Achieving operational effectiveness across serveral jurisdictions involves careful investigation and planning to ensure that what your group does not adversely affect your counterpart.
Simple but careful oversight of the intra-group arrangements can yield considerable efficiencies and significant tax savings and we describe a number of areas on which any international group should focus. Not all will be relevant but you should use them as a template for good tax and commercial management.
Two things always to bear in mind though: always check the tax effects in each location, because what tax savings you achieve in one jurisdiction can be outweighed by adverse consequences in another; and never let the tax tail wag the commercial dog. Whatever you do must always make commercial sense.
Transfer Pricing
Compliance with transfer pricing legislation is now a requirement in most countries and plays a key role in determining a tax efficient structure. Broadly speaking, a company should be remunerated on an arms length basis for the functions it performs and the risks it bears.
Determining the level of reward for each member of a group is complex. For example, a distributor which has a restricted role and accepts limited risks will recognise a smaller amount of group profit compared to, say, the group manufacturing company which designs and makes goods. But determining precisely what proportion each should receive is an art!
Thin Capitalisation
Many countries have policies to deny tax relief for interest on a loan from a group company if the company could not have borrowed the amount in question had it been dealing with the lender at arms length. Essentially the rules require the borrowing company to fund itself from a proper level of share capital rather than using borrowings from other group members.
These rules may operate in a variety of ways, such as through specific interest deduction rules, transfer pricing rules or even via tax treaties. Some countries have published ‘safe harbours’ for acceptable debt to equity ratios.
The UK has recently introduced what it calls Debt-cap rules which determines the tax deduction for interest paid based on the level or worldwide debt.
Treaty Shopping
Most countries impose withholding tax on payments of interest, royalties and dividends to non-residents. However, they may have agreed a reduced or nil rate of withholding tax under a double tax treaty. To prevent the insertion of companies resident in a favourable territory simply to route interest, royalties or dividends in a tax efficient manner, many countries have anti-treating shopping rules.
These rules are included in modern tax treaties either by specific conduit articles and/or by a limitation of benefit article.
Interest and Royalties
You need to check that withholding tax is applied where required and if it can be paid at a reduced rate under a tax treaty. Even where a reduced rate applies, it may need a prior clearance from the tax authorities of the payer. If you are dealing with companies based in the EU then you are likely to be able to apply reduced withholding tax rates.
Dividends
It is important to check whether withholding tax needs to be applied to dividend payments to parent companies and also whether a reduced rate is available under a tax treaty. As with interest and royalty payments, even where a reduced rate applies, it may need a prior clearance from the tax authorities of the payer.
The treatment of the dividend in the hands of the shareholder needs close examination. For example, the UK has recently introduced a dividend exemption providing certain considerations are satisfied. Other countries will tax the dividend and give relief for the tax already suffered as tax on profits in the subsidiary company.
Arbitrage
This is aimed at arrangements exploiting the difference between or within national tax systems, often involving hybrid entities or instruments. It could involve a double deduction for the same expenditure in two countries. Another example would be obtaining a deduction for expenditure in one country whilst the receipt escapes tax in the other.
If the UK tax authorities regard the main purpose for using the hybrid was to obtain a UK tax advantage they have the power to deny the tax advantage.
Branch versus Subsidiary
Whether to operate through a branch or subsidiary is a question which is often faced when entering a new territory. Whilst ultimately the decision should be based on commercial and legal considerations the tax treatment of each should also be taken into account.
For taxation purposes, one of the main considerations is the use of losses. Those of a branch may be easier to use against the parent’s tax liabilities. The profits of the branch are likely to be taxed in the country where it is based in addition to that of the parent.
Group Relief
<:orma>In the UK and other countries losses of one company may be set off against the profits of another in the same group. Normally, the losses are not available against a fellow group company in another country. However, recent changes in tax law allow cross-border group relief in certain, exceptional, cases.
It is important to check the chain of ownership to ensure the location of common parents or other intermediate companies does not prevent relief being obtained, particularly where there are outside shareholders or it is a consortium company.
Management and Control
In some countries the residence of an entity may be determined other than by where it is registered or incorporated, such as where the management and control exists. It is important to review regularly how this operates to ensure that this does not affect the residence position. Practice must follow what has been included in agreements and particular care needs to be taken when it comes to the decision making process and determining where authority lies.
VAT
There are specific rules for cross border supplies of services to determine which entity charges the VAT. For Groups, VAT on management charges is often incorrectly applied. Groups need to look at the underlying supply to determine whether the supplier should apply VAT or whether the recipient applies the reverse charge.
Holding Companies
Apart from commercial considerations, the following questions need to be asked when setting up a holding or sub-holding company:
- Can the income of the holding company be received in a tax efficient manner (for instance, are dividends received tax free or with credit for underlying tax)?
- Can profits of the holding company be paid out in a tax efficient manner?
- Can the holding company dispose of its subsidiaries without a tax cost?
- Can the holding company be wound up with minimal tax cost?
- Does the holding company have access to a tax effective treaty network?
NIC and remuneration
You should take account of NIC and social security treaties when moving staff around groups. There are EU rules that enable staff to be moved for short periods. Errors in this area are common with many companies paying too much social security or social security in the wrong territory. You should check the procedures well in advance.
The global economy is a fast moving place and these days operating cross-border is necessary to maintain the competitive edge. As businesses explore new territories and spread their operations across the world, the plethora of tax issues that need to be taken into account are almost mind blowing. Change is the constant when it comes to international tax – as tax authorities struggle to keep up with businesses and strive to maintain their share of the tax cake, there is always something to consider.