Relocation, relocation, relocation
This article reviews some of the different mechanisms a group may consider when looking at relocating activities and functions from the UK. It is not comprehensive, but we have focussed on some of the key structural issues and recent developments.
One means of changing the international footprint of a company or group may be to ensure that an existing holding company or group company ceases to be resident in one jurisdiction and becomes resident in another for tax purposes.
A UK incorporated company will be resident in the UK unless it is also resident in another territory outside the UK under the domestic laws of that territory and is treated as not resident in the UK for the purposes of an applicable double tax treaty (DTT) (the treaty non-resident rule; CTA 2009 s 18). It is not open to a UK incorporated company to re-register as a company incorporated in another jurisdiction, so the starting point for a UK incorporated company that is seeking to become tax resident in another jurisdiction will be to focus on the treaty non-resident rule.
That rule is dependent on the domestic residence rules of the other territory. However, if we assume that a change of residence is possible under the applicable domestic laws of the chosen territory, whether this is a feasible route will turn upon the application of the relevant UK DTT.
Double tax treaties
UK DTTs have, in the past, typically contained the previously standard OECD tie-breaker rule to determine residence for the purposes of a DTT of a company which is resident in both the UK and the other contracting state under their respective domestic laws. This rule focused on the "place of effective management" (POEM) as a test for determining the jurisdiction in which the company would be treated as resident for the purposes of the treaty.
Some more recent UK DTTs have moved away from the POEM test as the tie-breaker rule for corporate residence. In cases where a company is resident in both contracting states under their domestic laws, these treaties provide for the competent authorities of the contracting states to resolve the question as to the jurisdiction in which a company is to be treated as resident by mutual agreement (see, for example, the UK/Netherlands treaty). The number of UK treaties which adopt a mutual agreement procedure (MAP) as a form of tie-breaker is relatively few but it is likely to increase significantly. This is a result of the ratification of the multilateral instrument (MLI) by other contracting states as a part of the OECD/G20 BEPS project, the effect of which will be to replace the POEM test in UK treaties with a MAP-based tie-breaker.
In the absence of an agreement between the competent authorities, the effect of a MAP-based tie-breaker will be that the company will not be entitled to relief under the relevant DTT. However, the effect for our present purposes is that a UK incorporated company would remain resident in the UK notwithstanding the fact that it is also resident in the other contracting state unless and until an agreement is in place.
As the MAP involves an application to the competent authorities of both states for a determination of residence, the process of obtaining a ruling under the MAP could take some time. Different countries may take very different approaches: some may be amenable to the process: others less so. Furthermore, the MLI version of the MAP-based tie-breaker provides for the residence position to be determined by reference to POEM, place of incorporation and "any other relevant factors", which leaves plenty of scope for debate between tax authorities on the correct approach.
Moving the residence of a UK incorporated company can therefore be difficult in practical terms. Whilst steps can be taken to identify more clearly the point in time at which the location of management and control changes, there may also be a residual level of uncertainty given the fact based nature of the test.
The tax implications of migration
Exit charges: When a company ceases to be a UK tax-resident, it may be subject to a variety of exit charges. These look to capture: any gains accrued on capital assets whilst the company was resident in the UK (TCGA 1992 s 185); and any profit arising on disposal at a market value at the time of exit of intangible fixed assets (CTA 2009 s 859(2)(a)), financial loan relationships (CTA 2009 s 333), and derivative contracts (CTA 2009 s 609).
If the company is trading, it will be treated as ceasing to trade when it ceases to be UK tax resident and will be required to take into account the value of its trading stock, at its market value, when calculating the profits of the trade (CTA 2009 s 162 and CTA 2009 s 41).
Notification: When a company intends to cease being UK tax resident it must notify HMRC of its intention and provide HMRC with a statement of its tax liability. The company will then need to agree with HMRC arrangements for paying any tax liability on an exit.
Deferral of exit charges: For some time, UK legislation allowed a deferral of the exit charge for corporation tax on chargeable gains (TCGA 1992 s 187) in some circumstances. A similar deferral was permitted for the exit charge on intangible fixed assets (CTA 2009 ss 860–862).
Since December 2012, following the decision of the CJEU in National Grid Indus BV (Case C-371/10), UK legislation has incorporated rules applicable to all corporation tax exit charges which, subject to certain conditions, allow a migrating company to enter into an exit charge payment plan under which it can pay exit charges in instalments or defer payment to the date of realisation of the relevant assets (or, if earlier, ten years following the date of migration) in cases where a company ceases to be resident in the UK but becomes resident in another EEA member state.
