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“Brexit” and withholding taxes

A key change arising from the end of the transition period on 31 December 2020 is that the UK is no longer bound by either the EU Parent-Subsidiary Directive (PSD) or Interest and Royalties Directive (IRD). In addition, and of particular relevance to structures with UK parents or intermediary companies, EU resident companies are similarly no longer bound by the directives insofar as payments to UK companies are concerned.

What are the directives?

Broadly speaking, the PSD exempts withholding tax on dividends when the payee is an EU resident company that owns at least 10% of the capital in the relevant payer.

Similarly, the IRD exempts interest and royalty payments from withholding tax when the payer and the payee are EU resident companies and there is either: a direct 25% or more ownership relationship between them; or 25% or more of each is directly owned by another EU resident company.

These ownership requirements need to be met for an uninterrupted period of 2 years in order for the relevant relief to apply.

What does this mean for UK companies?

In short, UK companies that have relied on either the IRD or PSD to receive payments from EU companies free of withholding prior to 1 January 2021 are no longer be able to do so.

Instead, such companies will need to consider whether there is any:

  • possible relief or exemption under domestic legislation (i.e. the domestic legislation that applies to the relevant EU company making the payment); or
  • in the absence of any such domestic relief, whether there is any relief under the relevant double tax treaty between the UK and the relevant EU jurisdiction.  

If there is no applicable domestic relief (a point that should be confirmed by local tax counsel), the treaty position should be carefully considered:

  • A number of UK treaties include specific provisions that need to be satisfied in order for the relevant relief to apply; these are often related to required ownership levels (for example, a requirement for the payee to hold at least 10% of the capital of the payer) or the type of entity receiving the payment (for example, there may be a distinction between a company and a tax exempt pension fund).
  • Furthermore, a number of UK treaties have seen the introduction of anti-avoidance provisions following the Organisation for Economic Co-operation and Development’s focus on base erosion and profit shifting. One of these provisions is intended to a deny a treaty benefit where it is reasonable to conclude, having regard to all relevant facts and circumstances for this purpose, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in those circumstances would be in accordance with the object and purpose of the relevant provisions of the treaty.  While in the past it may be have been possible to insert an intermediary company in a ‘friendly’ jurisdiction to address a withholding tax issue, this will highly likely fall foul of such avoidance provisions today.

What does this mean for EU companies?

The recently enacted Finance Act 2021 provides for the repeal of UK domestic legislation giving effect to the IRD. The repeal of these provisions is intended to ensure that EU resident companies will cease to benefit from UK withholding tax exemptions now that the UK no longer has an obligation to provide relief under the IRD. Subject to certain anti-avoidance measures, the repeal takes effect in relation to payments made on or after 1 June 2021.

In other words, as from 1 June 2021, EU companies will similarly need to consider whether there is any:

  • possible relief or exemption under UK domestic legislation; or
  • in the absence of any such UK domestic relief, whether there is any relief under the relevant double tax treaty.  

EU resident companies will not be impacted by the UK not being bound by the PSD as the UK does not impose a withholding tax on dividends.

Examples of the impact of the PSD/IRD no longer applying

Despite the UK’s broad network of double tax treaties, companies should not assume that the existence of a treaty means the level of relief will be the same as previously provided under the directives. By way of example:

  • dividend payments by companies in Germany, Ireland, Italy and Luxembourg to a UK company may now be subject to local withholding tax of 5% where the PSD used to apply to exempt any withholding tax; and
  • interest payments by companies in Italy, Malta, Belgium and Portugal to a UK company may now be subject to local withholding tax of 10% where the IRD used to apply to exempt any withholding tax.

It is worth emphasising that each payment should be considered on a case by case basis as there are number of factors that could determine whether a relief or exemption is available.

What to do next

If you think that your structure is now or could in the future be impacted by these changes, please do not hesitate to contact us.

In addition to advising you on the UK consequences of the PSD and IRD ceasing to apply, through our network of international offices and connections with leading local law firms, we can also assist you with obtaining advice in relation to the non-UK consequences too.  

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