US corporates doing business in Europe Tax guide
Contents France 2 French corporation tax Relief for tax losses Capital gains made by French companies Intellectual property ( IP ) regime and payments for the use of IP rights Research & development ( R&D ) tax credit Intra-group arrangements French company as a holding company Financing the French subsidiary Expansion by share acquisition Repatriation of profits from the French company Sale of shares in French company Reorganisations Indirect taxes Registration duty Investing in French commercial property Germany 24 German corporation tax IP regime Intra-group arrangements German company as a holding company Financing the German subsidiary Expansion by share acquisition Repatriation of profits from the German company Payments for the use of IP rights Sale of shares in German company Indirect taxes Investing in German real estate iii
United Kingdom 36 UK corporation tax Taxation under the diverted profits tax regime IP regime Patent Box and R&D Intra-group arrangements UK company established as a holding company Financing the UK subsidiary Expansion by share acquisition Repatriation of profits from the UK company VAT Transfer taxes General taxation issues 50 EU taxation VAT on digital supplies to consumers International developments base erosion and profit shifting ( BEPS ) Tax treatment of local subsidiaries Tax regime of the holding company About us 62 iv
This is a guide to the key tax considerations for a US corporation wishing to commence doing business in the European jurisdictions of France, Germany and the United Kingdom. It is not comprehensive and is provided for general guidance only. It should not be relied upon as tax advice in your particular circumstances. Publication date: 15 January 2016 1
France French corporation tax French companies are generally subject to tax on their French-source income. As a result, French companies carrying on a trade or business outside France are generally not taxed in France on the related profits and cannot take into account the related losses. 2
A French subsidiary will be resident in France for tax purposes if: XXit has its legal seat in France (i.e. it is incorporated and registered in France); or XXits place of management is in France. Place of management is defined as the place where key management and commercial decisions that are necessary for the conduct of the entity s business as a whole are, in substance, made. All relevant facts and circumstances must be examined to determine the place of such effective management. If the company is US incorporated but its place of management is in France, then it is possible that the company is resident in both France and the US. The France / US tax treaty provides that, in this case, the US and French competent authorities shall endeavour to settle the question by mutual agreement having regard to the company s place of effective management, the place where it is incorporated or constituted and any other relevant factors. In the absence of agreement between the competent authorities, the company will not be considered to be a resident of either France or the US for the purposes of enjoying the benefits of the France / US treaty. The standard French corporate income tax rate is 33.33%. Companies with an annual turnover of at least 7,630,000 and corporate tax liability above 763,000 are subject to a social security surcharge of 3.3%, with the overall effective corporate tax rate being 34.43%. Companies with an annual turnover over 250 million are subject to an exceptional surcharge until 31 December 2016. If the exceptional surcharge applies the effective tax rate is increased to 38%. A reduced corporate income tax rate of 15% applies to the first 38,120 of the profits of small and mediumsized enterprises ( SMEs ) if certain conditions are met. Overall, the marginal effective tax rate for companies in France would generally be between 33.33% and 38%. Commercial buildings, office equipment, plant and machinery are eligible for tax depreciation generally using the straight-line method or accelerated method at rates of between 5% and 20%. Higher rates of amortisation can be available for certain qualifying industrial, manufacturing and scientific research equipment and tax depreciation is available on certain software. 3
Relief for tax losses Carry-forward losses can be set off against future profits indefinitely subject to a limit of 1 million plus 50% of the profit which exceeds 1 million. The profits remaining after the set off of carry forward losses will be taxed at the standard corporation tax rate referred to above. Alternatively, losses of a given fiscal year may also be carried back and set off against undistributed taxable profits of the preceding fiscal year subject to a limit of the lower of the profit for the previous fiscal year and 1 million. 4
Capital gains made by French companies Capital gains derived from the sale of fixed assets by French companies are subject to corporate income tax at the rate of 33.33% (and 34.43%, where social security surcharge applies). Capital gains derived from the sale of shares held by a French company which are treated as qualifying shareholdings (titres de participation) are exempt from corporate income tax, save that a lump sum equal to 12% of the gross amount of the capital gain remains taxable. This means that the current effective tax rate for capital gains on the sale of qualifying shareholdings is equal to 4% (calculated as 33.33% x 12%). Shares held by the French company (which can be shares in French or foreign companies) must satisfy both of the following conditions to benefit from this tax exemption: XXthey must be considered to be qualifying shareholdings. This involves either a specific class of shares enabling the shareholder to have a controlling interest for accounting purposes or for the shares to be eligible for the participation exemption regime; and X X they must have been held for at least 2 years before their disposal. 5
Intellectual property ( IP ) regime and payments for the use of IP rights US companies establishing subsidiaries in France can benefit from the favourable tax regime applicable to revenues and proceeds derived from IP assets. A reduced tax rate of 15% applies to companies subject to corporate income tax in respect of royalties derived from the licensing of patents or patentable rights which are included as fixed assets in the company s accounts. Capital gains arising from the disposal of patents or patentable rights are subject to the favourable tax rate of 15% provided that the seller and buyer of the rights are not related companies. 6 Any royalties paid by a French subsidiary to a non-resident company will be subject to withholding tax of 33.33%. However, such royalties should be fully exempt from such French withholding tax where the royalties are paid to a US tax resident company pursuant to the provisions of the France / US tax treaty. Where royalties are paid by a French subsidiary to a direct parent resident in the European Union ( EU ) or to a direct EU subsidiary (related to it by at least 25% of the share capital), the royalties should be exempt from French withholding tax pursuant to the EU Interest and Royalties Directive.
