Whilst the impact of the coronavirus outbreak remains the main focus for business at this time, international businesses should also consider the effect of some key international tax developments.
Brexit conclusion – fast approaching
The Government has recently reiterated its commitment to the 11 month EU withdrawal transition period, which will end on 31 December 2020 as scheduled, albeit it remains uncertain whether the UK’s future trading relationship with the EU will be on a ‘deal’ or ‘no deal’ basis. Businesses must therefore continue to focus on identifying and addressing the potential tax and wider implications of EU withdrawal whilst also dealing with the immediate challenges of the coronavirus pandemic.
A potential risk area for multinational groups will be the corporation tax treatment of intra-group interest and royalty payments between EU and UK companies. If the UK leaves the EU with no deal, or a basic stripped-down free trade agreement, then from 1 January 2021 such payments involving UK businesses will lose the benefits of access to the EU Interest and Royalties Directive, which exempts from withholding taxes most interest and royalty payments between associated companies in EU member states. If the UK leaves the EU with a wide-ranging trade agreement, however, then whilst UK businesses will not be able to access the Directive itself, an alternative mechanism may be agreed to mitigate withholding taxes.
Subject to the finally agreed withdrawal terms, UK taxpayers may have to rely on the relevant double tax treaty to obtain relief from withholding taxes. The UK already has tax treaties in place with all 27 EU member states, but not all provide for nil rate withholding tax on interest and/or royalties. Where this is the case, and in the absence of further action, additional withholding taxes could increase costs and erode margins.
If the UK leaves the EU with no deal, then the UK will also lose access to the EU Parent Subsidiary Directive which exempts from withholding taxes dividends between EU and UK companies where the recipient holds at least 25 per cent of the capital of the paying company. The UK does not currently apply withholding tax on dividends, so the position will be unchanged for dividends paid by UK companies, but where a dividend is paid by a relevant EU company, UK recipients may again have to rely on the relevant double tax treaty to obtain relief from local withholding taxes, subject to an alternative mechanism being agreed under a deal scenario.
Businesses should begin to quantify their potential exposure to withholding taxes and establish the terms under which treaty relief may be available (eg is a formal clearance required in advance) and, if the withholding tax cost is prohibitive, consider alternative commercial structures.
New withholding taxes in the Netherlands
Groups with entities in the Netherlands should also be aware of upcoming Dutch legislative changes. The Netherlands has recently reformed its withholding tax regime, not with the aim of raising revenue but with the objective of tackling tax evasion. The Netherlands has a long-established domestic withholding tax of 15 per cent on dividends, but new rules will apply withholding tax to interest and royalties from 1 January 2021 at a rate equal to the headline rate of corporation tax of 21.7 per cent (FY21).
However, unlike the dividend withholding tax, this new withholding tax will only apply to payments made to connected parties in either low tax or EU blacklisted jurisdictions, or in what the Dutch tax authorities consider to be ‘abusive structures’ - very broadly structures that lack economic substance or involve a hybrid entity.
Digital services tax
The UK digital services tax (DST) was introduced from 1 April 2020, with the high-level objective of taxing the revenues of search engines, social media services and online marketplaces which derive value from UK users at a rate of 2 per cent. Businesses likely to be within scope of DST are primarily the US tech giants such as Amazon, Netflix, and Facebook.
A number of European states have already introduced a tax similar to DST and other jurisdictions have published plans to follow suit. In response, the Trump administration initiated a formal investigation on 2 June into the potentially discriminatory scope of the various digital services taxes.
The US government is concerned that the scope of the taxes unfairly targets a handful of major US groups. An example of this perceived unfairness might be the quantum of the revenue thresholds beneath which the rules will not apply. The US authorities may therefore argue, for example, that these thresholds have been set at a level to exclude most European groups that would otherwise be in scope of the rules.
If the US investigation concludes that the UK’s DST is discriminatory, it is worth noting that the Trump administration has shown a readiness to use aggressive tariffs as a response to other international barriers to US business. This is only likely to complicate the ongoing UK-US trade deal negotiations.