UK holding companies are often used to hold overseas investments. The combination of relatively low rates of UK taxation, the availability of double tax relief in respect of foreign income, the large number of UK double tax treaties and the lack of any withholding tax on dividend payments are factors which make the UK a favourable location for holding companies. The favourable taxation position of UK holding companies is further enhanced by a participation exemption for dividends and gains.
The main tax issues arising in respect of a UK holding company are discussed below.
UK Corporation Tax Position on Inward dividends
A UK holding company is prima facie taxable on all domestic and overseas dividend income. However, widely-drafted exemptions apply so that, in reality, the vast majority of dividends received from both UK and overseas investments will be exempt from tax in the UK.
The dividend exemption applies as follows1:
(Less than 50 employees AND turnover < €10M OR balance sheet < €10M)
Generally all dividends received by small groups will be exempt providing
- Dividend is not a disguised payment of interest
- Dividend is not deductible by paying company
- Not part of a scheme to avoid tax
- Payer is resident in the UK or a qualifying territory. A qualifying territory is one with which the UK has a double tax agreement – most “tax haven” jurisdictions will not meet this definition
Dividends are exempt if they fall into any of the following categories:
- Paid by a company controlled by recipient – i.e. >50% holding. Most subsidiaries will fall into this group
- Dividends from portfolio holdings – i.e. of less that 10%
- Dividends paid out of profits which have not been diverted from the UK. Will apply to dividends from most UK companies
- Certain other categories1
Where foreign dividends are taxed in the UK, double tax relief is available in the form of a credit against the UK tax payable. Credit is given for any withholding tax suffered on the foreign dividend income and also where the UK company owns 10% or more of the voting share capital of the overseas company, double tax relief will be given for any underlying tax. The underlying tax is the foreign tax suffered by the overseas company on the profits out of which dividends are paid.
Dividends paid by the UK Company
The UK is unique amongst European industrial nations in not applying any withholding tax whatsoever to dividends paid by a UK company.
Tax position on Capital gains
A UK company is generally subject to UK corporation tax on any capital gains. The capital gain will be calculated by reference to the sales proceeds and the original cost of the investment. These values are calculated in Sterling using the appropriate exchange rates on the date of purchase and the date of sale.
Transactions with connected parties must be on an arm’s length basis, i.e. as if the parties were independent third parties. Therefore for example if the investment is sold to a connected party for less than the market value then for UK tax purposes the market value would be used to calculate the capital gain arising rather than the actual sales proceeds. In a similar way if the investment is purchased from a connected party for an amount in excess of the market value then for UK tax purposes the base cost of the investment would be the market value rather than the amount actually paid by the UK company.
Capital gains arising on the disposal of qualifying substantial shareholdings by a UK company will not be subject to UK corporation tax. Also capital losses arising on the disposal of qualifying substantial shareholdings will not be available for off set against other taxable gains.
The main conditions to benefit from the exemption are as follows:
- The shareholding in the participation must be more than 10%;
- The shares must have been owned for at least one year;
- The subsidiary sold must be a trading company or the holding company of a trading group both before and after its sale.
- The UK holding company must be a trading company or the member of a trading group both before and after the sale of the subsidiary.
In order to ensure that the capital gains exemption is applicable it is important that all the conditions are met. For further information on the capital gains exemption please refer to our detailed briefing sheet.
Disposals of non qualifying shareholdings, e.g. where the shareholding is less than 10% or where the subsidiary is a non trading company or in respect of the disposal of other investments, e.g. real estate, any capital gain arising will be taxable. In these cases it may be possible to mitigate any gain arising with appropriate advance planning.
(i) Taxation of other income
It is important to understand that although a UK company may effectively not suffer taxation on dividend income, it is nonetheless taxable on all other income such as interest income, or if the company carries on a trade, trading income.
(ii)Taxation of foreign exchange movements
A UK company is subject to taxation on an arising basis on foreign exchange movements on monetary assets and liabilities held in its balance sheet. Monetary assets and liabilities broadly mean all assets and liabilities except for overseas shares and property. If a company prepares its accounts in foreign currency, the taxable foreign exchange movements are calculated by reference to the currency in which the accounts are prepared.
(iii) The taxation of financing loans
It is common for a UK holding company to wish to finance its subsidiary in the form of loans as well as equity. If a UK company makes a loan to a subsidiary company and it is connected to that company, interest at a commercial rate may have to be charged on the loan. This interest will be taxable in the UK company on an arising basis. This means that the interest will be taxable in the UK company whether it is paid by the foreign subsidiary or not.
Where a UK company lends to its subsidiaries, it may often wish to finance the loans to the subsidiaries by borrowing. When borrowing from a connected party if the loans are interest bearing it is important to ensure that the UK company is not thinly capitalised. Issues such as the deduction of UK income tax as a form of withholding tax also arise.
(iv) UK Controlled foreign company rules
The UK operates CFC rules which may bring into charge to UK tax certain profits of overseas profits on an arising basis. However, the rules have been modernised so as to broadly only catch profit artificially diverted from the UK, rather than genuine overseas trading profits.
Nevertheless, it is still important for us to be provided with full details of all shareholdings acquired by the UK company including indirect shareholdings however held.
(v) Loans to Participators
Where a UK company makes a loan to a participator, it is required to account to HMRC for 32.5% (for loans made on or after 6 April 2016) of the amount of the loan (known as a Section 455 liability). This amount has to be paid to HMRC if the loan to the participator is outstanding more than nine months after the end of the accounting period in which the loan is made. The 32.5% must be paid to HMRC nine months after the end of the accounting period in which the liability arises. Therefore although a payment arising under the loan to participators rules will eventually be repaid to the company, it will nonetheless represent a significant liability at the time the loan is made. Furthermore, if the company does not pay the Section 455 liability on time, interest and penalties will arise.
(vi) Acquisition Cost and Sales prices
When a UK company transacts with an unconnected third party the directors of the UK company will of course negotiate the best price or sales value. The commercial considerations require them to do so, and as a consequence HMRC have no powers under UK tax legislation to disturb the prices freely negotiated between two unconnected parties. Where an investment is acquired from a connected party or sold to a connected party the position differs. In such circumstances if the transaction is not undertaken at arm’s length under the UK Corporation Tax Self-Assessment rules the value used is substituted by an arm’s length market value. It is important therefore when an investment is acquired from a connected party or sold to a connected party the purchase price or sales value can be shown to be the appropriate market value for that investment.
Of course irrespective of the taxation position the directors have a legal duty to their shareholders to ensure that transactions undertaken by the company are undertaken for the benefit of the shareholders.
In summary UK holding companies are both tax efficient and cost effective. Following the introduction of the exemption from taxation in respect of capital gains and dividends arising from qualifying shareholdings, the UK holding company will be suitable in respect of tax efficient planning for both dividend flow and future capital gains.
Finally we would stress that the taxation and legal position of UK holding companies is complex and the taxation position outlined above will only apply if all the relevant conditions have been met.
1. Please see our briefing note on the UK Inward Dividend Exemption for further information