors

Although the United Kingdom’s company and tax law regimes have traditionally made it a relatively congenial jurisdiction in which to locate a holding company, the perception has been growing that the United Kingdom has failed to keep pace with business-friendly reforms elsewhere in Europe, which have reduced headline rates of tax more dramatically and, in many cases, introduced generous “participation exemptions” which provide exemptions from tax on dividends from, and disposals of, substantial shareholdings in both domestic and foreign companies.

Possibly more significant is the increased compliance burden in the United Kingdom associated with strengthened transfer pricing and thin capitalisation rules and range of anti-avoidance measures attacking cross-border arbitrage and other tax planning mechanisms that were previously tacitly accepted. By way of comparison, the Republic of Ireland has no CFC rules, very limited transfer pricing legislation and generous tax relief for expenditure on research and development. A number of other EU member states (such as the Benelux countries) have also deliberately sought to establish benign holding company regimes, although the breadth of the United Kingdom’s tax treaty network remains a key selling point.

Structure of the Proposed Migrations

Shire and UBM both propose to effect their migrations by using a scheme of arrangement, which would superimpose a new Jersey incorporated company as the new holding company for the group. This would be UK listed and tax resident in Ireland. The new holding company would have the same board and management team as the original UK holding company. The use of a Jersey incorporated company means that dealings in the new holding companies’ shares will not be subject to stamp duty in either the United Kingdom or Ireland.

In addition, devices are available to enable shareholders to choose whether they receive their dividends from a company resident for tax purposes in the United Kingdom or the Republic of Ireland.

Where relevant, it is possible to structure the arrangements so that the new holding company retains the benefit of being subject to the UK Takeover Code.

Who Is Affected

UK multinationals with significant overseas profits (particularly in the pharmaceuticals/IP sectors) are recognising the importance of undertaking a cost-benefit analysis in relation to the migration of their tax residency. In addition, non-UK multinationals with UK intermediate holding companies may consider it prudent to do likewise (although in such cases, the migration would be achieved by means other than a scheme of arrangement).

However, other UK corporates not falling within those categories may nonetheless wish to consider their position. The possibility of a lower rate of corporation tax and potential reduction in compliance costs may well, in certain cases, favour migration.

Relocation of a holding company outside the United Kingdom will not in and of itself significantly reduce the overall UK tax burden of a group in the short term without the relocation of functions and employees. However, it can offer greater structuring flexibility to enable tax-efficient holding of IP and repatriation of earnings, by enabling multinationals to hold their IP outside the UK group structure and thus avoid the potential CC charge.