Research & development ( R&D ) tax credit To encourage investment in R&D, an R&D tax credit is available which equates to 30% of the expenses related to R&D activities of up to 100 million and 5% for such expenses above 100 million. The R&D tax credit is available for all companies. The term R&D encompasses three activities: basic research, applied research and experimental development. The R&D credit is generally set off against corporate income tax for the year in which the qualifying expenditure is incurred (with any excess carried forward for 3 years and, if not utilised within those years, refunded by the French tax authorities). However, the R&D tax credit can be immediately refunded to certain companies such as SMEs, innovative new enterprises and newly created companies in certain redevelopment areas. An additional R&D tax credit is also available for SMEs referred to as the innovation tax credit. This enables a tax credit to be set off against corporate income tax equating to 20% of the innovation expenses (up to a limit of 400,000 per year). Consequently, the maximum innovation tax credit a company can obtain is 80,000 per year. A company will satisfy the definition of SME where the enterprise has: XXfewer than 250 employees; XXturnover of less than 50 million; and XXa balance sheet of less than 250 million. This innovation tax credit will only apply to expenditure incurred on the design of new product prototypes. 7
Intra-group arrangements French resident companies which are more than 95% owned (directly or indirectly) by another French resident company may (subject to certain conditions) set up a tax consolidated group for corporate income tax purposes. Profits and losses of group companies are then aggregated and tax is levied on the aggregate income of the tax group after certain adjustments. Under transfer pricing rules, French entities controlled by, or controlling (through de jure or de facto control), entities which are established outside France and which carry out transactions with the French entity must do so in accordance with arm s length principles. French companies must provide transfer pricing documentation to the French tax authorities where either: XXthe company s turnover or gross assets on its balance sheet is at least 400 million in the financial year; or X X the company s direct or indirect major shareholder (being a shareholder owning more than 50% of the shares in the French company) or a subsidiary of the company, has turnover or gross assets of at least 400 million. 8
The required transfer pricing documentation comprises two parts: XXmandatory transfer pricing documentation: in the event of a tax audit, a company must provide transfer pricing documentation within 30 days of a formal demand from the French tax authorities, which is usually made at the beginning of the audit; and XXmandatory submission of simplified transfer pricing documentation: entities established in France which fall within the scope of the mandatory transfer pricing documentation are also required to automatically disclose a simplified version of the transfer pricing documentation (including a general description of the activity carried out and a general description of the transfer pricing policy of the group). This documentation has to be provided within six months of the filing date of the relevant entity s tax return. 9
French company as a holding company If any French subsidiary is to be established by a US company for the purposes of operating as a holding company for further expansion into European territories, it is important to consider the French controlled foreign company ( CFC ) rules. Under the French CFC rules, if French companies subject to corporate income tax in France have either a foreign branch or if they hold (directly or indirectly) an interest of at least 50% in any foreign entity which benefits from a preferential tax regime in its home country (such that the effective tax paid is 50% lower than the tax that would have been payable in France if the entity was resident in France), the profits of this foreign entity would be subject to corporate income tax in France in the hands of the French parent. The CFC rules do not typically apply if the foreign entity is engaged in real industrial or commercial activities in its state of residence. Moreover, where the foreign entity is established in the EU, only artificial arrangements are affected by the French CFC rules. In the case of an actual distribution from a foreign subsidiary to a French parent company, the dividends received by the French parent would generally be eligible for the participation exemption regime. This regime requires that the French parent company holds at least 5% of the share capital of the subsidiary company for at least 2 years. Dividends received by the French parent company are exempt from 10
French tax, save for a lump sum amount equal to 5% of the dividends which remains subject to French taxation (this lump sum amount is reduced to 1% in certain situations from 1 January 2016). This lump sum of 5% (or 1%) of the dividend is subject to corporate income tax at the standard rate, typically resulting in an effective tax rate of up to 1.6% for the French parent in respect of the dividends it receives from its subsidiary. A corporate income tax surcharge of 3% applies to distributions to shareholders made by all French resident companies (or foreign companies that are liable to corporate income tax in France). This surcharge does not apply to distributions made within a French tax consolidated group and distributions made by companies qualifying as SMEs (as defined above). 11
Financing the French subsidiary The availability of tax relief for interest payable by the French subsidiary in relation to financing provided to it will be of importance to US groups together with the application of French withholding taxes on the payment of interest by the French subsidiary. Interest on borrowings paid by a French subsidiary to its US parent would be allowable against French profits, subject to restrictions imposed by certain rules such as French thin capitalisation rules. French thin capitalisation rules apply to loans made between related companies (such as a company who de jure or de facto manages the borrower company or holds more than 50% of the shares in the other company). Under these thin capitalisation rules, the amount of tax-deductible interest paid to all related parties is capped, in respect of a given tax year, at the higher of the following three thresholds (as computed in respect of that tax year): XXthe amount of interest paid to all related parties computed on the basis of 1.5 times the shareholders equity held in the borrower company; XX25% of the adjusted operating profit; and X X the amount of interest received from all related parties. 12
