Most countries impose a withholding tax on payments of interest, royalties and dividends to non-resident individuals and entities. However these withholding taxes can be reduced or eliminated where a double tax treaty applies.
Tax treaties are bilateral agreements between two countries and are not themselves affected by Brexit. In general, for relief under a double tax treaty (“DTT”) to be available the recipient of the income stream (usually interest, royalties and dividends) needs to be the beneficial owner of the income and taxable on that income in the country of receipt unless an exemption applies. It is worth noting here that most dividends received by UK companies, irrespective of whether or not they are received from the UK or overseas, are exempt from UK corporation tax. The devil is always in the detail and there will be exceptions from this general rule.
In many treaties there is a minimum ownership threshold – within Europe this is typically a 10% shareholding and there is sometimes a minimum holding period of 12-24 months.
EU Directives
Prior to Brexit we could rely on the following EU Directives to eliminate withholding taxes and we did not have to rely on individual double tax treaties:
- The Parent-Subsidiary Directive which provides that there is no withholding tax on dividends paid by EU company to 10% EU shareholder, and
- The Interest and Royalties Directive which provides that there is no withholding tax on interest and royalty payments by EU company to an “associated company”. This is defined as an EU company with 25% direct shareholding or an EU company where a third EU company has direct 25% shareholding in both companies.
UK outbound payments post Brexit
- There is no change regarding outbound dividends because the UK does not impose a dividend withholding tax
- Domestic law also provides for the payment of royalties without deduction if there is a reasonable belief that the conditions for paying the royalties gross are met.
- Interest payments will be subject to the deduction of 20% income at source unless the rate can be reduced to nil under a DTT
EU outbound payments
- As the directives no longer apply to EU payers of dividends, interest and royalties they will need to rely on the relevant double tax treaty.
- The UK has tax treaties with all EU members states plus Switzerland. Several treaties provide full exemption for withholding tax on interest, royalties and dividends on 10% shareholdings, and some provide exemption under domestic law if any treaty applies.
- Payments from some countries will however attract withholding tax where previously there was none. This includes dividends from Germany, Portugal and Greece and interest, dividends and royalties from Italy.
Indirect consequences of Brexit on US double tax treaties
Relief under US treaties is normally contingent on satisfying limitation on benefits conditions. One of the tests is that the recipient is 95% owned by ”equivalent beneficiaries”. As the UK will no longer be an “equivalent beneficiary” for these purposes (i.e. an EU/EEA or NAFTA member state) this can result in the loss of the ability to take advantage of the 0% dividend withholding tax rate if the company investing into the US is an EU company owned by a variety of EU and UK shareholders.
Treaty shopping
Many treaties also contain anti treaty shopping provisions. Treaty shopping involves the improper use of a tax treaty, whereby a person sets up an entity in another state with no real economic substance, with the aim of obtaining treaty benefits which would not be available directly.
HMRC views such arrangements as abusive, and as a result many double tax agreements have limitation of benefit clauses or other restrictions which designed to target intermediate companies which are being used to minimise withholding tax.
What next?
It is possible that the UK will be able to renegotiate some existing treaties so that the replicate the position under the EU directives. Alternatively, some EU countries may amend their domestic tax rules to achieve the same outcome.
If companies wish to take advantage of the treaty rates of withholding tax, then they may need to make new or amended withholding tax applications. This is can be a cumbersome process whereby forms need to be submitted to the tax authority of the paying company, after being certified by the tax authority in the recipient jurisdiction to provide evidence that the recipient company is entitled to the relevant treaty benefits.
As a result of the changes, we recommend that all companies that pay or receive interest, dividends and royalties should review their position under the relevant double tax treaties, and take action to make additional claims where necessary. Groups may also wish to consider restructuring where the post Brexit tax position results in unacceptably high withholding tax rates.
Please contact us for more details on how we can help.
