Currently, being a member of the EU, the UK benefits from two valuable tax reliefs in relation to withholding tax (WHT) on interest, royalties and dividends, which are paid both to the UK and also from the UK to other EU member states. These two reliefs are:
For EU groups of companies, dividends can currently be paid between associated companies without the need for tax to be withheld.
The IRD currently allows EU companies to make interest and royalty payments to associated organisations within the EU without needing to deduct tax from the payments.
On 1 January 2021 both of these valuable reliefs may no longer apply, potentially leaving both UK and EU resident companies with the need to account for WHT on the payments they make.
HMRC have published guidance on the impact of Brexit on WHT on interest, royalties and dividends under the banner of: New rules for January 2021. However, currently their guidance is not conclusive on the impact with statements such as:
“From 1 January 2021, the way that interest, royalties and dividends are paid between UK and EU companies may change and tax may be deducted from some payments.”
Clearly, this is unhelpful for business as it provides them with no certainty. What we do know is that some EU countries are seeking to amend their domestic tax legislation in relation to WHT in the short term, thereby softening the blow for not only their own resident businesses, but also UK business that have an interest in the territory.
However, on the basis that there is still much uncertainty, it is sensible for businesses to continue to model their plans based on the worst case scenario should WHT revert back to treaty rates.
The UK domestic law does not currently impose any obligation to withhold tax on dividend payments. There will therefore be no impact on dividends paid by UK companies to companies resident in the EU after 1 January 2021.
From 1 January 2021, the PSD is unlikely to apply to dividends paid to the UK by companies resident in the EU. Dividend payments which were previously exempt from domestic WHT under the PSD may require WHT to be deducted. The applicable double taxation treaty will therefore need to be considered to see if it totally exempts dividends from WHT, as in the case of France or Spain, for example, or whether it imposes a limit on the level of WHT that can be deducted.
To benefit from the reduced treaty rate, a new or revised WHT application may need to be submitted to the EU taxing authority of the payer.
Some EU member states (e.g. Portugal) will only allow a reduced rate of tax under the double taxation treaty if the dividends received by the UK company are ‘subject to tax’ in the UK. A decision will therefore need to be made as to whether it is advantageous to elect for the dividend received in the UK to be taxed to secure the treaty rates of WHT.
“Many companies that currently do not suffer WHT on intra-EU group dividends seem unaware the PSD and IRD Directives may disappear from 1 January 2021.
“In many, but not all situations, the UK’s double taxation network with EU countries will enable groups to mitigate the WHT requirement. However, treaty reliefs are not automatic and generally must be applied from the local taxing authority. This process can be time consuming and can, in some situations, lead to payments needing to be delayed to prevent WHT occurring.
“I would strongly advise companies with overseas operations to urgently evaluate their cross border transactions, identify where they may have a potential WHT tax problem and put preventive treaty applications in place.”
UK companies, and EU companies that have a permanent establishment in the UK, will now need to consider whether they are obliged to deduct WHT from payments of royalties and interest made to associated companies in the EU.
Royalty payments will still be able to be made gross and without UK WHT being deducted if the payer reasonably believes that the payment meets the conditions for exemption as set out in the UK tax legislation.
The UK tax legislation also allows for interest payments to be paid gross. However, this exemption is not automatic and the person receiving the interest payments will need to apply for the exemption by completing the appropriate treaty relief form. This form also enables a repayment claim to be made for any WHT suffered.
After 1 January 2021, the position in relation to interest and royalty payments from the UK should therefore remain unchanged, although it will be important for UK companies to ensure the recipient of the payments has the correct treaty relief forms in place.
From 1 January 2021 the IRD will no longer apply and therefore some EU states may require WHT to be deducted on future interest and royalty payments.
In the absence of the IRD, the quantum of tax to be deducted at source will be determined by the level set in the appropriate double taxation treaty between the UK and the EU member state. In many cases, such as the Spanish, French and German treaties there will continue to be full exemption from WHT.
To benefit from the tax treaty, a treaty application form will usually be required to be completed and stamped by the overseas EU taxing authority to enable the payer to make the payment at the reduced treaty rate, or be exempted. The form can also be used to claim back some or all of the WHT already suffered within the terms of the double taxation treaty. Most of the forms which are required should be available on HMRC’s website.
“Brexit discussions have been in the headlines for so long now, with no clear outcome. In these circumstances, it would be easy for companies to hesitate before taking action, however time is clearly running out. Times are currently tough, particularly in this current COVID environment, with companies having to be competitive, and this can mean reducing prices.
“In order to protect their margins, they need to consider costs such as WHT and take mitigating actions to reduce their exposure to such taxes. This is the time to innovate and to consider whether there are other locations that combine favourable WHT rates with attractive trading markets. Failure to plan and take action now may set UK companies behind the competition at a time when they are likely to innovate and rationalise their operations to stay ahead.”
There are four actions we would recommend that groups with EU interests take to prepare themselves for 1 January 2021 and the UK’s eventual exit from the EU.
Review and identify existing dividends, interest and royalties that are being paid cross border with the EU.
Assess whether any elections are required (and are beneficial) to tax dividends in the UK to enable treaty relief to be available.
Consider what the double tax treaty position will be for each; the WHT applications already in place and what new treaty forms are required in the jurisdiction of the paying company to enable payments to be made with the benefit of the treaty rate.
Monitor local EU country legislation for any changes to mitigate the UK's departure from the EU.
Review the wider group structures to assess whether it may be necessary to reorganise the EU group to mitigate the UK's departure from the EU.
Partner and Head of Tax
“Companies and groups have become used to relying on EU directives to reduce or eliminate WHT and to simplify their administration costs and procedures.
“Come 1 January 2021 it will be essential that those businesses with overseas interests in EU territories determine whether this will have a real cash cost, particularly if they are charities, non-taxpayers, or are a loss-making entity.
“For group structures, it will not just be WHT which may disappear. Other direct tax reliefs and simplifications which are currently in operation may also soon cease to exist, so it is vital that specialist advice is sought to ensure compliance and to reduce the risk of unnecessary impacts on operations.”
For further support and assistance in evaluating your withholding tax position, please contact Simon Crookston.