Anti-Tax Avoidance Directive: The specific deferral provisions for exit charges for corporation tax on chargeable gains and intangible fixed assets are repealed by FA 2019. FA 2019 (in Schedule 8) also substantially amends the provisions which allow a company to enter into an exit charge payment plan to give effect to the EU Anti-Tax Avoidance Directive (2016/1164) (ATAD). The new rules take effect for accounting periods ending on or after 1 January 2020.
Under the revised rules, in line with the requirements of ATAD, a company will be able to enter into an exit charge payment plan if at the time of the event giving rise to the exit charge the person carries on business in an EEA member state and becomes resident in an EEA state other than the United Kingdom. The exit charge payment plan must provide for the deferred tax to be paid in six equal instalments beginning 9 months after the end of the accounting period in which the company migrates.
The new rules no longer allow an exit charge to be to be postponed until a realisation of the underlying asset. Nor do they permit any postponement of exit charges on a migration by a UK company to a country which is not a relevant EEA state (as defined).
As an alternative to moving the tax residence of an existing UK company, a business may decide to interpose a new non-UK resident holding company above the existing UK resident company; for example, by a share for share exchange or, in the case of public companies, by scheme of arrangement.
The introduction of a non-UK holding company can be tax neutral for any UK resident shareholders. An exchange of shares may qualify for roll-over relief from tax on chargeable gains under TCGA 1992 s 135 (although, particularly in the case of private companies, shareholders may prefer to apply to HMRC for clearance that the exchange meets the motive test in TCGA 1992 s 137). And, although a transfer of shares in an existing UK incorporated holding company to the new non-UK holding company will prima facie attract stamp duty at 0.5% of the value of the shares that are issued in exchange, it may be possible to qualify for relief from duty under FA 1986 s 77.
One clear benefit of this route is that it does not involve any exit charges that might otherwise apply on the migration of an existing company.
Controlled foreign companies
Simply interposing a non-UK holding company on top of a UK group is, of itself, unlikely to achieve much, if anything, from a tax perspective. However, once a new holding company is on top of the group, the next step will often be a reorganisation of the group under which assets or shares in non-UK resident group companies are transferred so that they are held through non-UK resident companies in the group structure. Any such reorganisation will require an analysis of the tax costs of extracting shares and assets from the UK group structure and the implications for the clearance (if any) obtained for the insertion of a new holding company.
This type of inversion structure was typically used by UK companies prior to the reform of the UK’s controlled foreign company rules in order to escape the perceived lack of competitiveness of the UK system by ensuring that foreign subsidiaries were not controlled directly or indirectly by a UK company. That driver for inversion structures has materially reduced:
- first, as we have mentioned the UK’s own CFC rules have been substantially reformed to focus on the diversion of profits from the UK; and
- second, many other jurisdictions are adopting CFC regimes following the recommendations of the OECD/G20 BEPS project. Within the EU, ATAD imposes a basic requirement on all member states to introduce CFC regimes to deter profit shifting to low/no tax countries.
This does not mean that the consideration of CFC regimes is not relevant in this type of structure. It will always be necessary to take into account the potential impact of the CFC regime in the jurisdiction of any new holding company. This may become even more relevant if, as anticipated, the UK’s corporation tax rate continues to fall and, post-Brexit, some of the safe harbours that might otherwise have been available under CFC regimes of other EU member states cease to be available.
Residence, governance and substance
In any of these structures, it will be important to ensure that the holding company is clearly resident in and only in the jurisdiction in which it is intended to be resident. As we have described above in the context of corporate migrations, appropriate governance procedures may need to be put in place to ensure that: the holding company is not resident in the UK; and, where relevant, that the company meets the requirements to be treated as resident in the intended jurisdiction as a matter of its domestic laws; and that any treaty tie-breaker rule will operate in favour of the chosen jurisdiction.
Cross-border payments: Governance and substance issues are also likely to be relevant to the ability of the non-UK holding company wants to claim the benefit of tax treaties to reduce the effects of withholding taxes on payments from its subsidiaries.
In the past, such questions have revolved around the issue of whether or not the recipient is the beneficial owner of the relevant payment. Following the adoption of the MLI and its ratification by relevant contracting states, more UK tax treaties are likely to include the principal purpose test (PPT) pursuant to which treaty benefits will be denied for arrangements where one of the principal purposes of the arrangements is to secure a benefit under the treaty. In addition to the traditional beneficial ownership requirements it will then be necessary to demonstrate the relevant arrangements do not fall foul of the PPT in order to claim treaty benefits. The extent to which the PPT can be met through the provision of relevant substance in the jurisdiction of the recipient entity is a matter of some debate, although the recent OECD Model Tax Convention on Income and on Capital Condensed Version 2017 (10th edition) contains some helpful guidance (see, for example, example G in para 182).
