UK: A Closer Look, UK Holding Companies – An Attractive Proposition

I. Introduction

A series of UK corporate tax reforms during recent years have quietly made the UK a more attractive jurisdiction in which to locate a holding company for other companies located worldwide. These tax reforms provide shelters for dividends and gains on certain stock holdings in non-UK companies and also liberalize the UK's controlled foreign corporation ("CFC") regime.

This article provides a brief overview of the highlights of these major features.

II. 2009 Legislation On Taxation Of Dividends

A new UK corporation tax regime, effective from July 1, 2009, exempts from corporation tax most dividends under a number of broad exemptions, which apply to both UK and overseas source dividends paid on or after July 1, 2009 to UK resident companies.

Under the "controlled corporation" exemption, no UK corporate tax applies to dividends received on a greater than 50 percent voting stock interest by a company that is not a "small company" – a "small company" is generally one with less than 50 employees, and annual turnover and net asset value per balance sheet not exceeding EUR10m, tested on a group basis. Under a second exemption, no UK corporate tax applies to dividends paid to a "small company," provided the dividend paying company is located in a qualifying territory with which the UK has an income tax treaty. Companies that are not small companies may also be exempt from UK corporate tax on portfolio dividends – i.e., paid on shares representing less than 10 percent of share capital – as well as distributions in respect of non-redeemable ordinary shares.

These new rules exempting dividends from UK corporation tax – whether arising from UK or non-UK underlying companies – complement the long-standing UK domestic tax law position that no withholding tax is levied on any outbound dividends. Together, the overall corporate tax regime then essentially places no tax "drag" on non-UK profits transferred upstream through the UK holding company and outbound to non-UK shareholders.

III. Substantial Shareholding Exemption ('SSE') Enacted In 2002

Under the UK's decade-old SSE regime, no corporation tax is imposed on gains from the disposition of shares in other companies where the disposing company has a 10 percent or greater interest and the company satisfies a one-year holding period requirement.

To qualify for the SSE, both the disposing company and the company disposed of must be trading companies. Another requirement is that the disposing company must continue to be a trading company immediately after the disposal. The sale of a stock interest will qualify for the SSE only if the sale proceeds are promptly reinvested by the holding company in other trading companies or distributed by the holding company to its shareholders. HMRC has not issued clear guidance on what is an acceptable period for the UK holding company to retain the proceeds of sale without either reinvesting or distributing them.

In this regard, the accumulation of a large cash position from such dispositions at the holding company level might lead to its classification as an investment company, rather than overall a group of trading companies, which may jeopardize eligibility for the SSE. Accordingly, given that the existing SSE legislation needs further clarity on these points, the holding company will need to carefully manage its share dispositions, reinvestments and distributions to shareholders to best insure that the SSE is preserved.

IV. New CFC Tax Regime

The UK's new tax regime governing CFCs took effect on January 1 2013. The new CFC regime, in addition to the benefits discussed above, further makes the UK a more attractive jurisdiction to locate an international holding company for non-UK companies that conduct non-UK trading activities and/or non-UK intellectual property exploitation.

A CFC is a foreign company that meets the following criteria: (i) it is resident outside the UK; (ii) it is controlled by UK persons, and (iii) it is subject to a level of tax that is less than 75 percent of the UK corporate tax on such profits. Profits of a CFC that fall within one of five general "gateways" (discussed below) and not within a prescribed exemption are subject to CFC taxation only if they are considered to be earned through tax avoidance.

Under the new CFC regime, any relevant profits of a CFC not eligible for exemption are attributed to one or more UK companies that have minimum 25 percent participations in a CFC (or that are otherwise regarded as entitled to at least 25 percent of relevant CFC profits) and are then subject to the UK corporation tax (23 percent from April 1, 2013, reducing to 20 percent by April 1, 2015). The tax on CFC activity is limited to the CFC apportioned profits, which, unlike the prior statutory approach, in theory is limited to profits considered to be "artificially" diverted away from the UK. (General OECD principles on attribution of branch profits are adopted on a modified basis to identify activities or assets with a relevant UK connection and CFC taxation is applied as though UK-related business was conducted from a UK-based permanent establishment).

Before CFC profits are attributed to a UK company and subject to UK corporate tax, the CFC's taxable profits must fit within one of five "gateways" – of these, four gateways essentially target finance and insurance activities, while the fifth captures all other types of commercial activity with a UK connection. Active "trading" activities may still be exempt by a "safe harbor" based on criteria that include the following: (1) the existence of a formal business establishment in the CFC's country of residence; (2) not more than 20 percent of trading activity income is generated from a UK connection or dealings (10 percent in certain banking situations); and (3) the trading activity may not be based to any significant extent upon any IP rights which have derived from a UK source – either owned or developed within the UK during the seven preceding years from a "related" party. These safe harbor criteria do not apply to passive or investment income generating activities.

Even if such CFC profits fall within a generally taxable gateway, they may still be exempt on various specific grounds, e.g., on the basis of small amounts of profits or location in certain approved foreign territories. The basic threshold amount for low profits is £50,000, but up to £500,000 of profits may be exempted if no more than £50,000 consists of non-trading profits. A list of approved territories has been issued by HMRC; while the list is long, it is important to note that various conditions may attach to such exemption (in particular, in respect of any exploitation of IP rights previously exported from the UK).

Although, unlike the prior statutory regime, the exploitation of IP rights is not generally considered a prohibited CFC activity that would result in UK taxation of CFC profits, the potential for CFC taxation exists if there are IPrelated profits coupled with material avoidance of UK tax through the transfer away from the UK of UK-source IP rights (whether by overt transfer or through the creation of derivative rights).

Finally, investment income arising from IP exploited outside the UK through licensing and similar agreements will not be subject to CFC taxation if there is no UK connection (determined by OECD economic criteria concerning the location of various risk and reward elements of the venture) and, even if there is a link or connection to the UK, CFC profit taxation generally will not apply where more than 50 percent of the profits are derived from outside the UK.

Originally published in Global Tax Weekly

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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