Groups with international structures will have already been reviewing their group structure in the EU to assess whether it will be optimal for a post-Brexit environment. Clearly, this should encompass the customs and VAT implications and consideration of which group companies import or export and from where – read more here. However, it is also vital to review the funds flow around the group in terms of dividends, interest and royalties.
Where there are significant intra-group payments across borders, groups should pay close attention to the way withholding tax is currently mitigated and whether there is reliance on EU directives or UK membership of the EU to claim tax reliefs. You can check out the rates of withholding tax between the UK and EU member states using our online WHT tool but there are other issues when entities based in the USA are involved.
From 31 January 2020, the UK ceased to be part of the EU and this affects the operation of the UK-US double tax treaty.
US double tax treaties
US double tax treaties, under certain conditions, allow companies that invest in the US to qualify for reduced withholding tax rates on payments from US-based subsidiaries (e.g. interest on intra-group loans or US source royalties).
This benefit can be restricted under the limitation on benefits (LOB) clause in US tax treaties. This clause essentially tests the commercial substance of an arrangement or holding structure to assess whether the granting of treaty benefits is within the intended purposes of the treaty. In the case of groups that are listed outside of the US or the UK, are privately held by individuals who are resident outside the US or the UK or who invest into the US via non-US/UK based structures, they may seek to satisfy the criteria of the LOB clause through reliance on the “derivative benefits provision” in the LOBs that allows treaty benefits to a company resident in the other state (i.e. Luxembourg in the example below) if the two conditions below are met.
The first condition includes a test that at least a certain proportion of the shares (for example, for example, 95% in the case of the Luxembourg/US treaty) of the company claiming the benefits are ultimately owned by seven or fewer persons that are residents of a different EU/EEA member state, or party to the North American Free Trade Agreement with which the other state (i.e. Luxembourg) has a comprehensive double tax treaty. Therefore, in the example below, the Luxembourg company (although it’s a shell company) previously may have met this test if it was ultimately owned by seven or fewer persons that are residents in the UK, and the UK has a comprehensive double tax treaty with the US.
The second condition is that less than half of the company’s gross income is paid (or accrued) to persons who are not "equivalent beneficiaries" as tax-deductible payments. For most group companies this is unlikely to be a difficult test to meet.
Under the withdrawal agreement and the Free Trade Agreement, UK groups have ceased to be resident in the EU or EEA. Therefore, if a UK group invests into the US through, for example a Luxembourg shell company structure as below, it will no longer get the benefits under the current US-Luxembourg double tax treaty. This may mean that withholding tax or a higher rate of withholding tax will apply to intra-group payments made from the US subsidiary to the group company in Luxembourg.
What should businesses do?
The US double tax treaties with other EU member states (including Ireland) will have a similar impact where group transactions are made through those member states. Therefore, any groups that have US subsidiaries and an EU-based financing or investment structure should review their arrangements to examine their future exposure to withholding tax.
As yet we have no indication as to whether, and if so how, either the US Government or the Government of impacted EU member states might seek to address this, for example by amending treaties such that the UK will continue to be regarded as an equivalent beneficiary. Therefore, groups will need to take great care over this issue for the foreseeable future.
For help and advice on international tax issues please contact Ross Robertson, Tim Ferris or Julia McCullagh.