Nevertheless, if the amount of non-deductible interest does not exceed 150,000, interest will remain fully deductible. Any non-deductible portion of interest is added back to the taxable income of the French company borrower. However, such non-deductible interest can be carried forward for deduction in subsequent financial years (subject to certain conditions). The thin capitalisation rules also apply to interest paid on loans made by a third party if the loan is secured or guaranteed by a related party in certain circumstances. Other rules also limit the tax deduction for interest such as the anti-hybrid rule. This rule broadly provides that interest will generally only be deductible in France if the interest income is subject to tax in the hands of the recipient at a rate which is at least equal to one quarter of the French corporate income tax rate. In addition, the amount of interest relief can also be limited by the interest barrier rule which is applicable where the net financial expense incurred by the French company during a fiscal year exceeds 3 million. Where this is the case, only 75% of the net financial interest incurred will be deductible in determining the company s taxable income. Other rules which restrict interest relief are also applicable to a debtfunded acquisition of a French company (Charasse Amendment and Carrez Amendment). French withholding tax is not applicable to interest paid by a French corporate borrower to a US parent or other US group companies. French withholding tax can, however, apply where interest is transferred or paid by a French company to an entity located in a non-cooperative state or territory ( NCST ). 13
Expansion by share acquisition In addition to the issues outlined in this guide, additional key considerations for a US corporation acquiring shares in a French company will involve: XXregistration duty applicable on the acquisition of shares in a stock company (such as an SAS or SA) or private limited liability company (such as a SARL) set out in more detail below; XXno step up in the basis of the underlying assets of the French company for French tax purposes and no additional amortisation of any underlying goodwill; and XXinheriting the tax history of the French company and, as such, a buyer would typically undertake tax due diligence and seek standard tax warranties and indemnity protections. French entities that can check-thebox for US tax purposes include SARL, SC, SNC and SAS entities. 14
Repatriation of profits from the French company In general, the payment of dividends by a French subsidiary to a US parent will attract French withholding taxes under French law at a rate of 30%, but this withholding tax rate may be reduced or eliminated by the tax treaty concluded between France and the US. The France / US tax treaty should operate to reduce the withholding tax to 5% of the dividends paid if the beneficial owner is the US parent company that owns directly at least 10% of the capital in the French subsidiary. The US parent company will benefit from a full exemption from withholding tax if the US parent has held, directly or indirectly, at least 80% of the capital of the French subsidiary during a holding period of 12 months preceding the payment of the dividends and satisfies certain other requirements. In certain circumstances, it may be preferable for a US group to hold the French subsidiary through a holding company located in the EU in order to benefit from the EU Parent- Subsidiary Directive which can operate to reduce the withholding tax to 0%. This would apply where the EU intermediate parent company is itself subject to a corporate income tax and has held the shares of the French subsidiary for at least 2 years. The US parent may also need to show that the ownership of the French company through an EU holding company was not principally established in order to benefit from the EU Parent-Subsidiary Directive. Formalities will need to be complied with to ensure reduction or elimination of dividend withholding tax under the France / US Treaty or the EU Directive. 15
Sale of shares in French company According to French law, capital gains on a disposal of shares in a French subsidiary by a foreign parent company are subject to a tax rate of 45%, provided the foreign parent held at least 25% (directly or indirectly) of the French company s share capital at any time during the 5 years preceding the sale. However, the existing France / US tax treaty states that capital gains resulting from the sale of shares are only subject to tax in the state of residence of the seller company (save for the disposal of a real estate company s shares, i.e. a company whose assets are mostly composed of French real estate assets). Therefore, a sale of shares in a French subsidiary by a US parent company should not be subject to French capital gains tax. 16
Reorganisations French companies which are involved in mergers, spin-offs, split-offs and dissolution without liquidation may qualify for a special rollover regime. 17
Indirect taxes A French company will be required to register for the EU wide value added tax ( VAT ) in France when the turnover of the company exceeds 82,200 (for suppliers of goods) and 32,900 (for suppliers of services) in the preceding calendar year or is likely to exceed these thresholds in the current calendar year. The current standard rate of VAT in France is 20% and two reduced rates of 5.5% and 10% apply to certain specified transactions. Even if the French company does not meet the registration thresholds, it can voluntarily register for French VAT in order to recover VAT on the supply or delivery of goods to the French company. 18
