International review

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Corporate tax reform

Consultation on the changes to the taxation of foreign branches and interim improvements to the Controlled Foreign Company (CFC) rules discussed in my last column continues and HM Treasury and HMRC held an open event on 7 September 2010 to present the proposals.

On the plans for foreign branches it was confirmed at the open event that detailed proposals along with draft legislation for consultation should be published in spring 2011 which suggests it is likely the Government will proceed with introducing the new regime in some form.

The previously announced timetable for the introduction of the CFC interim improvements was re-confirmed with further details and draft legislation due to be published for consultation later in autumn 2010 and the final improvements being legislated for in spring 2011.

It was also announced that further details of the scope and design of the full CFC reform, to be delivered in 2012, will be published in spring 2011. The presenters mentioned that, unsurprisingly given its importance, more than 60 submissions were received in response to the discussion document setting out proposals for reforming the CFC rules which was issued by the previous Government in January 2010. It was confirmed that these responses will be considered when designing both the CFC interim improvements and the new CFC regime.

Debt cap draft regulations

HMRC has published a technical note and draft regulations in relation to the debt cap rules introduced in Finance Act 2009. The aim of these draft regulations is to allow a wider range of financing expenses to be taken into account in calculating the ‘available amount’ which is, effectively, the ceiling on the total interest and other specified financing expenses for which Corporation Tax deductions are available to a group of companies within the scope of the debt cap rules.

The debt cap rules came into effect from 1 January 2010 and many groups are trying to get to grips with this very complex legislation for the first time as year end approaches. It is therefore unfortunate that so much of the legislation is still not final.

Draft regulations on mismatches have not yet been published and numerous amendments to the primary legislation first published in draft last year are still awaiting inclusion in the third Finance Bill of 2010 (confusingly titled Finance (No.2) Bill 2010/11) which, at the time of writing, is expected to be published on 30 September.

EU issues

Taxation of cross-border interest and royalty payments in the EU

On 24 August 2010 the European Commission launched a public consultation on possible amendments to EU Directive 2003/49/EC regarding the taxation of cross-border interest and royalty payments in the EU. This Directive aims to provide a common system of taxation applicable to interest and royalty payments between associated companies of different Member States, in particular by exempting such payments from withholding tax.

The consultation document says that options being considered include: extending the Directive’s scope to other legal entities; reducing the threshold to be considered an associated company; taking account of indirect shareholdings in applying that threshold; alternatively, extending the Directive to payments between unrelated parties. Consideration is also given to how the Directive applies to interest paid by permanent establishments.

Extension of the Directive is to be welcomed as withholding taxes can result in double taxation and restrict cross-border investment – hence the growing number of cases brought before the ECJ by taxpayers and by the Commission to challenge various withholding tax regimes.

The consultation closes on 31 October 2010.

Global update

India: Bombay High Court ruling in Vodafone case

This recent decision of the Bombay High Court in the case of Vodafone International Holdings BV has triggered wide media interest because of its potential repercussions for other foreign investors in India and the disincentive to invest this could cause.

The key point at issue was whether the sale of a Cayman Islands company which held an indirect controlling shareholding in Hutchison Essar Limited, an Indian company, was subject to capital gains tax in India.

Vodafone acquired 100% of the shares in this Cayman Islands company from Hutchinson Telecommunications International Limited and the Indian tax authorities argued that the transaction was subject to tax in India and therefore Vodafone should have withheld tax from its payments to Hutchinson.

The Bombay High Court in its decision has accepted the Indian tax authorities arguments that they have jurisdiction to seek to tax the transaction, although upholds that the legal form of the transaction should be respected. 

It suggests that where an asset or source of income is situated in India or where the capital asset transferred is situated in India, income which accrues or arises directly or indirectly through or from it shall be treated as income which is deemed to accrue or arise in India.

Consequently, the Court implies that some part of the Hutchison transaction could be apportioned between income that has accrued or arisen (or deemed to have accrued or arisen) as a result of an Indian nexus and that which does not. In particular the Court refers to certain ancillary rights and entitlements such as brand, non-compete agreements and option arrangements and suggests (but without deciding) that these might be Indian source and could be taxable.

The exact implications, whilst unclear, could be very far reaching. For example, if a purchaser acquires a non-Indian holding company which has many international subsidiaries, it may still have to apportion part of the purchase price to Indian assets or rights indirectly transferred and withhold Indian tax on that amount.

