15 July 2022
A number of international tax developments may impact on businesses with international interests.
Deferral of pillar two
The UK government announced on 14 June 2022 that its implementation of pillar two of the OECD’s proposed solution to address the tax challenges arising from the digitalisation of the global economy is to be deferred from 1 April 2023 and will now take effect for accounting periods beginning on or after 31 December 2023.
The Government’s announcement attributes the deferral to key themes that emerged from the responses to its public consultation on the implementation of pillar two, which ended on 4 April 2022, including:
- the importance of providing businesses with sufficient lead time prior to implementation given the complexity of the rules;
- the need for businesses to develop and implement the infrastructure required to ensure compliance;
- the fact that certain fundamental aspects of the pillar two rules (eg safe harbour provisions) have yet to be finalised at an international level; and
- the likelihood that UK implementation of the rules from Spring 2023, as originally envisaged, would have preceded the start date in many other countries, which could, ‘compromise the long-term sustainability of the regime and put UK businesses at a competitive and administrative disadvantage.’
The finalisation of the pillar two rules by the OECD is currently not expected until late 2022 or early 2023. The decision to defer implementation in the UK is, therefore, welcome. Time will tell, however, if this additional lead time will be sufficient to address the key concerns raised in consultation responses.
New UK : Luxembourg double tax treaty
A new double tax treaty between the UK and Luxembourg was signed on 7 June 2022 and is expected to come into force in 2023.
The new treaty includes changes relating to the taxation of chargeable gains arising on the disposal of UK real estate, which will be of interest to certain property investors.
Of potentially wider interest, is the removal of the 5 per cent dividend withholding tax that currently applies under the terms of the previous treaty. While no such withholding tax applies to dividends paid by UK companies, the change is relevant to dividends paid by Luxembourg companies to UK shareholders, for which the 5 per cent withholding tax currently deducted by those companies represents a cost to UK company shareholders if the dividends are within the scope of the UK dividend exemption and to certain UK individual shareholders with low levels of dividend and/or other income.
Luxembourg companies considering paying dividends to their UK parent companies and other shareholders may therefore wish to defer such payments, where commercially possible, in order for those shareholders to benefit from the new 0 per cent rate that should apply once the new treaty enters into force.
More generally, this new treaty is evidence that action is being taken to update the UK double tax treaty network following the UK’s withdrawal from the European Union (EU). It is critical that the government continues to renegotiate double tax treaties with EU member states that currently impose withholding taxes, particularly major trading partners such as Spain, Germany and Italy, as UK entities are no longer able to benefit from the exemptions from withholding taxes afforded by the EU parent-subsidiary and interest and royalties directives.
The so-called ‘FinCo exemption’ forms part of the UK controlled foreign company (CFC) regime and provides for a reduced effective rate of corporation tax to be applied to the profits of certain offshore finance companies controlled by UK companies. In its original form, the FinCo exemption applied between 1 January 2013, when the current CFC regime was initially enacted, and 31 December 2018. However, it was amended following a European Commission decision that it provided an unfair competitive advantage to UK resident companies and therefore constituted illegal state aid, and that the relevant tax savings they had achieved should be recovered. Following hearings in late 2021, the European General Court upheld the Commission’s decision in June 2022, although it appears likely that the UK government and certain taxpayers that applied the rules prior to 31 December 2018 will lodge an appeal to the European Court of Justice.
The decision is, of itself, limited in its application, but it is a reminder of the continued influence of EU courts on the UK tax code. EU derived law that remains on the UK statute books may be subject to amendment as the UK realigns itself following withdrawal from the EU, but taxpayers should ensure that, where filing positions have been taken that rely on the application of EU-derived law, steps are taken to verify that the UK legislation remains valid and continues to support their position.
New foreign tax credit relief rules in the United States
New US domestic regulations that determine whether a foreign tax is creditable for US federal income tax purposes are causing significant concerns for US businesses. The new rules primarily apply to taxes paid or accrued for years beginning on or after 28 December 2021. Whilst the new regulations include many features of the previous rules, a new attribution requirement, also referred to as ‘jurisdictional nexus’, is the focus of the concern.
This attribution requirement introduces tests based on activities, sourcing, and the location of property in relation to the foreign tax. These tests are intended to limit the scope for claiming credit for foreign digital services taxes against US federal income tax, but the broad framing of the attribution requirement has created wider issues. There is a concern that the new jurisdictional nexus requirement may preclude credit claims for a range of taxes that were previously creditable (eg withholding taxes on royalties, withholding taxes on certain services performed outside the country imposing tax (eg Latin American and Caribbean countries), and taxes paid in jurisdictions whose transfer pricing rules do not adhere to the arm’s-length standard). If this proves to be the case, US parent entities may be exposed to double taxation, and this is likely to have adverse implications for the competitiveness of affected US businesses.
The US Treasury is currently being lobbied to amend the new regulations to ensure they are better targeted, and these rules may be subject to amendment in due course. In the meantime, however, non-US businesses owned by US entities, may wish to take a closer look at how these new regulations apply to their particular circumstances with their US counterparts. For UK businesses, this analysis will likely focus on whether taxes withheld in respect of royalties paid or payable by a UK subsidiary are creditable in the US.
For more information, please get in touch with Suze McDonald, or your usual RSM contact.