Is the UK leaving the EU next week with or without a deal? This blog provides a reminder of the key tax implications corporate treasurers in UK and EU businesses should think about now in anticipation of a no deal Brexit.
EU directives currently provide exemptions from withholding tax on dividends, interest and royalties between related parties in the EU. In addition, privileged treatment for payments within the EU sometimes applies under the domestic law of a member state. While the international network of double tax treaties would eliminate or reduce withholding tax, post-Brexit there will be withholding situations that would not have previously arisen. Some of these issues may be addressed via renegotiation of treaties, further negotiations and/or the EU27 implementing domestic measures to maintain the status quo (for example Italy has proposed treating the UK as an EU member state for a further 18 months after exit day for tax purposes).
Withholding tax on dividends
From a dividends perspective, corporate treasurers will need to assess the impact of the loss of the Parent/Subsidiary Directive on their ability to repatriate cash from subsidiaries to the parent company. Some 12 out of the 27 member states currently impose withholding tax on dividends that would not be reduced to nil under a UK double tax treaty. For example, post-Brexit dividends paid by a German subsidiary to its UK parent would suffer withholding tax at 5% versus the nil rate currently mandated by the Parent/Subsidiary Directive. Similarly, inbound dividends received by EU parents from UK subsidiaries may become subject to tax in jurisdictions such as Ireland where tax treatment varies between EU and non-EU source dividends.
Withholding tax on interest and royalties
Equally, corporate treasurers will need to review the position for interest and evaluate (and determine allocation of) any new potential gross-up risk. Double tax treaties with a number of countries provide for zero withholding on interest, but not all do. Italy, for example, already permits withholding tax at 10% on interest payments. This 10% withholding tax rate could, in the future, result in withholding tax leakage on interest payable by Italian borrowers on loans granted by UK third-party banks as an Italian withholding tax exemption applies to interest on loans granted by EU banks, which will not (in the absence of any transitional extension of the rules to the UK) encompass UK banks post-Brexit. A borrower’s withholding tax position could also be affected by Brexit-related bank restructurings (for example if this results in changes in the bank entity with which they transact).
The loss of the Interest and Royalties Directive is significant to interest and royalty withholdings in group and joint venture situations rather than third-party funding, given that its scope is restricted to payments between associated parties. Broadly, it requires a 25% ownership relationship between the payer and payee or that another company resident in the EU owns 25% of each of the payer and payee. A recent extension of the UK royalties withholding tax regime may render the loss more relevant for groups with UK operations. In any event, the loss of this directive may be one-sided; the UK tax authority has previously commented that, in a no-deal scenario, it expects that the UK’s domestic implementing legislation will remain in place and unchanged, meaning that interest and royalty payments paid from qualifying UK entities to qualifying EU entities would remain exempt from UK withholding tax.
Limitation of benefits
Although double tax treaties will often assist in reducing withholding tax, US double tax treaties typically contain limitation of benefits provisions that can restrict the availability of treaty reliefs. Some groups will have been relying on being EU-headed (and so satisfying a ‘derivative benefits’ let-out) to avoid triggering these provisions. Post-Brexit, this option might no longer be available for groups with UK parents.