Vodafone have appealed to the Supreme Court so this is not the end of the story. However, it is worth noting that even if Vodafone were to win the Direct Taxes Code 2010 (see below) proposes to tax transfers outside India of shares in a foreign company, in proportion to the fair market value of assets located in India. This rule will apply if the fair market value of assets in India exceeds 50% of the value of all assets owned by the foreign company.

India: Direct Taxes Code 2010

The Direct Taxes Code (DTC) Bill 2010 was tabled in the Indian Parliament on 30 August 2010. This is the latest stage of a long consultation process for the introduction of fundamental changes to the Indian tax regime. I discussed the main points in my article of 28 June 2010 so will just briefly mention some key issues remaining in this draft.

One of the biggest issues for overseas investors is the proposal to tax transfers of shares in a foreign company holding India assets mentioned above. Other areas of concern are the plans to bring in a new CFC regime and a general anti-avoidance rule which have been retained in this draft. On a more positive note, plans to introduce Advanced Pricing Agreements to minimise transfer pricing disputes are also retained.

The Bill will now be considered by a Parliamentary Standing Committee for six to nine months and further amendments are likely to be made on the basis of their recommendations. When enacted the final provisions will be effective from 1 April 2012.

US: FATCA priority guidance

On 27 August 2010 the US Internal Revenue Service (IRS) released priority guidance with respect to withholding tax provisions of the Foreign Account Tax Compliance Act (FATCA) sometimes more memorably referred to as ‘FATCAt’.

Broadly stated, FATCA uses withholding taxes to enforce detailed reporting and disclosure requirements for certain foreign entities that receive US source income. The main aim is to reduce the need for investigations by the US authorities (in conjunction with foreign governments) of foreign financial institutions that maintain accounts for US taxpayers.

Under FATCA, a US withholding agent must deduct and withhold a tax equal to 30% on any ‘withholdable payment’ made to a foreign financial institution (FFI) unless the FFI agrees to disclose the identity of its US accounts and to annually report certain information (eg, account balance, gross receipts) with respect to such US accounts.

For this purpose, a withholdable payment includes not only the normal categories of US source investment income paid to foreign persons but also includes gross proceeds from the sale or disposal of securities or debt obligations that produce US source dividends or interest.

The new rules therefore provide a significant departure from the existing withholding tax regime by including gross proceeds from the sale or other disposal of certain property as a withholdable payment. In general, FATCA applies to withholdable payments made after 31 December 2012.

The IRS and the US Department of the Treasury have previously stated their intention to release FATCA guidance in stages so that those affected by the new rules have enough time to prepare for the new regime.

The notice the IRS released on 27 August provides preliminary guidance on a number of priority issues including: obligations that will be grandfathered, the definition of an FFI, certain entities exempt from this definition, the FFI verification process for withholding agents and the FFI account identification process.

US: Changes to foreign tax credit regime

Other recently enacted US tax legislation, this time affecting US multinational corporations, includes changes to the foreign tax credit rules. The new legislation stemmed from Congressional concern that US multinationals were using the foreign tax credit regime to reduce US tax in situations that did not give rise to double taxation.

The changes include, amongst others, provisions that:

• Prevent a US shareholder from using loans from lower-tier foreign corporations to manage foreign tax credit utilisation by adding a limitation on the amount of foreign taxes that the US shareholder is deemed to pay to the amount that would have been allowed had an actual dividend been paid through the chain of ownership to the US
• Prevent a US corporation from splitting foreign tax credits from income in instances in which foreign income remains offshore and untaxed in the US while the foreign taxes imposed on the income are currently available as credits to offset the US corporation’s other foreign source income;
• Partially deny foreign tax credits with respect to income deemed not subject to US taxation by reason of certain asset acquisitions (‘covered asset acquisitions’). The new rule disallows foreign tax credits attributable to additional depreciation or amortisation deductions that are taken into account for US federal income tax purposes but not for foreign tax purposes;
• Require US taxpayers to maintain separate foreign tax credit limitation baskets for items of income re-sourced under an income tax treaty;
• Modify the US affiliation rules for purposes of allocating interest expense between US source income and foreign source income.

For many US multina­tionals, the changes to the foreign tax credit regime are likely to limit their ability to use foreign tax credits in certain circumstances which may result in higher US federal income taxation on amounts repatriated (or deemed repatriated) to the United States.

As a result many US multinationals will be currently reviewing cash flows and group operating and legal structures. UK members of US owned groups may well see changes within their organisations as a direct result of these new US provisions.

Chris Morgan has been a Partner at KPMG in the UK for 11 years and is currently Head of international corporate tax. His main areas of focus are cross-border structuring and financing and EU tax law. Email: christopher.morgan@kpmg.co.uk; tel: 020 7694 1714.