Registration duty Sale of shares The registration duty due and payable by a purchaser on an acquisition of shares depends on its legal form and its assets. The registration duty is calculated as a percentage of the purchase price (or the fair market value, if higher) of the shares. Type of company being sold Stock companies (SA, SAS) 0.1% 1, 2 Private limited liability companies and partnerships (SARL, SNC, etc.) Predominantly real estate companies (that is, companies whose assets primarily consist of French real estate) 1 except for the sale of a listed company s shares without a deed 2 intra-group transfers benefit from a tax exemption Rate of registration duty on the purchase price 3% (after a 23,000 rebate) 2 5% 19
Disposal of a going concern In the event of a transfer or disposal of a going concern, registration duties payable by a purchaser of the assets are calculated as a percentage of the purchase price (or the fair market value, if higher) and are assessed as follows: Purchase price/fair market value of the going concern From 0 to 23,000 0% From 23,000 to 200,000 3% Exceeding 200,000 5% Rate of registration duty on the purchase price 20
Acquisition of real estate France imposes a registration duty on the acquisition of French real estate at a rate between 5.09% and 6.4%, depending on the location and the type of the property. The seller must also add to the registration duty the real estate security contribution applicable at the rate of 0.1%. 21
Investing in French commercial property Typically, US companies invest in French commercial property through three vehicles: SAS, SCI or OPCI. Using an OPCI may give rise to significant tax advantages. An OPCI may be set-up under the legal form of a SPPICAV. The SPPICAV is a regulated entity which is tax exempt in France if it complies with the following distribution obligations: XXit distributes 85% of its (distributable) income from rent and the leasing of its properties which it holds directly (or indirectly through a partnership); and XXit distributes 50% of its (distributable) net capital gains arising from the disposal of a property or a disposal of shares in a company holding the property. In this case, neither the capital gain nor the rental income derived by such a regulated SPPICAV entity will be subject to tax in France. 22
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Germany German corporation tax A German resident subsidiary will be taxable on its worldwide profits and gains on the disposal of assets held by it. A German subsidiary will be resident in Germany for corporate tax purposes if: XXit has its statutory seat in Germany; or X X its main place of management is in Germany. 24
If the company is US incorporated but its place of management is in Germany, then the company could be treated as resident in both the US and Germany. The Germany / US tax treaty provides that the competent authorities of the contracting states shall seek to determine, through consultation, the state in which the company will be deemed to be resident, and, if they are unable to do so, the company will not be considered to be a resident of either Germany or the US for the purposes of enjoying benefits under the treaty. German resident companies are generally liable to corporate income tax on their worldwide income and all income is categorised as business income. Plant and machinery, not being part of inventory, will be eligible for tax depreciation at a rate depending on applicable average useful life. Acquired goodwill can be amortised for tax purposes over a 15 year period. The German corporate income tax rate is 15%. In addition, German resident companies are subject to a solidarity surcharge of 5.5% of the corporate income tax due. The overall effective corporate income tax rate (including solidarity surcharge) is, therefore, 15.825%. A company doing business by way of a permanent establishment ( PE ) located in Germany is also subject to trade tax (Gewerbesteuer). The taxable income for trade tax purposes is essentially determined in the same manner as for corporate income tax purposes, subject to certain adjustments. Trade tax is broadly calculated by applying the basic federal tax rate of 3.5% to the taxable business income in order to determine the basic tax amount. This basic tax amount is then multiplied by a multiplier fixed by the local municipalities (but is a minimum of 200%). The current multiplier is 410% for Berlin, 440% for Dusseldorf, 460% for Frankfurt am, 470% for Hamburg and 490% for Munich. Overall, the effective tax rate for corporations in Germany would be approximately 30% (assuming a municipality multiplier of 410%). 25
IP regime Companies cannot currently benefit from any favourable IP or patent box regime in Germany to reduce the effective tax rate on income generated from such IP. However, there are ongoing political discussions considering the introduction of a patent box regime in Germany. 26
Intra-group arrangements Germany allows different companies (with their management in Germany and statutory seat in the EU / European Economic Area) to be grouped for both German corporate income tax and trade tax purposes as if they form a single unit so that their profits and losses are pooled in the hands of the controlling company. The controlling company must not be exempt for corporate income tax purposes in Germany. The controlling company will then be liable for the corporate income tax applicable to the pooled income. However, grouping is generally only available where the companies are financially integrated into the controlling parent and a profit and loss pooling agreement is concluded. There are also additional requirements that need to be met such as an actual implementation over a 5 year period. The German tax regulations provide that transactions between a company and its shareholder (wherever that entity is resident) shall be taxed in accordance with arm s length principles. Moreover, arm s length pricing is required for all cross-border transactions between related persons where one of them holds (directly or indirectly) at least a 25% participation or where one controls the other or a third person directly or indirectly holds a 25% participation or controls both. Whilst advance pricing agreements with the German tax authorities are possible, they are uncommon. 27
