The UK left the EU on 31 January 2020, entering a transition period during which the UK and EU continue to act for most purposes as if the UK were still a Member State. That period is due to end at 11pm (UK time) on 31 December 2020. There may be unexpected tax costs for UK companies with debt/equity interests in EU member state companies after the end of the transition period. Companies need to make sure that they understand the implications this might have on their current international group/debt structures and plan accordingly.
Cross border loans
Issues for UK lenders to associated EU borrowers
What’s the current position?
Many countries (including the UK) impose withholding tax on payments of interest in certain circumstances, however, under the EU Interest and Royalties Directive (the “IRD”), associated companies (companies which have broadly a 25% capital ownership connection) can pay interest on loans gross without any withholding tax being applied to the interest in the borrower’s country of residence.
There are often procedures which need to be followed, but once these are met interest payments may be made without withholding. International group debt arrangements will typically be structured so as to ensure no withholding applies.
What will happen after the end of the transition period?
As the UK will no longer be treated as an EU member state after the end of the transition period, EU associated borrowers will not be able to rely upon the IRD in order to pay interest gross to their associated UK lenders.
Local law and the terms of any double tax treaty agreed between the UK and the relevant borrower jurisdiction will determine whether withholding tax may apply to payments of interest on these loans from 1 January 2021. Although many countries have agreed a double tax treaty with the UK which provides that no withholding will apply to interest payments, there are some countries (e.g Italy, Portugal, Belgium) where some withholding would apply under the terms of the treaty.
Even where the terms of a double tax treaty provide that payments may be made without withholding, there may be additional treaty relief procedures which require to be undertaken in the borrower jurisdiction in order to permit this.
What should we be doing about it now?
UK companies with EU cross border intra-group financing arrangements should now be considering:
- whether interest payments may continue to be made gross after the end of the transition period
- what procedures need to be followed in the EU borrower jurisdiction to permit gross payment, how any delays can be mitigated and what the cash flow implications will be
- if gross payment cannot be achieved, what will the cash flow implications be and which entity will bear the cost? Should intra-group financing arrangements be restructured?
UK borrowers from associated EU lenders
What’s the current position?
As the UK passed legislation to apply the terms of the IRD, assuming there is no change in UK legislation, payments may continue to be paid to associated EU lenders post-transition period on a gross basis (provided HMRC has previously issued an exemption notice).
There are no current indications that the UK intends to change the the legislation, but if it did, the terms of the relevant double tax treaty between the UK and the EU lender country will apply to determine whether the UK borrower should apply UK withholding tax to the interest. The UK has a procedure for applying for permission to make interest payments gross where the lender is a “Treaty Lender”. This can include the overseas company applying for “passport holder” status which speeds up HMRC providing authorisation to pay interest gross.
What should we be doing about it now?
UK businesses should be considering whether their intra-group financing arrangements might be impacted if there were to be a change in legislation in the UK and, if necessary, identify what steps should be taken to allow interest to be paid gross with minimum time delay.
Payments of dividends
What is the current position?
The EU Parent-Subsidiary Directive (“PSD”) prohibits EU member states from imposing withholding tax on dividends paid by a company of one member state (“subsidiary”) to an associated company of the other (“parent”) where broadly the parent has at least a 10% stake in the subsidiary. Member states also need to exempt the taxation of dividends received from a member state subsidiary or at least provide a tax credit for the tax paid at subsidiary level.
In some cases in certain EU member states, procedures need to be followed to pay dividends gross.
What will happen after the transition period?
As the PSD will no longer apply, without any specific agreement between member states, a UK parent may suffer foreign withholding tax on dividends received from EU member state subsidiaries.
Whether withholding applies will depend upon the local law of the subsidiary and the terms of any UK/EU member state double tax treaty. There are some tax treaties agreed with EU member states which do allow withholding tax on dividend payments (e.g. Germany (5%) and Italy (5%)).
Even where a double tax treaty provides for 0% withholding tax on dividends, additional procedures may need to be followed from 1 January 2021 in the EU member state of the subsidiary to allow dividends to be paid gross.
Payment of dividends by UK companies to EU member state parents would not suffer withholding tax after the end of the transition period as the UK does not impose withholding tax on dividends.
Action points
UK businesses should review group structures and any equity stakes in EU member state companies and identify potential increased tax cost from dividend flow, and whether any restructuring is required.
Contributors
Director of Corporate Tax
Partner
