EU CLOSES TAX LOOPHOLE CONCERNING HYBRID INSTRUMENTS

By Matt Watts

The EU has announced that it would change the parent-subsidiary directive, to prevent groups benefiting from double non-taxation in the case of intragroup cross-border hybrid arrangements, where the receipt is by the parent company of the group.

The EU's proposal is that the member state of the parent company will be allowed to not tax profit distributions from the subsidiary only to the extent that such distributions are not tax deductible for the subsidiary. Member states have until 31 December 2015 to enact this into national law.

The parent-subsidiary directive is intended to ensure that profits made by cross-border groups are not taxed twice. So that such groups are thereby not put at a disadvantage compared to domestic groups. It requires member states to exempt from taxation profits received by parent companies from their subsidiaries in other member states.

However, this currently applies, even if profit distribution is treated as a tax-deductible payment in the country where the paying subsidiary is based. For example, some member states classify payments from hybrid loan arrangements as tax deductible 'debt'. Some countries have domestic legislation which already counters such advantages, including the UK, but not all.

The amendment will prevent cross-border companies from planning their intra-group payments in such a manner as to benefit from this provision in order to enjoy double non-taxation. The member state of the parent company will henceforth refrain from taxing profit distributions from the subsidiary, only to the extent that such profit distributions are not tax deductible for the subsidiary.

The EU agreed to separate this issue from a broader proposal, in order to allow early adoption of the new rule on hybrid loans, whilst allowing work to continue on another aspect, namely the introduction of an EU wide anti-abuse provision.

This part of the legislation will be adopted at a forthcoming Council session, after finalisation of the text. Member states will have until 31 December 2015 to transpose it into national law.

See EU press release at: www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/143274.pdf

NEW EU GUIDELINES ON TRANSFER PRICING

By Colin Aylott

The European Commission has broadly confirmed guidance on transfer pricing covering a range of matters. This is helpful in dealing with some of the problems that can arise from transfer pricing issues. We highlight three areas covered in their guidance.

Secondary adjustments

These are required in some member states to allocate profits in line with the original adjustment. They can have tax consequences, so double taxation can arise in certain circumstances. The guidance suggests that states should avoid imposing penalties on secondary adjustments. However, here are some possible methods of limiting double taxation.

  • Avoid the use of secondary adjustments if possible (nine EU states currently apply secondary adjustments - Austria, Bulgaria, Denmark, Germany, France, Luxembourg, the Netherlands, Slovenia and Spain).
  • If secondary adjustments cannot be avoided, make them as constructive dividends or constructive capital contributions.
  • Apply the Parent Subsidiary Directive so no withholding tax is applied on a transaction between a parent and its subsidiary (Bulgaria and France do not currently apply the directive); or
  • Repatriate funds within an agreed timeframe, free of withholding tax in line with the economic intent of the primary transfer pricing adjustment.

Double taxation can be avoided via a mutual agreement procedure or by the Arbitration Convention, though this is recognised as complicated and time consuming.

Transfer pricing risk management

This covers the legal and practical tools available to assess transfer pricing risks, address those risks and allow for dispute resolution. Suggested methods of managing risk cost effectively were to use:

  • common audit working procedures
  • common documentation standards; and
  • dispute resolution (using mutual agreement procedures and the arbitration convention).

The report also advises that resources should be allocated to matters which carry a high risk. Joint cross-border audits of companies are regarded as useful, including those initiated by the taxpayer.

Compensating adjustments

Compensating adjustments are transfer pricing adjustments, where the price reported for tax purposes is consistent with an arm's length price; in spite of the price actually charged in the transaction.

Some states adopt an ex-ante approach – taxpayers must demonstrate that they made reasonable efforts to comply with the arm's length principle at the time of the intragroup transaction.

Other states apply an ex-post approach, i.e. taxpayers review the outcome of transactions to demonstrate they were in accordance with the arm's length principle.

It has been recommended that each of the enterprises participating in a transaction should use the same price for respective transactions, and compensating adjustments should generally be accepted if certain conditions are fulfilled.

The statement by the Commission is welcome and essential to make the approach more consistent across states and fairer to taxpayers.

SIMPLIFIED DETERMINATION OF MARKET VALUE FOR LISTED COMPANY SHARES

By Christopher Lallemand

HMRC has recently published a draft Statutory Instrument, designed to simplify the manner in which the market value of shares in listed companies (and similar instruments) is to be determined for tax purposes. This follows on from a recommendation from the Office of Tax Simplification in its final report on unapproved share schemes. The Instrument is issued for consultation at this stage.

Currently, the market value of listed shares is determined using a calculation specified by the legislation. For shares, this is usually the 'quarter up' method, where market value is taken to be the value of the lowest bargain made during the day, plus one quarter of the difference between that value and the value of the highest bargain in that day.

The proposal in the consultation is that market values will be determined as follows:

  • listed shares – the closing price on the relevant day;
  • strips – the mid-point between the closing 'buy' and 'sell' prices known as the 'mid- price'; and
  • employment related securities sold on the same day of acquisition – the value under a bargain at arm's length on the same day as they are acquired, such that the value used for income tax when acquired and the capital gains tax value on sale are the same.

This is a welcome step and determining market value should be easier under the new provisions; the values accord with readily available market data from resources such as websites and newspapers.

If you want to read the draft instrument, please go to: www.hmrc.gov.uk/drafts/market-value-shares.pdf

There is an explanatory note at: www.hmrc.gov.uk/drafts/market-value-shares-em.pdf

If you have any comments on the proposal, you can write directly to HMRC at the address (by 22 August 2014) in the explanatory note or send them to us.

UPDATED GUIDELINES ISSUED ON IR35

By David Hewison

HMRC has issued new guidelines on IR35 intermediaries' legislation. These guidelines effectively replace its frequently asked questions concerning IR35. The new guidelines are fairly detailed and set out HMRC's views on those affected and how the legislation operates.

By way of background, IR35 can potentially affect those who provide services to a client through an intermediary, such as a limited company or partnership. IR35 can operate to apply payroll taxes to fees received relating to those services.

IR35 is considered on a contract-by-contract basis and additional tax and NIC may become payable on payments received by the intermediary. The legislation and its application is a complex area, which has been the subject of much debate and uncertainty over the years. The new guidelines http://www.hmrc.gov.uk/ir35/intermediaries-legislation-ir35.pdf may provide some assistance in this area although uncertainties are expected to remain.

A detailed review of the working relationship between individual and client is always recommended if there is any concern for the intermediary that IR35 may apply.

The new guidance issued covers:

  • the basics of the IR35 legislation;
  • in principle how to work out if IR35 may affect any payments received by the intermediary – as noted above, this may not be straightforward;
  • if IR35 applies, the method of calculation of any tax and NIC liability;
  • the HMRC helpline offering assistance on IR35;
  • enquiries by HMRC into IR35 status; and
  • where to find further guidance.

For those using an intermediary vehicle or otherwise interested in the subject, in 2012 a set of business entity tests was drawn up, with assistance from interested parties and bodies. This was intended to identify scenarios where there was a risk of HMRC making an IR35 enquiry into an intermediary.

These tests and scenarios are still available at: www.hmrc.gov.uk/ir35/guidance.pdf

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