German company as a holding company If any German subsidiary is to be established for the purposes of operating as a holding company for further expansion into European territories, it is important to consider the German CFC rules. Under the German CFC regime, where profits of foreign subsidiaries have been subject to foreign tax at a rate lower than 25% and where the foreign subsidiary generates passive income, such profits may be deemed to have been paid as a dividend to the German parent. On a distribution made from a foreign subsidiary to a German parent company, the dividends received by the German company from the foreign subsidiary would generally be exempt from German taxation, subject to certain minimum participation requirements. However, 5% of the gross dividends will be added back to taxable income of the German parent to represent non-deductible business expenses, although actual business expenses continue to be fully deductible against German taxable income. Any gain arising on a disposal of shares in the foreign subsidiary is generally exempt from German corporate income tax and trade tax, although a lump sum of 5% of the gain is added back to taxable income in Germany to represent the nondeductible business expense. 28
Financing the German subsidiary The availability of tax relief for interest payable by the German subsidiary in relation to financing provided to it will be of importance to US groups, together with the application of German withholding taxes on the payment of interest by the German subsidiary. The German interest deduction limitation rule limits the tax deductibility of net interest expense to 30% of the tax specific earnings before interest, tax, depreciation and amortisation ( EBITDA ), unless one of the following requirements is met: XXthe annual net interest expense does not exceed 3 million; XXthe relevant business is not part of a group of companies; or X X the German borrower company s equity ratio does not fall below 2% of the group s worldwide equity ratio. 29
Expansion by share acquisition In addition to the issues outlined in this Guide, additional key considerations for a US corporation acquiring shares in a German company will involve: XXno step up in the basis of the underlying assets of the German company for German tax purposes and no additional amortisation of any underlying goodwill; and X X inheriting the tax history of the German company and, as such, a buyer would typically undertake tax due diligence and seek standard warranty and indemnity protections. 30
Repatriation of profits from the German company The payment of dividends by a German subsidiary to a US parent will attract German withholding taxes under German law at a rate of 25% (which is 26.375% after including the solidarity surcharge). The US parent can apply for a refund of two-fifths of the withholding tax, subject to certain domestic antitreaty shopping rules. The Germany / US tax treaty could also operate to reduce the withholding tax to 5%. It may be preferable for a US group to hold the German subsidiary through a holding company located in the EU in order to benefit from the EU Parent-Subsidiary Directive which can operate to reduce the German dividend withholding tax to 0% where the EU intermediate parent company is subject to a corporate income tax and has held the shares of the German subsidiary for at least 12 months, subject to applicable anti-avoidance regulations. 31
Payments for the use of IP rights Any royalties paid by a German subsidiary to its US parent or other non-resident companies will be subject to withholding tax of 15% (which is 15.825% after including the solidarity charge). Such withholding tax on royalties can be reduced to 0% under the provisions of the Germany / US tax treaty or if the royalties are paid to a direct EU parent or subsidiary of the German company under the EU Interest and Royalties Directive. 32
Sale of shares in German company Capital gains derived by a US company from a sale of its shares in a German corporation are effectively exempt from German corporate income tax, subject to an amount of 5% which remains taxable. Consequently, 5% of the capital gain is deemed to be a non-deductible expense, although the Germany / US tax treaty can provide further relief from German taxation. 33
Indirect taxes The current standard VAT rate for the supply of goods or other services rendered in Germany is 19%. However, VAT will generally not be levied on supplies or other services rendered by an entrepreneur in Germany (and there is no registration requirement in this case), where the turnover of the company did not exceed 17,500 in the preceding calendar year and where it is not likely to exceed 50,000 in the current calendar year. Even if the turnover does not exceed these thresholds, the German company may opt to register for VAT in order to recover VAT charged to the German company on supplies of goods or services made to it. 34
Investing in German real estate Germany imposes real estate transfer tax ( RETT ) on the direct or indirect acquisition of real estate at a rate which ranges from 3.5% to 6.5% (depending on local federal state settings). RETT may also be triggered on an acquisition of shares, if (inter alia) the acquiring company, as a result of the acquisition, holds (directly or indirectly) at least 95% of the shares of a company owning real estate located in Germany. US companies often invest in German properties through a German KG partnership. It is noted that RETT, can be triggered at the level of the German Partnership, if at least 95% of the participation in the partnership has been transferred to new investors. 35
United Kingdom UK corporation tax A UK resident subsidiary will be taxable on its worldwide profits and gains on the disposal of assets held by it. The UK subsidiary will be resident in the UK if: XXit is incorporated in the UK; or XXit is centrally managed and controlled in the UK, and X X to the extent that the UK / US tax treaty applies, it is agreed between the UK and US tax authorities that it shall be treated as resident in the UK. 36
