EU Investigates the Legality of the UK Patent Box Regime
The recently introduced UK patent box regime is under renewed investigation by the EU. The EU has asked the UK to provide it with certain documents in order to enable it to investigate whether the patent box regime constitutes state aid. The UK government is robustly defending its position. If the regime is found to have breached EU legislation on state aid, the consequences could be significant and would fall not on the UK government but on the companies having claimed the relief, which could expect to be asked to pay a greater amount of tax on income within the regime.
The patent box regime was introduced by the current UK government soon after it was elected. Under the regime, certain income linked to the exploitation of EU patents is taxed at a reduced rate. The effective rate of tax for income within the regime is 10 percent, i.e., half the UK corporation tax rate on profits.
It was thought that the EU's challenge to the UK patent box regime had been "kicked into the long grass" at the end of last year but Financial Timesrecently reported that the EU had requested further documents from the UK in the course of examining the lawfulness of the regime. The UK did not consider that the patent box was a form of state aid and therefore did not seek clearance from the EU before introducing it. If it is finally determined that the UK patent box regime is a form of state aid, the fact that it was not cleared by the EU before it was introduced could lead to the regime being held to be unlawful.
Court Case Arguably Clarifies UK Source Rules with Respect to Interest
A recent case heard by the First Tier Tribunal (the junior UK tax tribunal) serves as a timely reminder of the complexities that surround the UK's regime for deduction of tax from interest paid. In general, the payer of UK-source interest to a recipient outside the UK is required to withhold 20 percent from the interest. This obligation can be reduced (either in whole or in part) under the terms of a tax treaty entered into by the UK. The recent decision, Andrew Collins Perrin v the Commissioners for Her Majesty's Revenue and Customs, although decided in favor of HMRC rather than the taxpayer, arguably clarifies how the question of whether interest has a UK source will be decided.
The source of the interest is to be distinguished from the situs of the debt. It is relatively easy to identify the situs of the debt—usually the place of residence of the debtor—but UK courts have consistently refused to identify the source of the interest with the situs of the debt. Instead, a number of factors must be weighed. The tribunal clarified which factors carry the most weight in determining the source of the interest. The most important factors are : the residence of the debtor, the location of any security, and the place where the debt can be enforced. Others, for example the place where the interest is contractually stipulated to be paid, are less important and in some cases completely irrelevant.
The Andrew Collins Perrin case serves as useful reminder that interest paid between two non-UK bank accounts can nonetheless have a UK source and therefore require the payer to deduct UK tax at 20 percent. Even if the recipient is in a country that has a double tax treaty with the UK, reduced withholding under such treaty is possible only if the payer has first received a direction from HMRC authorizing payment gross or deduction at less than the full 20 percent UK rate.
Increased Use of UK Tax Resident Holding Companies
There have been a significant number of high-profile transactions where UK tax resident companies have become new holding companies of multinational groups. In 2013, LyondellBassel Industries NV (market capitalization: $49 billion) moved to the UK, and Fiat Industrial and CNH Global merged and established UK residence. In 2014, Fiat, Chrysler, Omnicom, and Publicis announced similar transactions.
The UK has established itself as a very attractive holding company jurisdiction. Various changes to the UK rules (e.g., exemptions for dividends received, amendments to UK CFC rules) and existing features of the UK (no withholding tax on dividends, wide treaty network) make it a favorable environment in which to operate. Just as important, UK company law is flexible and familiar for common law jurisdictions. A number of these transactions have used EU style mergers to redomicile the company for corporate law purposes. Although the UK does not have a domestic merger regime, it has adopted legislation to confirm with the EU mergers directive, which allows UK companies to merge into EU companies or vice versa. We would expect more of these transactions to be announced in the future. Significant acquisitions/mergers provide a compelling rationale for redomiciliation, especially where neither of the companies involved wants to be perceived as becoming a subsidiary of the other, and both would prefer to find a neutral third party jurisdiction. Jones Day has been involved in a number of similar transactions and has the experience to implement them both on the tax and corporate side.