“Good for business, good for the UK” is a theme of much UK government rhetoric that has been reflected in a series of “good for business” tax changes.
The bad news is that newspaper reports of major businesses and high-profile entrepreneurs relocating from the UK to low-tax jurisdictions that began under the last government have continued this summer despite the new government’s assurances about its future fiscal policy.
The ugly result is that the effectiveness of new legislation enacted to encourage the establishment of EU holding companies is undermined by the negative impact of established UK groups moving abroad.
Relocation, Relocation, Relocation
At the end of September, Wolseley plc, a FTSE 100 plumbing and heating group, became the latest UK public company to announce its intention to leave the UK.
Perhaps not a household name, Wolseley is actually the biggest supplier of plumbing and heating products in the world. Headquartered in Britain for more than a 120 years, it now trades in more than 20 countries and derives over 80% of its revenues from its activities outside the UK, both factors that materially increased it UK tax costs.
This is not a new phenomenon. Since 2008, a string of significant UK groups have moved offshore including WPP (advertising and media), Shire plc (pharmaceuticals), UBM (business media) and Regus plc (office accommodation). The one thing they all have in common is that a high proportion of their profits is derived from activities outside the UK.
The trigger for all these moves has been dissatisfaction with the UK tax regime, but not necessarily with the same aspects of it. By the time the relocations began, a perception had developed that certain EU member states had more competitive regimes and the UK was not doing enough to keep up with them. The Republic of Ireland, for example, used fiscal incentives to encourage inward investment, introducing a 12.5% tax rate on general trading income and establishing itself as a center for securitizations with the tax-favored “section 110” regime. By contrast, the UK’s own belatedly introduced securitization regime aimed merely at tax neutrality.
Also, despite an ongoing program to simplify the tax rules, each year’s finance act seemed longer than the last and was usually augmented by voluminous secondary legislation. The complexity of the rules together with frequent changes materially increased the compliance burden for many groups. The final straw for a number of companies that had significantly expanded outside the UK was a perception that the Labour government planned to extend the UK’s taxing rights in relation to certain offshore activities.
When announcing Wolseley’s intention to reallocate its tax residence to Switzerland, Ian Meakins, chief executive, was very clear about the primary reason. He said, “Our underlying tax rate has now moved up to 34%; by redomiciling to Switzerland, that rate will come down to about 28%.” He went on: “We don’t want to go to Switzerland, but the tax number is enormous.” To emphasize the company’s reluctance to move offshore, he revealed that the prospect of relocation had been discussed with the government, but he concluded that “it is hard to see how the government can solve the problem.”
For UK purposes, the tax residence of a company normally resides in the location from where the central management and control of the company are exercised. So the tax residence of a UK-incorporated company can usually be moved offshore simply by holding all meetings of the board of directors outside the UK.
In practice, this is unlikely to be the most efficient means of relocating a UK-incorporated company. First, the location of management and control is a question of fact, and the UK tax authorities are unlikely to be easily persuaded that central management and control have moved offshore if, as is likely, a significant proportion of influential directors remain resident in the UK. Second, if relocation is successful, an exit tax charge may be imposed on the company’s capital value on migration. Third, other methods provide material benefits in addition to the direct tax savings.
The more usual method of migration is to transfer the ownership of the existing UK group to a new parent company incorporated, and resident for UK tax purposes, offshore. This may be achieved either by the existing shareholders exchanging their shares for new shares in the offshore company or pursuant to a court-authorized ‘scheme of arrangement.’ The latter allows the existing UK shares to be cancelled and, in effect, replaced by new UK shares issued to the offshore company so that the UK group becomes owned by the new offshore parent. Shares in the new parent company are issued to the original shareholders of the UK parent so that there is no change in the ultimate ownership of the group, but a new non-UK parent has been interposed between the ultimate shareholders and the UK holding company.
Unlike simple migration, both methods of reconstruction migration should be tax neutral. Although the current shareholders dispose of their UK shares, the fact that they are exchanged for, or otherwise replaced by, shares in the new parent should enable their capital gains tax positions to be “rolled over” into the new holding. Similarly, because the beneficial interests of the ultimate shareholders in the underlying businesses are unchanged, it should also be possible to avoid a UK stamp duty on the reconstruction.
The final step is to create at least two sub-groups so that only the UK activities remain under the original UK holding company. Once the new offshore parent is in place, the foreign trading subsidiaries and trading sub-groups can be transferred from under the UK parent to be directly owned by the new offshore parent. Although these transfers are disposals for the purposes of the charge to corporation tax on capital gains and the involvement of the offshore parent generally means that ‘group relief’ is not available, the transfers will not give rise to UK taxation if the UK’s substantial shareholding exemption criteria are satisfied.
In the majority of cases to date, the new offshore parent has been incorporated in one jurisdiction but tax resident in another. Jersey has proved a popular jurisdiction for incorporation because it offers a respected but flexible company law environment and does not impose any capital or transfer tax on the issuance or subsequent transfer of shares.