The starting point for calculating taxable profits of a trade carried on in the UK by a UK resident subsidiary is the profit disclosed in the UK subsidiary s accounts. Tax relief is available for depreciation (referred to as capital allowances) in respect of certain assets such as plant and machinery. Enhanced reliefs are available for research and development and certain goodwill can be amortised for tax purposes in accordance with the accounting amortisation. A UK corporation will be subject to UK corporation tax which is currently charged at a full rate of 20% and all companies are taxed at the same rate regardless of size. The corporation tax rate is to reduce to 19% from 1 April 2017 and to 18% from 1 April 2020. 37
Taxation under the diverted profits tax regime From 1 April 2015, the UK has introduced a new diverted profits tax ( DPT ) aimed at applying a penal rate of 25% tax to profits artificially shifted out of the UK. The DPT is intended to apply to two broad situations: XXwhere a foreign company structures its arrangements to avoid creating a UK PE and, broadly, makes more than 10 million annually in UK-related sales revenues from the supply of goods, services or other property and its UK-related expenses exceed 1 million. UK-related sales of affiliated companies are also included in determining the application of the 10 million threshold where such sales are not subject to UK corporation tax; and XXwhere entities or transactions (involving affiliated parties) lack economic substance and either involve a UK resident company or a UK PE of a foreign company to exploit tax mismatches where it is reasonable to assume that expenditures in the UK would not have been incurred or taxable UK income would have arisen but for the tax benefit of the actual arrangements. Broadly, profits which are chargeable to UK taxes are generally subject to usual transfer pricing rules (see below), with the diverted profits tax intended to apply particularly in those cases where the transfer pricing adjustment is insufficient or there is a recharacterisation of the arrangements and the tax is applicable to diverted profits determined on a just and reasonable basis. In that case, the diverted profit amount is subject to 25% tax (rather than the current 20% corporation tax). 38
The rules are intended to apply only to large enterprises and not to SMEs in any accounting period. SMEs broadly comprise enterprises employing globally fewer than 250 persons and which globally have an annual turnover not exceeding 50 million and/or annual balance sheet not exceeding 43 million. The rules are not limited to transactions or arrangements with tax haven or low-tax jurisdictions, but can apply more broadly. Larger US enterprises will need to consider the impact of these new rules particularly if they are generating, or are looking to generate, significant revenues from UK activities as the rules could influence how they structure their activities in the UK. Affected companies are generally required to notify HMRC within 3 months of the end of an accounting period (ending after 1 April 2015) in which it is reasonable to assume diverted profits might arise, although for accounting periods ending on or before 31 March 2016, the notification period has been extended to 6 months. A tax geared penalty applies if there is a failure to do this. Further information regarding DPT is available on the Taylor Wessing website. 39
IP regime Patent Box and R&D Any company within the charge to UK corporation tax may, subject to phasing-in rules, be able to elect to benefit from a 10% effective rate of corporation tax on worldwide income arising from the exploitation of qualifying patents. Subject to certain adjustments, the Patent Box can be applicable to income from the sale of the patented invention (or to sales of items incorporating the patent), to royalty income from licensing of the patent and to amounts received for infringement of the patent and loss of patent income. The phasing-in rules mean that the full benefit of an effective 10% corporation tax rate on patent box profits will be applicable from 1 April 2017. Broadly, the company must (in the relevant accounting period) own or exclusively license-in qualifying IP rights (that is, patents, including supplementary protection certificates granted by either the UK Intellectual Property Office or the European Patent Office or corresponding patent rights granted by certain European patent offices). In addition, the company applying the patent box regime must satisfy the active ownership condition such that the company must have either: XXcarried out qualifying development itself in respect of the qualifying IP rights; or X X performed a significant amount of management activity in respect of the qualifying IP rights, subject to qualifying development having been carried out by a company within the same group. 40
These rules apply to all arrangements entered into by 30 June 2016. However, for UK companies which acquire patented IP or receive an exclusive licence of patented IP on or after 1 July 2016, it is anticipated that substantial activity (in the form of research and development investment) will need to be undertaken by the UK company owning the IP itself in order to benefit from the Patent Box. The Government has published a consultation document and draft legislation setting out the proposed changes to the Patent Box regime to be applicable from 1 July 2016, Further information is available on the Taylor Wessing website. Enhanced R&D tax credits are available in the UK which differ depending on the size of the relevant company and whether it falls within the SME regime. Under the SME regime, enhanced allowances are available up to 230% of qualifying revenue expenditure on R&D activities and an allowable loss arising from R&D expenditure may be surrendered to HMRC in return for a repayable credit. For large companies, the R&D tax credits regime is changing from April 2016 to allow for above the line enhanced R&D credits for income expenditure. 41
