The EU Parent – Subsidiary Directive
Before The EU Parent – Subsidiary Directive came into force, the tax provisions underlying the relationship between the 28 European countries varied depending on the agreement between one European Country and another. As some of these agreements are more favourable than others, having a parent company in Member State A might be more beneficial than having a parent company in Member State B.
The Subsidiary Directive exempts dividends from any withholding tax where certain criteria are met, ensuring that double taxation is eliminated at the level of the parent company by allowing the parent company to claim a relief for underlying tax paid by any of its subsidiary entities.
The criteria which allow such a treatment are when:
- The company is deemed to be a company of a Member State
- The company is considered to be resident for tax purposes in a Member State
- The company is subject to one of the taxes listed in the Annex of the directive
Apart from this, the Parent-Subsidiary Directive also requires the two companies to have a 10% minimum relationship.
Without the Parent – Subsidiary Directive, the bilateral agreements between the UK and the other Member States will serve as the binding law, however, this could lead to certain distributions being subject to withholding taxes. Furthermore, certain Double Taxation agreements may not provide for the relief of underlying tax at the level of the parent company.
The Double Taxation agreement between the UK and Malta outlines that:
- An individual who is a resident of Malta and who receives a dividend from a company which is a resident of the UK, shall be entitled to:
- A tax credit in respect thereof of an amount equal to the tax credit to which an individual resident in the UK would have been entitled to had he received that dividend less 15% of the aggregated of the amount or value of that dividend and the amount of the resident’s tax credit
- Payment of any amount by which the tax credit to which the individual is entitled to by virtue of the above subparagraph, exceeds one’s liability to tax in the UK
- Dividends paid by a company which is a resident of Malta to a resident of the UK may be taxed in the UK. Such dividends may also be taxed in Malta and according to the laws of Malta, however, if the recipient is the beneficial owner of the dividends the tax so charged shall not exceed that chargeable on the profits out of which the dividends are paid.
Distributions by Maltese resident companies to UK persons shall not trigger any withholding taxes. Furthermore, Malta also provides relief for underlying tax, being the tax paid at source to a resident person receiving a dividend from the UK, hence double taxation would be completely eliminated.
This does not necessarily mean that the same binding principles will apply to other relationships with the UK. Thus, it is now all the more important to look at the relationship between the UK and other European countries on case-by-case bases to assess the tax implications of each particular scenario.
Other Binding EU Laws
The European Court of Justice (ECJ) ensures that the fundamental freedoms of the European Union are safeguarded by those decisions taken by the ECJ which are binding to all countries. Despite there being no harmonisation in the area of direct taxation, a form of ‘back door’ harmonisation policies has arisen from these ECJ case laws.
By leaving the EU, the UK is no longer bound by the decisions taken by the ECJ. A good understanding of this change can be grasped when reviewing the landmark decision taken in the Marks & Spencer PLC, Case C-446/03 as outlined hereafter.
Marks & Spencer had loss-making subsidiaries in Belgium, France and Germany and wanted to offset these foreign losses against its UK profits. Whilst group loss relief in the UK was restricted to losses of the UK resident subsidiaries, the ECJ determined that the UK group loss provisions would not observe the principles of proportionality and go beyond what is necessary to reach the objective being pursued by UK regulations where the non-resident subsidiary company has exhausted all possibilities available in the state of residence by using the losses in that particular jurisdiction. Therefore, the ECJ allowed Marks & Spencer to claim a deduction for the losses incurred by the foreign subsidiary, since those subsidiaries in Belgium, France and Germany had already exhausted all possibilities of utilising those losses in the state of residence.
Given the uncertainties, it is not yet indicative whether the UK will have to be bounded by such ECJ decisions, and how the UK may amend its laws – and this would typically depend on what the British Law makers would want in their new EU trade agreement.
The European Union also imposes certain rules of Transfer Pricing between the Member States whereby the principle of ‘an arm’s length transactions’ would generally come into force. Typically, countries have the right to tax income and capital gains based on the territoriality rules in a structured and organised manner, not leaving space to aggressive tax planning and in turn leading to Tax avoidance. In absence of such rules, countries would be bound by their domestics laws, and where provisions are included, the Double Taxation agreements agreed by the UK and the European Countries.
VAT laws are harmonised across the EU through the implementation of a Directive. Despite this, the UK is likely to keep the VAT rules and therefore one cannot expect to see much changes in the short-term. However, over time, laws may be amended, altered and new laws may be enacted. The EU and the UK might take their legislation in separate ways and hence the two jurisdictions may create alternative VAT treatment, leaving taxpayers exposed in certain situations.