Issue 69 - 12 Feb 2007
Sentiment
Finally winter has arrived – a couple of centimetres of snow and the UK grinds to a halt; some things never change! I’m also feeling my age – I have been pouring over the first edition of the ITN and was amazed that we are 6 years young this month. A lot of water has gone under the proverbial bridge since our inaugural edition and long may that continue to be the case. I’m ashamed to say that as time goes by so my carbon foot-print gets bigger – I had a fabulous three day trip to Hong Kong and Taiwan (made all the more interesting by bumping into Take That on the ‘plane – a dream come true!), followed by three day’s skiing in Lech, Austria. A bigger difference you couldn’t imagine: Hong Kong all hustle and bustle, while Lech is a picture of real breathtaking beauty, not to mention the after ski! Sage and Zoe are now back from their academic studies at the IBFD in Amsterdam, which went very well. We have a variety of interesting deals on the go at the moment, ranging from advising on a fine art investment fund, to a significant UK land development project all the way through to a solar panel / renewable energy fund in Spain and relocation of a corporate executive to Scandinavia! This edition of the ITN is equally varied and we hope you enjoy reading the latest news.
Happy reading!
Tax tip of the day
Hungary as a holding company regime
Hungary has become a competitive EU holding company location since it became an EU member in May 2004. It has an extensive double tax treaty network enabling Hungarian-based holding companies to benefit from a reduction in withholding taxes on dividends, interest and royalties.
A Hungarian resident company will be subject to corporate income tax on its worldwide income at 16% and solidarity tax of 4%, which broadly equates to an effective corporate tax rate of 20%, one of the lowest in Europe.
The Hungarian tax regime for holding companies already featured a participation exemption from corporate income tax for all inbound dividends without a minimum participation threshold. As of 1 January 2007, the participation exemption is extended to capital gains. The participation exemption will apply in relation to capital gains on the sale of a participation acquired after 1 September 2006 where the participation is at least 30% in the capital of a Hungarian or foreign company (except for controlled foreign companies), the taxpayer has informed the Hungarian tax authorities of the acquisition and the participation is held for at least two years.
Further, there are no withholding taxes on dividends, interest and royalty payments made from a Hungarian company to resident and non-resident companies. In addition, from 1 January 2007, taxpayers will be able to request advance transfer pricing rulings, providing clarity and certainty about pricing.
These tax benefits together with Hungary’s much-improved infrastructure and its economic and political stability, make it an excellent holding company location which may bring about some interesting planning opportunities.
Italy
Changes to the trust regime
The Italian Corporate Income Tax Code (TUIR) has detailed new tax rules with respect to trusts, which stipulate that resident and non-resident trusts are subject to Italian corporate income tax in accordance with the general principle provided by Art. 73(3) of the TUIR (i.e. a company is considered resident if its legal seat, place of effective management or main business purpose is in Italy for the greater part of the financial year). Furthermore, based on the new rules, a trust established under the laws of a country with which Italy does not have an adequate exchange of information system, is deemed to be resident in Italy (unless proof to the contrary is given) if:
- At least one of the beneficiaries and one of the settlors is tax resident in Italy; or
- An Italian resident person, whether an individual or corporation transfer real estate or any right thereof to the trust.
Further, income derived by the trust is attributed proportionally to the beneficiaries and qualify as income from capital in their hands. This is an interesting development and will no doubt pose some unusual questions – if a beneficiary does not know they are a beneficiary of a trust how will the law apply? If the beneficiary is a minor, what is the effect of the new provisions? Are there types of trust which could be used which do not fall within the rules and are their quasi-trust arrangements, such as a company limited by guarantee with shares, an alternative to consider?
United Kingdom
Controlled Foreign Companies
Following the recent ECJ ruling in the Cadbury Schweppes case (as reported in ITN 65) draft legislation was published in the Pre-Budget Report amending the CFC rules to comply with EC Law.
Under the UK's current CFC rules, a UK parent company can be taxed on the profits of subsidiary companies located in jurisdictions, which are classified as low tax. Ireland, Cyprus and Gibraltar currently fall into this category. Whilst there are exceptions from this tax charge, these are very limited. Following the opinion of Advocate-General Léger, the ECJ have made it clear that the establishment of a company to take advantage of a favourable tax regime was not an abuse of UK tax laws, as long as the CFC operated from genuine offices and employed genuine staff.