Intra-group arrangements The UK does not operate a fiscal unity arrangement for group companies. However, losses (including trading losses and losses arising from tax relief on interest) arising to companies subject to UK corporation in an accounting period can be surrendered (i.e. transferred) to offset against profits arising to other companies subject to UK corporation taxes who are within the same group in the same accounting period. This is known as group relief. The company receiving the benefit of the losses can pay for the benefit of the losses to the loss making company without any tax consequences. The UK operates transfer pricing rules for transactions involving related companies. Under the UK s transfer pricing rules, if a UK resident company does not reflect arm s length pricing in its transactions with its US parent (or other non- UK group companies), the UK tax authorities can seek to assess the UK company to corporation tax on the resulting reduction in taxable profits unless the UK company is part of a small enterprise (i.e. an enterprise with fewer than 50 staff and annual turnover not exceeding 10 million or balance sheet assets not exceeding 10 million). 42
UK company established as a holding company If any UK subsidiary is to be established for the purposes of operating as a holding company for further expansion into European territories, it should be noted that the UK operates a CFC regime. Under this regime, profits of foreign subsidiaries in lower tax territories could be attributed to the UK parent company. In consequence of recent reforms, foreign profits artificially diverted from the UK could be subject to the CFC charge. Any dividends received by a UK company from a foreign subsidiary would generally be exempt from taxation in the hands of the UK company. It should also be possible to elect for profits of a foreign branch of a UK company to be treated as exempt from UK taxation. In addition, any gain arising on a disposal of shares in subsidiaries held by a UK company for a period of at least 12 months could be exempt from UK corporation tax under the UK s substantial shareholdings regime. In general terms, this regime requires that the subsidiary being sold and the UK company seller, or the group of which it is a member (if applicable) are trading both before and after the sale of the relevant subsidiary. 43
Financing the UK subsidiary The issues involved in the consideration of the financing of the UK subsidiary will often be tax driven. Of particular importance is the availability of tax relief for interest due from the UK subsidiary in relation to the financing and UK withholding taxes on the payment of interest by the UK subsidiary Interest paid on borrowings by a UK subsidiary to its US parent would generally be allowable on an accruals basis as a deduction in calculating the UK subsidiary s taxable profits. However, in general, tax relief for interest can be restricted depending on whether: XXthe loan could be effectively treated as a form of equity (such that the interest on the loan is treated as a distribution ); XXtransfer pricing and thin capitalisation rules apply to disallow interest on related party borrowings where the borrowing does not reflect arm s length terms, based on the debt capacity of the UK subsidiary itself; XXcertain other anti-avoidance rules apply, for example where the loan has been entered into for unallowable purposes or where either the interest on the loan is also available for tax relief in another territory or the interest on the loan would not be taxable for the lender (pursuant to certain anti-hybrid rules); and X X the worldwide debt cap restrictions are applicable where the group is considered large. These rules essentially compare the worldwide debt of the group with the debt of the UK resident group entities. 44
It is noted that the Government has issued a consultation document regarding proposed changes to the UK s regime for tax relief for interest in order to meet the OECD s best practice recommendations. The proposed changes are not expected to be introduced before April 2017. Further information is available on the Taylor Wessing website. UK withholding tax would be applicable to any interest paid by a UK corporate borrower to a US company, although this could be reduced from 20% to 0% under the UK / US tax treaty or if the loan is a quoted Eurobond listed on a recognised stock exchange. Formalities will need to be complied with in seeking clearance under the UK / US tax treaty to reduce any interest withholding taxes. 45
Expansion by share acquisition In addition to the issues outlined in this guide, additional key considerations for a US corporation acquiring shares in a UK company will involve: XXstamp duty is payable by the buyer at the rate of 0.5% of the consideration given for the transfer of the UK company shares; XXno step up in the basis of the underlying assets of the UK company for UK tax purposes and no additional amortisation of any underlying goodwill; and XXinheriting the tax history of the UK company and, as such, a buyer would typically undertake tax due diligence and seek standard warranty and indemnity protections. UK entities that can check the box for US tax purposes include UK private limited companies (but not plcs), UK limited partnerships and UK limited liability partnerships. 46
Repatriation of profits from the UK company The payment of dividends by a UK subsidiary to a US parent does not attract any UK withholding taxes under UK domestic law. The payment of royalties by a UK subsidiary to a US parent would ordinarily give rise to withholding taxes of 20%, although these could be eliminated under the UK / US tax treaty. Where the US parent ultimately wishes to sell the UK business, the UK would generally not subject the US parent to UK taxation on the sale of its shares in the UK subsidiary. 47
VAT VAT is a sales tax and the current standard rate is 20%. The UK company will become liable to be registered for UK VAT if its turnover of taxable supplies for the previous 12 months is more than 82,000 or if there are reasonable grounds for believing that the taxable supplies of the business may exceed 82,000 in the next 30 days alone. Moreover, even if the UK company does not meet these registration thresholds, it can voluntarily register for UK VAT (which would assist it with recovering VAT on supplies made to the UK company). VAT is charged on all supplies made by a UK company to its customers in the UK unless the supplies made by the UK company fall within certain exempt or zero rated categories. Most businesses outside the financial, insurance or real estate sectors would typically need to charge their customers UK VAT. Specific rules apply to determine where supplies of goods or services are made where they involve customers located outside the UK. 48
