The effect of Brexit on corporate groups will extend well beyond the sphere of customs duties and VAT. Groups will need to consider the potential eect of the loss of benecial EU directives on the ows of dividends, interest and royalties. Provisions of domestic law in the UK and the rest of Europe which have been introduced to implement CJEU decisions – including provisions on group relationships, controlled foreign companies, reorganisations, mergers and share exchanges – may also be aected by Brexit, with implications for future transactions, current group structures and past periods too.
the long arm of brexit This article first appeared in The Tax Journal 12 4 August 2017 | Insight and analysis www.taxjournal.com Ashley Greenbank Macfarlanes Ashley Greenbank is a partner in the tax group at Macfarlanes LLP. He advises on the full range of corporate tax issues, group tax planning and dispute resolution. He is a CEDR accredited mediator. Email: email@example.com; tel: 020 7849 2512. Penny Van den Brande Macfarlanes Penny Van den Brande is a solicitor in the tax group at Macfarlanes LLP. She advises on corporate tax issues, the establishment and structuring of investment funds and group tax planning. Email: penny. firstname.lastname@example.org; tel: 020 7791 4228. T he potential tax implications of Brexit are fast becoming leading topics of conversation amongst tax professionals. !e issues troubling tax directors and their advisers have now progressed well beyond the signi"cant e#ects of Brexit for customs duties and VAT into some of the more detailed implications for the operation of UK domestic law and the domestic tax laws of the remaining EU member states (the ‘EU27’). On 13 July 2017, the government published the European Union (Withdrawal) Bill (the ‘Withdrawal Bill’) which has the stated intention of preserving EU law as it stands at the date of Britain’s exit from the EU into UK legislation. However, without the agreement of the EU27, UK domestic legislation will not be su$cient to deal with the implications of Brexit under the domestic tax laws and treaties of the EU27. !is article sets out some examples of where this may lead to some unexpected results for international groups depending on how Brexit is ultimately implemented. Withholding taxes and double tax treaties Withholding taxes on UK: EU27 payments We will start on familiar ground. As many others have commented, the direct application of EU directives to UK companies is one of the areas which will be instantly a#ected from the day the UK leaves the EU. !is will apply equally to signi"cant EU directives in the tax "eld such as Council Directive 2011/96/EU (the ‘Parent-Subsidiary Directive’) and Council Directive 2003/49/EC (the ‘Interest and Royalties Directive’). Even if the Withdrawal Bill has the e#ect that the Parent-Subsidiary Directive and the Interest and Royalties Directive are given e#ect in the UK the day a%er Brexit, without some form of agreement with the EU27, UK companies in receipt of dividends, interest and royalties from companies established in the EU27 will no longer be able to rely on the provisions of those directives to eliminate withholding taxes that would otherwise be imposed on such payments under the domestic laws of EU27 states. In those circumstances, UK companies will instead have to rely on the UK’s double tax treaties with EU27 states to reduce or eliminate withholding taxes imposed by the domestic laws of EU27 states on such payments. !e UK has a wide treaty network. But the relevant treaties will not always put a UK company in the same position as it would have been in under the directives. !e main concern here relates to dividends paid to UK parent companies by subsidiaries in EU27 states. !ere will be cases where the relevant double tax treaty will provide for a zero rate of withholding. !e UK/France treaty is an example. In such cases, provided that the conditions for relief under the relevant treaty are met, there is at least the prospect of replicating the tax treatment that would have applied under the Parent-Subsidiary Directive. In other cases, the relevant treaty may not operate to eliminate domestic withholding taxes. For example, under the UK/Germany tax treaty, payments of dividends by a German subsidiary to a UK parent company may be subject to a withholding tax of 5%. Given that most dividends received by UK companies are exempt from UK corporation tax, any withholding tax will be an additional cost of repatriating pro"ts from German subsidiaries. !e inability of UK parent companies to obtain the bene"ts of the Parent-Subsidiary Directive may, therefore, have material consequences for some groups, particularly for UK parent companies with substantial operating subsidiaries in EU27 states (such as Germany) which have a treaty with the UK which does not entirely eliminate domestic withholding taxes. Such groups may have to consider whether or not it is possible to restructure in order to improve the *ow of dividends through the group – although any restructuring options may be limited by the introduction of principal purpose tests into relevant double tax treaties as a result of OECD BEPS Action 6. Withholding taxes on EU27: third country payments !e presence of UK companies within corporate groups may also a#ect the ability of companies in EU27 states to claim the bene"t of tax treaties with other third countries. !e primary example of this e#ect is for EU27 companies that rely on double tax treaties with the US to reduce or eliminate withholding taxes on payments of dividends, interest and royalties where the relevant treaty contains a limitation on bene"ts (LOB) provision. !is is not the place to enter into a detailed review of LOB provisions in US treaties. However, it is worth noting that there are circumstances when the usual test of control by residents in contracting states will not be met and when corporate groups need to rely upon some of the other tests in the LOB provisions in order to bene"t from the treaty in question. In such circumstances, the presence of a UK company in a group (or as a parent company of the group) may have an e#ect on the ability of an EU27 company to claim bene"ts under