The international briefing for May

What’s new?

There has been no let up in the media interest in international taxation over the last month, with many journalists trying to get to grips with the complex rules around what constitutes a permanent establishment, as Google and Amazon both find themselves in the spotlight again. This ongoing debate around tax dominates the first part of this month’s article, and then I move on to looking at a number of interesting technical developments from around the world.

Unsurprisingly, given the media focus, there has been a lot of political attention on the subject of international taxation, including a string of press releases from the chancellor of the exchequer, mainly around transparency and exchange of information. Most notably, on 2 May, HM Treasury announced that all the British overseas territories with significant financial centres have signed up to the government’s strategy on global tax transparency. The Cayman Islands, Anguilla, Bermuda, the British Virgin Islands, Montserrat and the Turks and Caicos Islands have all agreed to much greater levels of transparency of accounts held in those jurisdictions. Gibraltar, which already operates the relevant transparency directives as part of the EU, has also made the same commitments.

There was a meeting of EU finance ministers on 14 May, where tax featured heavily on the agenda. It was announced at the end that they had agreed the mandate for the European Commission to negotiate tax transparency agreements with third countries, including Switzerland and Liechtenstein, which had been stalled for several years. The UK also signed a joint statement with 16 other EU Member States pressing for the development of a new global standard for automatic exchange of information to tackle tax evasion, based on the US FATCA legislation.

HMRC has also been contributing to the ongoing debate and on 2 May published Taxing multinationals: transfer pricing rules, one of its issue briefings on topical subjects. This briefing, which focuses purely on how the transfer pricing rules operate, follows on from an earlier briefing published last October, Taxing the profits of Multinational Companies, which looks at a number of different aspects of corporate taxation, including less detailed commentary on transfer pricing. What is interesting is how, in just six months, the tone has shifted considerably. In the October briefing, HMRC focused on explaining why a multinational may not be paying the amount of tax that some commentators think they should be and how this may be an entirely legitimate result of the way international tax rules operate. However, in the latest briefing on transfer pricing, there is more emphasis on multinationals deliberately exploiting the current rules. This change in tone demonstrates the impact the ongoing debate is having at
HMRC and, in particular, what behaviour HMRC is prepared to defend publicly.

Global update

Australia – 2013 Budget: Australia’s 2013 Budget was delivered on 14 May and included a number of business taxation changes. Of particular interest for multinationals with operations in Australia:

• Thin capitalisation: A number of changes to the Australian thin cap rules were announced which potentially restrict interest deductions. These include a change to the safe harbour gearing ratio for general non-bank entities from 3:1 to 1.5:1 and for certain financial entities from 20:1 to 15:1. Most companies have 13 months to transition, as the proposed commencement is on/after 1 July 2014. The safe harbour minimum equity requirement for banks has also been lifted from 4% to 6%.
• Interest deduction: From 1 July 2014, interest on borrowings used to purchase non-portfolio share investments in overseas subsidiaries will no longer be deductible. This change results from government concerns about the integrity of the corporate tax base. There will, however, be consultation with taxpayers on how this will be implemented.
• Foreign non-portfolio dividends: The current exemption for foreign non-portfolio dividends will exclude shareholdings that are debt for tax purposes (e.g. redeemable preference shares) from 1 July 2014.

There are a number of changes here that groups will need to consider, but the Australian government has given a reasonable amount of time for restructuring before they take effect.

India – services rendered in the UK not taxable in India: In August 2010, I mentioned a case (Linklaters LLP v ITO [2010] 40 SOT 51 (Mum)) concerning the UK law firm, Linklaters, at the Mumbai bench of the Income Tax Appellate Tribunal. Linklaters had no office in India but, as some of its clients had operations there, partners and staff sometimes visited India to render professional services. The tribunal concluded that the firm had a permanent establishment (PE) in India under art 5 of the UK/India treaty and further, that the force of attraction rule in art 7 meant that the entire profits relating to services rendered by them, whether in India or outside, in respect of Indian projects were taxable in India.

A contrary conclusion was reached by a division bench of the tribunal in another case (ADIT v Clifford Chance [ITA Nos. 5034/Mum/2004, 5035/Mum/2004, 7095/Mum/2004, 3021/Mum/2005] – Taxsutra.com) involving the UK law firm, Clifford Chance, and therefore the matter was referred to the Special Bench of the Tribunal to conclude on this matter. The Special Bench has now overturned the earlier decision in the Linklaters case and concluded that, even where there is a PE, the force of attraction principle would not apply to the UK/India treaty and that services provided by the overseas taxpayer outside India cannot be taxed in India.

This is a welcome and sensible outcome in an area where there has been uncertainty for a number of years.

France – 3% surcharge on distributions: I last mentioned the new 3% tax on dividend distributions introduced in France, in response to the CJEU Santander case (joined cases C-338/11 to C347-11), in my article of 30 November 2012. Last month, the French tax authorities published guidance on this new surcharge, so the impact on various common group structures is now clearer. In the following examples, the comments about a UK company would apply equally to any EU resident company:

• A UK company with a French branch: In the great majority of cases, transfers of income between a French branch and its UK head office should not be caught by the surcharge.
• A UK company with a 95% French subsidiary: Where a UK company holds directly or indirectly at least 95% of the capital of a French subsidiary, the 3% surcharge is likely to apply except where specific exemptions apply (e.g. stock dividends). There is a strong argument that the surcharge is contrary to EU law, because a distribution paid to a French parent company with the same shareholding and belonging to the same tax consolidated group as the subsidiary would be exempt. It is therefore likely that there will be a challenge through the courts but this will take time and the outcome is uncertain, so groups in this situation may wish to consider alternative strategies to eliminate or reduce the surcharge. Various options could be considered, such as a cross-border merger to create a branch structure, moving the subsidiary into a French branch of the holding company and forming a tax consolidation, upstream loans, carrying out a capital reduction or stock redemption, etc.
• A UK company with a less than 95% subsidiary: Where a UK company holds less than 95% of the capital of a French subsidiary the 3% surcharge also applies. However, in these circumstances, the EU argument is much weaker and restructuring is likely to be the best approach, although this may well be complicated in practice by the existence of minority shareholders.

Poland – new CFC rules: The Polish government has published draft legislation to introduce controlled foreign company (CFC) rules in Poland from 1 January 2014.

As currently drafted, a CFC will be defined as a foreign company where:

• a Polish taxpayer (corporate or individual) holds directly or indirectly at least 25% of its shares/voting rights for at least 30 days; and
• at least 50% of its income is passive income; and
• at least one category of this passive income is either not subject to tax in the state of residence or is subject to tax at a rate that is at least 25% lower than the rate in Poland (which is currently 19%).

There will also be a blacklist of countries deemed to be engaged in detrimental tax competition published by the Ministry of Finance and any company resident in one of these countries will be considered a CFC.

The CFC provisions will not apply to companies that are engaged in genuine economic activities in other EU/EEA Member States and subject to taxation in those states.

There will also be a de minimis exemption for foreign companies with gross income up to €250,000 and for those whose net income does not exceed 10% of the gross income arising from actual business activities in countries outside the EU.