Transfer taxes Any purchaser (regardless of tax residence) must pay stamp duty land tax ( SDLT ) on the purchase or transfer of property or land in the UK where the amount paid is above a certain threshold. SDLT is charged as a percentage of the purchase price and for nonresidential property is charged at the rate of 4% where the consideration is more than 500,000. SDLT would be applicable on a transfer of UK property unless the property is exempt or a relief applies. On a sale of shares in the UK company, the purchaser of the shares will need to pay stamp duty on the transfer. Stamp duty is charged at 0.5% of the total chargeable consideration. If shares are transferred via a paperless system (such as CREST) then stamp duty reserve tax (also at 0.5%) is applicable. 49
General taxation issues EU taxation VAT on digital supplies to consumers The VAT regime for suppliers of digital services to EU consumers changed across the EU from January 2015. Businesses established in the EU that supply digital services to consumers in other EU jurisdictions need to charge, and account for, VAT in the jurisdiction in which their customer belongs. Previously, the supplier charged VAT in its own jurisdiction and applied a single rate of VAT to those supplies. The changes to the rules were designed to ensure that digital services are taxed where they are consumed. This has increased the burden of VAT compliance on digital businesses operating crossborder within the EU. Digital services encompass supplies of: XXbroadcasting scheduled broadcasting of TV and radio, live streaming and webcasts but not on-demand downloads; XXtelecommunications landline and mobile services, internet connections supplied by ISPs; and X X e-services services which are supplied electronically and whose provision involves little or no human intervention but is highly automated e.g. digital downloads of content (such as music, videos and e-books); services provided by online marketplaces; and automated online examination and testing (such as multiple choice testing). 50
In an attempt to ease the administrative burden, businesses can account for VAT on their crossborder supplies, by registering under the mini one-stop shop ( MOSS ). This means that suppliers of digital services need not register for VAT in each EU jurisdiction in which they operate. The MOSS is a voluntary scheme intended to simplify VAT compliance for businesses who supply digital services to consumers in more than one EU jurisdiction by providing a single point of registration and a single VAT return for supplies of digital services to consumers belonging to other EU jurisdictions. Businesses using the MOSS must continue to ensure that they correctly determine the VAT status of their customers and apply the correct VAT rate to their supplies. It should be noted that the MOSS is only available in respect of supplies made in jurisdictions in which the business supplying digital services does not already have a business establishment or a VAT registration number. If the MOSS is not available in a particular jurisdiction, the business should account for VAT on digital supplies under any existing VAT registration it has in place in that jurisdiction. Further, the MOSS cannot be used to recover input tax, so businesses should continue to recover in the normal way using either their existing VAT registration or, if they are not registered or established in the relevant jurisdiction, the EU s electronic VAT refund scheme. Registration for the MOSS is completed electronically. Although businesses may register for the MOSS in any EU jurisdiction in which they have an establishment, it is anticipated that many will decide to register in the same jurisdiction in which they have their main EU business establishment. 51
International developments base erosion and profit shifting ( BEPS ) The key developments of the OECD s BEPS project, which issued its final reports on 5 October 2015, and which are most relevant to US corporations doing business internationally are: XXproposed changes to double tax treaties. In this regard, the OECD report recommends that treaties include an express statement that they are intended to eliminate double taxation without encouraging treaty shopping and either including a general treaty anti-abuse rule and/or including a limitation on benefits ( LOB ) rule together with a rule to deal with conduit arrangements. This could make it more difficult for US companies to benefit from double taxation treaties where they establish holding companies with limited substance; XXproposed changes to the definition of permanent establishment which are aimed at avoiding commissionaire structures which were previously distributor arrangements; ensuring certain activities which have been viewed as auxiliary or preparatory will in future give rise to a PE in the local jurisdiction (such as warehousing); and 52 expanding to include within the concept of a PE a dependent agent undertaking activities in a jurisdiction which are intended to result in the regular conclusion of contracts. Additional work will be undertaken to determine the appropriate amount of profit to be allocated to such permanent establishments in addition to work being undertaken in relation to the multilateral instrument which is intended to implement the proposed changes to the tax treaties; X X recommendations of changes to interest reliefs for financing arrangements. In particular, the OECD recommends the introduction of a fixed ratio rule to limit interest reliefs to a fixed net interest to EBITDA ratio of 10% to 30% (subject to a group ratio rule which allows interest relief up to the net interest: EBITDA ratio of the group). Additional targeted and optional elements could also be introduced. Should these recommendations be introduced in countries such as the UK, they would have a significant impact on the ability of US multinationals to benefit from tax reliefs for financing costs in the UK;