Effective from 6 December 2006, the rules are relaxed by allowing UK parent companies to apply to HMRC to disregard the profits of their subsidiaries where they arise from genuine economic activity in business establishments in other EU Member States or certain other states in the European Economic Area. Currently the CFC charge is calculated by reference to the amount of chargeable profits of a CFC apportioned to the UK parent company. The new rules amend the “exempt activities” test so that a CFC in an EU Member State will only be considered to be “effectively managed” in that State on condition that there are adequate individuals working for that company who have the proficiency and power to carry on the business of that company, i.e. more than mere nominees or administrators. The German authorities have also published guidelines in response to this case (please see below under Germany), setting out what they consider to be “substance indicators”, which we believe will be very useful in a practical context.
The ECJ handed this case back to the UK courts and for this reason it is surprising that draft legislation has been published regarding the issues in the Cadbury Schweppes case prior to the final verdict of the Special Commissioners.
European Union / the Netherlands
Dutch patent box regime approved
On the 25 January 2007 the European Commission approved the Dutch patent box regime under the state aid procedure. Under the patent box regime, the “net earnings” derived from a self-developed intangible asset are taxed at an effective rate of 10%. As a result of the approval, the patent box regime entered into force with retroactive effect from 1 January 2007.
The patent box regime was notified together with the group interest box regime. Under the proposed interest box regime, the balance of interest income earned and interest expenses incurred in relation to loans taken up from or granted to related parties is taxed at an effective rate of 5%. The latter regime is still being investigated by the European Commission under the state aid procedure.
France
Guideline on French CFC rules published
On 16 January 2007 the French tax administration published Guidelines on controlled foreign company (CFC) rules. As from January 2006 the French CFC rules apply to resident companies that directly or indirectly own an interest of more than 50% in a foreign legal entity or permanent establishment, which is established or constituted in a country with an effective tax rate which is 50% lower than that of France.
The most important features of the Guidelines can be summarised as follows:
Determination of low-tax jurisdictions
To determine whether a jurisdiction is low tax a comparison must be made between the tax burden effectively borne by the foreign entity in that jurisdiction and the one that would apply if the foreign entity was operating in France. The Guidelines note that a foreign tax regime providing for a participation exemption regime on capital gains, similar to that of France, may not, in itself, constitute a low-tax jurisdiction.
Determination of deemed income
Based on the CFC rules, income derived by the CFC, is deemed to constitute passive income or business income for the French company. In general the income is deemed to be distributed in proportion to the financial rights (not the voting rights) directly or indirectly held by the French company. According to the Guidelines losses from the French entity may be offset against CFC profits. However, losses from the foreign CFC may not be offset against profits of the French entity.
Double tax relief
- it may be possible to off set foreign tax due on the profits falling under the French CFC rules against the corresponding French tax;
- withholding taxes on passive income, received by the foreign entity and levied by third countries that have concluded a treaty with France containing an administrative assistance clause, may be credited against the French tax due on such income up to the amount provided for by the tax treaty.
In the Guidelines it is furthermore clarified that the French CFC rules do not apply:
- within the EU unless the structure is purely artificial and the sole purpose is to avoid French tax. Whether a structure is purely artificial will be determined according to the meaning provided by the ECJ in the Cadbury Schweppes case; The ECJ held that a genuine establishment must be something which pursues economic activity. Artificial arrangements would be those which do not reflect an economic reality and which are undertaken in order to escape tax on profits on activities which would otherwise be generated in another member state. The creation of a fictitious company operating solely as a "letter box" or "front" would have the characteristics of a wholly artificial arrangement.
- with regard to non-EU entities, if the entity is principally engaged in commercial and industrial activities. However, even if this is the case, the French company must prove that the operations of the foreign structure are not only motivated by tax reasons if:
- the income derived from the management of shares, participations or assets for its own account or for the account of group companies which are directly or indirectly controlled by the French company, or from the sale or concession of intangible rights related to industrial or intellectual property, exceeds 20% of the total income; or
- the income derived from operations mentioned in a) and intra-group services exceeds 50% of the total income.
Germany
As stated above the Federal Ministry of Finance issued a circular on 8th January clarifying the application of German CFC rules following on from the Cadbury Schweppes case. The circular states that no CFC taxation maybe applied if the German taxpayer proves that the CFC performs real economic activities in the low-tax country. The circular is very helpful in that it gives examples of what these activities might be, which we have termed “substance indicators”, which are as follows:
- the CFC should have active, permanent and sustainable market participation;
- the CFC should employ personnel with sufficient qualifications to run the business and fulfil the tasks of the CFC;
- the CFC should generate income from its own activities; and
- the added value to the business as a whole should be proportionate
If the above boxes are ticked the CFC should have sufficient substance to fall outside the scope of the antiavoidance provisions.