its treaty with the US. LOB provisions in EU27/US treaties o%en permit a company to claim treaty bene"ts, in circumstances where the EU company in question would not necessarily be a Analysis !e long arm of Brexit Speed read e eect of Brexit on corporate groups will extend well beyond the sphere of customs duties and VAT. Groups will need to consider the potential eect of the loss of benecial EU directives on the ows of dividends, interest and royalties. Provisions of domestic law in the UK and the rest of Europe which have been introduced to implement CJEU decisions – including provisions on group relationships, controlled foreign companies, reorganisations, mergers and share exchanges – may also be aected by Brexit, with implications for future transactions, current group structures and past periods too. | 4 August 2017 13 www.taxjournal.com Insight and analysis ‘quali"ed resident’, by reference to tests which depend upon EU or EEA membership. !ose other tests come in various forms but common requirements are: direct or indirect ownership of a proportion of the voting power or share capital in the company by persons who are resident in member states of the EU or the EEA (see, for example, articles 30(1)(c)(iii) and 30(4)(b) of the US/France treaty). Post-Brexit, EU27 companies which are relying on these provisions by reference to direct or indirect ownership by UK residents will no longer be entitled to treaty bene"ts; and in addition, and o%en supplemental to the ownership test outlined above, base erosion tests which specify a limit on the level of deductible payments that can be made to persons who are not resident in an EU member state (see, for example, articles 30(1)(d) and 30(4)(c) of the US/France treaty). In a similar vein to the point above, post-Brexit payments to UK companies will need to be taken into account by EU27 companies when considering such limits. Here is a simple example highlighting the potential e#ect of the ownership provisions in practice. Under this example, a US company pays interest to a Luxembourg "nancing company. Both companies are subsidiaries of a UK parent company which is owned by UK resident individuals and is not listed. Interest payment US Co Lux Fin Co UK Parent Co !e payment of interest attracts US withholding tax at 30%. However, the withholding is reduced to 0% if the Luxembourg company can claim the bene"t of the US/ Luxembourg double tax treaty. In order to claim the bene"t of the treaty, the Luxembourg company will need to satisfy the requirements of the LOB provision which is found in article 24 of the US/Luxembourg treaty. If we assume for present purposes that the Luxembourg company does not qualify under any of the other tests in the LOB – so, for example, the Luxembourg company does not carry on an active trade or business within article 24(3) – it may be necessary for the Luxembourg company to rely upon the provisions of article 24(4) of the treaty (the equivalent bene"ciaries provision) in order to obtain treaty bene"ts. Inter alia, article 24(4) requires that 95% of the company’s shares are ultimately owned by seven or fewer residents of a state that is a party to NAFTA or that is a member state of the EU, with which the US has a comprehensive income tax treaty (which provides a rate of tax equal to or less than the rate under the US/Luxembourg treaty for that item of income). In the example above, this requirement of the LOB is satis"ed: the UK parent company owns 100% of the Luxembourg company’s shares, the UK is a member of the EU and the UK/US treaty also provides for a 0% rate of withholding on interest. Post-Brexit, this test will not be met simply because the UK is no longer a member of the EU and the payment of interest will attract US withholding tax. Group relationships !e tax implications of Brexit will go well beyond withholding taxes, the potential loss of bene"cial EU directives and the application of double tax treaties. !ere are also many provisions of domestic law in the UK and the rest of Europe which have been introduced to implement decisions from the Court of Justice of the European Union (CJEU) giving e#ect to the fundamental freedoms under the EU Treaty. !ese provisions may also be a#ected by Brexit. One such area is how the domestic law of EU member states has de"ned group relationships for the purposes of provisions of domestic laws which permit tax-neutral transfers of assets and arrangements for the use of tax losses within corporate groups. Following Brexit, the presence of UK companies in corporate groups involving EU27 companies may break existing group relationships and "scal consolidations preventing relevant reliefs being available in the future and, in some cases, resulting in the clawback of reliefs obtained in past periods !e starting point was probably the CJEU decision in ICI plc v Colmer (Case C-264/96). !e case itself concerned a relatively narrow question of whether a particular provision of UK tax law governing the conditions for certain consortium relief claims infringed the freedom of establishment of companies under the EU Treaty. However, the implications of the decision were much wider. In response, as well as implementing the changes to give e#ect to the CJEU decision, the UK made changes to other grouping de"nitions. So, for example, in Finance Act 2000, the UK changed its de"nition of groups for the purpose of corporation tax on chargeable gains so that the principal company of the group could be a non-UK company and that group relationships could be traced through non-UK companies. !ose de"nitions operated on a worldwide basis; the bene"t of the changes was not limited to companies established in EU member states. !is is not always the case in other EU jurisdictions. For example, in Ireland, the grouping de"nition for the purposes of Irish corporation tax on chargeable gains applies so that only companies which are EU resident can be members of the same group. !is means that UK companies that are currently treated as members of groups for Irish tax purposes will cease to be members of those groups at the time of Brexit. Furthermore, without some form of agreement, or a unilateral concession or change of law