An Inland Revenue press release issued on 17 March 1999 stated that the Revenue were commencing a review of the United Kingdom's system of double taxation relief for companies.
Following a period of consultation with interested parties, the Inland Revenue published a discussion paper this summer entitled "Double Taxation Relief for Companies" outlining their views for the future of double taxation relief ("DTR") in the UK. While much of the discussion paper sets out the economic arguments underlying DTR, a considerable part of the paper analyses the future for the efficient repatriation of profits earned overseas to the ultimate UK parent company of a worldwide group and the future role of so called "mixer" companies.
Dutch Mixers in the melting pot
The use of sub-holding companies through which a UK parent can own overseas subsidiaries is a well known tax planning strategy. The inflexibility of the UK's source-by-source approach to the taxation of foreign income prevents excess credit relief for foreign tax on one source of income from a foreign subsidiary to a UK parent from sheltering UK tax on another source of foreign income from a different subsidiary. The excess foreign tax credits are wasted, with the result being an increase in the overall effective rate of tax of the UK parent company. The most common technique to relieve the problem is to transfer foreign subsidiary shareholdings into the ownership of a non-UK "mixer" company, being a sub-holding company in a tax efficient jurisdiction, (most often, and for the purposes of this article, the Netherlands). The Dutch mixer pools the foreign dividends, achieving a mix of different foreign tax credits. A dividend paid by the Dutch mixer to the UK parent will, owing to the provisions of section 801(2) ICTA 1988, be treated as a single source dividend carrying an averaged tax credit, thereby maximising relief for the underlying tax paid by the, now Dutch owned, foreign subsidiaries.
This basic tax structure is made possible by the existence of a 'participation exemption' in Dutch tax law, effectively exempting both dividends paid and capital gains realised from the Dutch mixer's overseas subsidiaries from Dutch corporate taxation. Combined with the EC Parent/Subsidiary Directive, eliminating withholding tax on payments of dividends between subsidiaries and parent companies both resident in the EU, dividends are generally able to pass through the Dutch mixer without local Dutch tax liabilities except where the subsidiary is situated in a full tax haven.
The Inland Revenue has considered the use of Dutch mixers in this manner to be acceptable tax planning. The insertion of anti-avoidance rules have targeted specific tax planning schemes, such as the scheme combated by section 801A ICTA 1988 (introduced in Finance Act 1997) in which the mixer company would "buy-in" highly taxed foreign income to raise its average foreign tax rate, and hence DTR.
The Inland Revenue discussion paper identifies the advantages of ensuring UK parent companies are able to continue to mix underlying foreign tax to achieve the right blend of highly and lowly taxed overseas income. The ideal result of mixing is to achieve full relief for all foreign tax, ensuring that lowly taxed foreign income is sheltered from further UK tax by higher rate foreign tax paid on different source overseas income. Where the ideal result is achieved, the mixing process brings the UK taxation system closer towards "full credit" then if no mixing took place and therefore closer to credit export neutrality. However, the discussion paper also identifies, to the Revenue's mind, potential disadvantages of the use of mixer companies.
Mixer companies are accused of distorting the UK tax system by incentivising UK investment in low tax jurisdictions in order to obtain extra double taxation relief in respect of overseas income from high tax jurisdictions. The Revenue also consider mixer companies to be ultimately inequitable to the wider body of all taxpayers owing to only large corporate groups with significant overseas interests deeming the expense of establishing and maintaining a Dutch mixer, sometimes in tandem with a Dutch trust company, to be cost efficient.
Onshore pooling: a potential revival of interest?
The discussion paper suggests that onshore pooling of foreign income and foreign tax could be a viable alternative to the continued use of 'mixer' companies. The intention would be that a company which has foreign income from more than one source could add together all its foreign tax payments and credit them against UK tax payable on its total foreign income. Onshore pooling has previously been considered in the UK both in the Royal Commission on the Taxation of Profits and Income in June 1955 and the Finance Bills of 1965 and 1966 and is in several respects similar to the existing US basket system for pooling non-US tax credits. While onshore pooling represents a departure in principle from the current source-by-source adopted in the UK for the relief of double taxation, the implementation of an onshore pooling system would move the UK tax system closer to credit export neutrality, which is, in itself, perceived as desirable by the Inland Revenue.
One practical suggestion made in the discussion paper is avoiding a single onshore pool for all types of foreign income from all countries. It is suggested that there could be a number of different pools organised by type of income (one could envisage different pools for direct income, portfolio investment, interest and royalties), country and the rates of foreign tax paid, potentially sub-divided into different bands. While the report is silent on the point, it is inevitable that avoidance rules would be required to prevent leakage of surplus tax credits and income from one pool to another. The additional time which would be required for companies to administer separate pools and comply with anti-avoidance provisions slightly contradicts the claim in the discussion paper that the introduction of onshore pooling could reduce the current compliance costs of using mixer companies.
The discussion paper identifies that the potential amendment to the UK's double taxation system, through the introduction of encouraging onshore pooling and re-assessment of offshore mixer companies gives rise to "a number of interesting and complex issues both of an economic and technical nature". However, the discussion paper fails to make a clear choice in favour of either system. While onshore pooling could reduce compliance costs (to the extent that mixer companies were no longer used) and to ensure groups held their cash reserves in the UK rather than offshore, there appears to be a concern in the Revenue that onshore pooling would protect UK companies from the full effect of a commercial decision to invest in countries with higher tax rates than the UK.
On balance, the discussion paper is to be cautiously welcomed. It is interesting that after an interval of almost 30 years the potential for onshore pooling has been resurrected, potentially as part of a system which does not automatically remove the potential for mixer companies as subsidiaries for UK parent companies. It is regretted that the discussion paper does not consider the possibility of introducing a UK participation exemption, similar to those currently existing in the Dutch, French and German tax regimes. Such an exemption would need to be extended to capital gains on the sale of shareholdings or to dividends paid by non-trading controlled foreign companies. However, a modified exemption would ensure a result similar to, but without the onerous compliance costs of, offshore mixing. Future developments in the discussion are awaited with interest although it seems unlikely that substantial legislation will be introduced before next year.
For further information please contact Adam Blakemore, 2 Park Lane, Leeds LS3 1ES, Tel: +44 113 284 7000
This article was first published in the Autumn 1999 issue of Hammond Suddards' Tax Insight Newsletter.
The information and opinions contained in this article are provided by Hammond Suddards. They should not be applied to any particular set of facts without appropriate legal or other professional advice.