Wolseley’s new holding company is to be incorporated in Jersey but resident for tax purposes in Switzerland; Shire chose the Republic of Ireland for its tax residence, and the Regus parent company is headquartered in Luxembourg.
For a US business looking to expand into Europe, news of another FTSE 100 company relocating offshore must inevitably create doubt as to whether the UK is an appropriate jurisdiction for a European holding company.
However, for many businesses the UK does now offer a competitive tax environment when compared with other common EU locations.
Since the spate of corporate emigrations in 2008, significant positive changes have been made to the basis of business taxation in the UK. Some of these changes were made as a reaction to the first set of relocations, and the flow appeared to have been stemmed. At the beginning of September, Chadbourne published a client alert that highlighted aspects of the UK tax regime introduced or adopted by the new coalition government to promote the UK as a viable location for EU holding companies.
In his “emergency budget” in June, the chancellor, George Osborne, announced a headline-grabbing program of four annual 1% reductions in the rate of mainstream corporation tax to just 24% from April 1, 2014 from the current 28% rate. The client alert gave details of the UK’s additional participation exemptions in relation to foreign dividends, introduced in 2009, and capital gains realized on the disposal of trading subsidiaries, the ability of the UK subsidiary holding companies to repatriate profits by way of dividends without being subject to withholding tax or, for those with long memories, “advance corporation tax” (which was abolished in 1999), and the entitlement of UK resident companies to access the benefits of more than 100 double tax treaties that will often reduce the incidence of foreign withholding tax on income and remove any UK requirement to withhold tax on cross-border interest payments.
The majority of commentators reacted positively to the program of change. No one expected that those companies that had already incurred the considerable expense of relocating offshore would be prompted to return to the UK but Mr. Osborne no doubt hoped and, presumably expected, that he had done enough to prevent further corporate emigrations.
Then came the news that Wolseley is leaving.
So, what is the problem? With the mainstream rate of corporation tax already at an historic low of 28% and a recently introduced dividend participation exemption, why was Wolseley’s effective tax rate 34%?
The answer is to be found in the controlled foreign company or “CFC” legislation that is similar to the US subpart F regime. Where those rules apply, a UK company that has an interest in an offshore holding company may be subject to UK tax on part of its undistributed profits, calculated according to UK standards, unless the arrangements fall within a statutory safe harbor.
The CFC rules do not apply to a UK holding company on a subsidiary in a country on the approved lists or a subsidiary in a jurisdiction where actual tax suffered is at least three quarters of the hypothetical UK tax on the same profits.
Accordingly, the CFC rules will not be a problem for many UK groups or for new EU holding companies established in the UK, but they were for Wolseley given the geographic spread and significant low-taxed profits of its very diverse group.
In reaction to Wolseley’s announcement, a Treasury spokesperson was quoted as saying, “The government’s long-term aim is to create the most competitive corporate tax system in G20 and, in the budget, we announced a 4% reduction in the main rate of corporation tax. The government is committed to reform of the controlled foreign company rules and will introduce new rules in 2012. Any changes will deliver a more territorial approach, refocusing on artificially diverting UK profits and exempting genuine commercial activities.”
Although Wolseley was not persuaded, the government appears confident that the CFC rules can be amended to limit their impact on genuine commercial arrangements, but that will take at least another 18 months.
International tax lawyers are often asked, “Which is the best country in which to establish a European holding company?” The answer will always depend on the nature of the client’s business, its plans for expansion, the source of funds, the status of the ultimate owners and so on. Most frustratingly of all for the client, the country that is ‘best’ today may not be ‘best’ tomorrow, as tax laws have a habit of changing and businesses seldom develop exactly as planned.
For many businesses, the UK has always been a favored location in which to establish an EU holding company, and it can now boast a tax regime able to compete with that of countries such as Luxembourg, the Netherlands and the Republic of Ireland, a position that may improve further without the UK having to make more changes. On October 1, The Financial Times reported that, despite the Irish government’s commitment to low corporate taxation, Olli Rehn, the European Commission’s head of economics and monetary affairs, had indicated that Ireland may have to increase its business and personal taxes and “become a normal tax country” in order to restore its public finances following the banking crisis.
But what the UK does not yet have, and what distinguishes Switzerland, is long-term fiscal stability. For some commentators, the real problem with UK taxation is that it seems to be in a constant state of flux, but happily the new government has already identified the problem and begun to address it.
George Osborne used his first budget to herald a new approach to the development of tax policy. This was followed by a discussion paper that highlighted the key objectives of simplifying the process of developing tax policy, bringing increased predictability to tax, and creating a more stable fiscal environment. In addition, the document revealed the government’s intention to bring transparency to the process of updating tax legislation so as to increase the level of public scrutiny.
The UK, like the US, is at the forefront of developments in the finance and broader business markets. Consequently, the tax policymakers are regularly faced with new challenges that inevitably require adjustments to the tax rules. Change is unavoidable and well-managed businesses can deal with change. But they should not have to cope with unnecessary secrecy and surprises. Hopefully, the new procedures will smooth the process so that surprises, at least in the tax regime, become a thing of the past.