in Ireland, clawbacks of relief granted pre-Brexit could occur. For example, if relief was claimed on the intra-group transfer of assets by an Irish resident company to an Irish branch of a UK resident company at any time within the period of ten years before the day of Brexit, the relief may be clawed back from the Irish branch. With the exception of the speci"c provisions relating to the cross-border surrender of losses by EU companies (introduced to implement the CJEU decision in Marks & Spencer v Halsey (Case C-446/03)), the de"nitions of group for group relief purposes operate in a similar (non-EU centric) way. !e same is not, however, the case in other EU member states, where group de"nitions and tax consolidations are 14 4 August 2017 | Insight and analysis www.taxjournal.com For related reading visit www.taxjournal.com ! Tax policy in the run up to Brexit (Sam Mitha CBE, 27.7.17) ! Tax and the Great Repeal Bill (Lydia Challen, 27.7.17) ! Brexit: UK tax policy considerations (Hilary Barclay, 9.3.16) ! 20 questions on Brexit (Andrew Scott & Darren Mellor-Clark,30.6.16) o%en limited by reference to companies established in EU member states. !e result is that, following Brexit, the presence of UK companies in corporate groups involving EU27 companies may break existing group relationships and "scal consolidations preventing relevant reliefs being available in the future and, in some cases, resulting in the clawback of reliefs obtained in past periods. !e task of identifying the consequences and dealing with them is herculean – for both tax professionals and tax authorities alike By way of example, Dutch entities can only form a "scal unity (essentially a tax consolidation) with other Dutch entities which are members of the same group. !is relationship can be traced through EU and EEA companies. So, for example, Dutch sister companies can form a "scal unity where they are linked by an EU or EEA parent company. !is principle does not apply where the parent is not established in the EU or EEA. Dutch Co 2 Dutch Co 1 Parent Company UK !erefore, in the structure above, the current position is that Dutch Co 1 and Dutch Co 2 can form a "scal unity, which enables losses made in one entity to be set against taxable pro"ts of the other and removes tax liabilities arising on intra-group transactions. Post-Brexit, and assuming that the UK does not remain in the EEA, Dutch Co 1 and Dutch Co 2 will no longer form a "scal unity. !is will prevent the companies from obtaining the bene"ts of "scal consolidation in the future, but will also result in the clawback of reliefs on any transfers of assets which have taken place between the two Dutch Cos in the previous six years. Controlled foreign companies Another area in which EU law has a#ected the development of domestic law systems is in the application of controlled foreign company (CFC) rules. In Cadbury-Schweppes plc v Inland Revenue Commissioners (Case C-196/04), the CJEU held that CFC rules applied by one EU member state to impose tax on a company resident in that state by reference to the pro"ts of its EU subsidiaries might infringe EU freedom of establishment principles unless their imposition could be justi"ed to prevent wholly arti"cial arrangements which did not re*ect economic reality. !e current UK CFC rules do not generally rely on speci"c exclusions for EU based companies in order to meet the requirements of the CJEU decision. Once again, this approach has not been adopted across the EU. For example, Spain considers a non-resident company to be a CFC where tax paid on its pro"ts in its jurisdiction of residence is lower than 75% of the tax that would had been paid if the company had been subject to Spanish corporate income tax. !ere is, however, an exception for EU resident companies that can demonstrate valid economic reasons for their establishment in the relevant jurisdiction and which carry on active business activities there. Post-Brexit, UK companies which are subsidiaries of Spanish companies will potentially fall within the Spanish CFC rules. If the UK reduces its corporation tax rate to 17% from April 2020 as currently proposed (a rate which is less than 75% of the current headline Spanish rate of 25%), there will be an increased risk of charges to tax under Spanish CFC rules. Reorganisations, mergers and share exchanges !e UK has implemented other EU directives and regulations in a manner which limits the bene"ts to EU resident companies. So, for example, the speci"c reliefs for the incorporation of EU permanent establishments or crossborder mergers (contained in Council Directive 2009/133/EC (the ‘Mergers Directive’)) extend only to EU based companies and businesses. !e Withdrawal Bill may preserve the UK tax treatment of these transactions, but, as before, any reciprocity in EU27 states will be dependent on some form of agreement with or unilateral action on behalf of EU27 states. !e UK did not have to make changes to UK law to give e#ect to those parts of the Mergers Directive that dealt with the share for share exchanges. !ose provisions have always operated without reference to the place of incorporation or tax residence of the companies involved. But again, that is not always the case in EU27 states. Some only permit share for share exchanges to receive a tax deferral where the relevant companies are based in the EU. Such transactions will be a#ected by Brexit and there is a risk that prior transactions may be revisited under applicable domestic laws. By way of example, if German resident shareholders in a German company exchange their shares for shares in a UK company, the exchange is exempt from German capital gains tax. However, if Brexit occurs within seven years of the exchange, the capital gains tax relief under these provisions will be clawed back by imposing a capital gains tax liability on the shareholders. Investee Investee UK Co UK Co Investee Final thoughts !is article could only ever scratch the surface of the potential tax implications of the UK leaving the EU. !ere are numerous other examples. !e task of identifying the consequences and dealing with them is herculean – for both tax professionals and tax authorities alike. ■ Fiscal unity