The holding company may also need to rely on EU directives (e.g. the interest and royalties directive and the parent subsidiary directive) in order to mitigate the consequences of withholding taxes on cross-border payments. The requirements for these directives to apply are evolving (see, for example, the four joined cases N Luxembourg 1 (Case C-115/16), X Denmark (Case C-118/16) and C Danmark 1 (Case C-119/16) and Z Denmark (Case C-299/16) (Danmark)), but, once again, governance and substance issues may need to be taken into account in determining whether the directives can apply.
Under both options outlined above, UK resident shareholders will, following any migration or inversion, be receiving any future dividends or other distributions in respect of shares in a non-UK resident company. Those dividends and distributions may be subject to withholding taxes in the jurisdiction of residence of the holding company.
These issues may be of particular relevance to UK resident individual shareholders. UK individuals in receipt of such dividends and distributions will be taxed in a rather different way to the receipt of distributions from a UK company. Dividends will be subject to income tax (under ITTOIA 2005 s 402) and a UK resident recipient may need to claim relief under an applicable DTT and/or claim credit for any non-UK withholding taxes suffered. The rules in CTA 2010 Part 23 will not apply to treat other distributions automatically as income. So there is a greater possibility that non-dividend distributions are taxed as capital.
In more closely-held companies and groups, there may also be a risk that UK resident individual shareholders’ income will be subject to income tax on income or gains accruing to a non-resident holding company under ITA 2007 s 720 or TCGA 1992 s 3.
Relocating assets and functions
Alternatively, a business might change its international footprint by relocating certain assets or functions.
A relocation of assets may of course take place without a change in ownership where a company establishes a presence in another jurisdiction, such as a branch or a representative office. Such a transfer does not usually involve a disposal of assets or other taxing event for UK tax purposes. The creation of a branch will generally result in a proportion of profit attributable to the branch becoming taxable both in the jurisdiction in which the branch is created and in the UK, although a UK company may be able to elect to exclude the branch profits from its profits for corporation tax purposes. That will leave the rather difficult problem of the allocation of profit between the UK company and the branch.
A transfer of assets by a UK company to an associated company outside the UK will be a taxable event for UK tax purposes and any gain or profit usually calculated by reference to the market value of the relevant asset will be subject to tax in the UK subject to the availability of any available losses or reliefs.
The recent First-tier Tribunal decision in Gallaher Ltd v HMRC  UKFTT 207 holds out the prospect that a transfer of assets by a UK company to a group company established in an EU member state might be made on a no gain no loss basis within TCGA 1992 s171 (and so without a charge to UK tax on any gain). The case itself related to the charge to UK corporation tax on capital gains but similar reasoning should apply to charges under other similar regimes (e.g. on a transfer of intangible fixed assets).
The OECD revised its transfer pricing guidelines in 2017 (Chapter IX of the OECD transfer pricing guidelines for multinational enterprises and tax administrations of July 2017) (the OECD guidelines) to include the concept of business restructuring (which it refers to as "the cross-border reorganisation of the commercial or financial arrangements between associated enterprises") and states that a business restructuring is "typically accompanied by a relocation of profit potential". One common example is where functions are relocated from the UK to an associated company in another territory which results in future profit being allocated to the associated company (and therefore a loss of profit-making opportunity in the UK).
Under the OECD guidelines, the arm’s length principle needs to be applied to a business restructuring to analyse whether there is a transfer of value between the parties that would be compensated if the parties involved were independent of each other. This will involve a consideration not only of a compensation payment on the transfer of value but also a consideration of the ongoing requirement for payments to be made between the associated companies (for example a payment equivalent to a licence fee). The application of the OECD guidelines may therefore result in an effective exit charge being applied when functions are transferred out of the UK.
The introduction of the EU Mandatory Disclosure Directive 2018/822 (known as DAC 6) may also impose a notification requirement on intermediaries or a taxpayer where as part of an intragroup cross-border transfer of functions, risks and/ or assets and the projected EBIT of the transferor during the period of three years after the transfer is less than 50% of projected EBIT if the transfer is not implemented (hallmark E). In such case, an intermediary or the taxpayer will be required to disclose the arrangement to the tax authority within 30 days. This is a strict liability hallmark, so it can apply even where obtaining a tax advantage is not one of the main benefits of the arrangement.
Any change in the international footprint of a corporate group will inevitably require consideration of a multitude of issues. This article may be a starting point, but nothing more.
This article was first published by Tax Journal