UK Corporate Tax Reform: International Competitiveness
August 2001
The UK Government finally published its consultation document this past July which outlined further corporate tax reforms in order to enhance the competitiveness of the United Kingdom for multinational businesses.
In particular, the consultation document outlines a proposal to exempt from tax gains arising to companies from the disposal of substantial shareholdings. If adopted, the new regime could take effect from March 2002.
The publication is part of a range of reforms which over the last four years have seen the reduction to 30 per cent of the rate of corporation tax, the abolition of Advance Corporation Tax (ACT), the relaxation of the test for group relief (consolidating results for tax purposes) and consultation on a new regime for the taxation of all intangible assets (including goodwill) and research and development tax credits.
The Proposal - Outline
The two main proposals comprise:
- An exemption (not a deferral) from corporation tax in respect of chargeable gains realised on the disposal of substantial shareholdings and
- An exemption for taxation of foreign dividends.
Although the Government clearly favours an exemption from tax on chargeable gains (the first proposal), it has reservations about exempting foreign dividends and suggests, in these circumstances, only a partial exemption to protect its ability to tax Controlled Foreign Company/Sub-Part F (CFC) income and is recommending the retention of the existing credit system.
An exemption of gains is to be welcomed on the grounds of greater simplicity and greater international competitiveness. There is already exemption from corporation tax for foreign gains on substantial shareholdings (and in some cases lower shareholdings) in Austria, Belgium, Denmark (after three years), under the prospective German regime, Luxembourg (after a one-year holding period which is being harmonised for the dividend participation exemption holding period), the Netherlands, Portugal, Spain and the proposed Swedish regime.
The Proposals - In Detail
Capital gains would be exempt, and losses will not be allowable where:
- A qualifying shareholder company;
- Which has held a substantial shareholding in a qualifying investee company throughout a 12 month period;
- Disposes of any shares in that company.
- There would be no requirement for the proceeds from the sale of the shareholding to be used in any particular way.
It will be noted that before relief is available a number of conditions must be satisfied.
A qualifying shareholder company is a company which both before and after the disposal is either a trading company, which is not a member of a group, or any member of a trading group.
It would, therefore, appear to be the case that where the parent company sells its wholly owned single subsidiary, no relief will be available since as a parent company it will not necessarily be a trading company, and after disposal it will not be a member of any group.
The qualifying investee company must be a trading company or the holding company of a trading group.
The definitions of "trading company" and "trading group" have been extensively reviewed and will be satisfied where the actual activities of the company demonstrate that it exists with a trading purpose in mind. Companies carrying on activities, which constitute investment business, are excluded. Such activities include dealing in securities and leasing of any description of property or rights.
It is not certain why the exemption relief has to be confined in this way to disposals by trading companies or members of a trading group in view of the fact that the continental capital gains exemptions do not make this distinction. This will be an observation made as part of further representations to the government during the consultation process.
A substantial shareholding is defined by reference to a 20 per cent threshold. Specifically a "beneficial entitlement to at least of 20 per cent of the investee company’s ordinary share capital, distributable profits and distributable assets."
The proposals indicate that it will be possible to aggregate the interests in the same investee company which are held by members of the same capital gains tax group to test whether or not the substantial shareholding threshold is met.
However, the scope of the exemption is still limited to shares. Securities will not qualify (even if a substantial shareholding is also held) and convertible interests will remain excluded until conversion has occurred.
The document notes the government’s concern that it might be necessary to introduce anti-avoidance measures without which such an exemption would facilitate changes in the tax residence status of a company which were driven more by tax than commercial considerations. Four options have been identified including a review of UK law and practice on company tax residence, amending the rules treating dual resident companies as resident outside the United Kingdom (to keep them within the scope of the CFC Rules) treating the migration of a company as a deemed dissolution tax purposes and some general anti-avoidance rule.
Conclusion
The proposed exemption for capital gains on substantial shareholdings is highly welcome and should make the United Kingdom more competitive internationally. Together with the other recent changes and proposed reforms and one of the largest networks of double tax treaties of any country in the world coupled with a proposed new double tax treaty between the United Kingdom and United States which for the first time proposes a zero withholding tax on certain dividends, the position of the United Kingdom as a major jurisdiction through which to structure global business operations will be reinforced should the Government decide to introduce the new regime described above.
