Leaving the EU: Tax impact on dividends and interest
The decision to leave the EU, following yesterdays referendum will no doubt have a number of implications for direct and indirect taxes.
In this article we look at the impact on the tax treatment of dividends and interest assuming the removal of the Parent-Subsidiary Directive and the Interest and Royalties Directive for the UK.
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Leaving the EU: Tax impact on dividends and interest
The decision to leave the EU, following yesterdays referendum will no doubt have a number of implications for direct and indirect taxes.
In this article we look at the impact on the tax treatment of dividends and interest assuming the removal of the Parent-Subsidiary Directive and the Interest and Royalties Directive for the UK.
The Parent-Subsidiary Directive eliminates withholding tax on dividends paid between associated companies within the EU and the Interest and Royalties Directive eliminates withholding tax on interest and royalty payments between associated enterprises within the EU. If those directives were no longer to apply, double taxation of dividends could arise for groups with a UK parent and EU subsidiaries or EU parent and UK subsidiaries and there could be withholding tax costs on payments of interest and royalties into the EU from the UK and vice versa (subject to applicable double tax treaties).
How would this work?
If the UK leaves the EU, it will no longer be required to give effect to the Parent-Subsidiary directive.
This provides that where a parent company in one EU Member State receives distributions of profits from a subsidiary company in another EU Member State, the EU Member State of the parent company must not tax the receipt or, if it does it must allow the parent company credit for tax paid by the subsidiary company in respect of the profits distributed.
If the UK leaves the EU and so the Parent-Subsidiary directive no longer applies, a group of companies with a parent company in the UK and subsidiaries in an EU Member State or a parent company in an EU Member State and subsidiaries in the UK may become subject to double taxation in respect of profit distributions, unless a double tax treaty or similar arrangement prevents such double taxation.
The UK is one of the jurisdictions that have concluded the greatest number of double tax treaties including with all current members of the EU. Some treaties however do not wholly relieve withholding tax on payments of dividends by subsidiaries to their UK parents (e.g. the payment of dividends by German subsidiaries to UK parents).
What impact would this have?
In fact it may not have as big an impact as you'd initially think, particularly on the tax treatment of inbound and outbound flows of intercorporate dividends.
Dividends
Current UK domestic legislation already provides for more favourable tax treatment than the EU Parent-Subsidiary Directive, exempting incoming foreign dividends without restriction. It also applies no dividend withholding tax to outbound corporate dividends (unlike the directive, which exempts dividends from withholding tax, but allows Member States to make the exemption subject to certain conditions).
However, there could be implications for the operations falling under the scope of other EU corporate tax law. Here, Brexit could increase the risk of less favourable tax treatment of operations between UK companies and EU companies.
Interest
Interest paid by an EU company to a company resident in a post-Brexit UK would no longer necessarily benefit from the abolition of withholding tax at source under the Interest-Royalties Directive.
The directive ensures that interest and royalties are only taxed in the recipient's state of residence. Such treatment is more favourable than under double tax conventions based on the OECD model. This permits taxation both by the residence state of the recipient (through inclusion in the corporate tax base) and by the residence state of the paying company (through a withholding tax). Furthermore, it only requires the residence state of the recipient company to offer tax credit for the foreign withholding tax.
In the absence of specific post-Brexit arrangements, any EU Member State could reintroduce withholding tax for interest payments by its own resident companies to group companies resident in the UK. In such case, the only way for the UK to maintain (from the viewpoint of group companies) the attractiveness of exclusive taxation would be to grant a unilateral exemption for incoming foreign interest payments.
Alternatively, the UK may re-visit some of its withholding tax rules and perhaps abolish the requirement to withhold tax on interest given the gradual erosion of the practical incidence of withholding in recent years and the fact that several other European jurisdictions do not levy withholding tax on interest.
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