UK holding companies – key tax considerations – Commentary

After a protracted exit from the European Union, the United Kingdom continues to be one of the most attractive locations for holding companies. The (current, at least) UK government appears committed to ensuring it remains this way. While the corporation tax rate may be on the up (increasing from 19% to 25% in April 2023), the United Kingdom has cultivated a holding company-friendly tax system where, among other things:

• dividends are generally exempt from tax in the hands of the recipient company;
• withholding tax is not charged on distributions; and
• relief is available for capital gains tax on the disposal of wholly owned trading subsidiaries.

This article considers these characteristics of the UK tax system and examines the key tax considerations for corporates looking to establish a holding company and how tax-efficient the UK system is in relation to these considerations.

A key tax issue for a corporate group establishing a holding company is whether that holding company will be able to receive dividends without incurring material tax. Dividends received by a UK holding company will typically be exempt from corporation tax, although the precise exemption will need some consideration.

There are a number of routes to exemption and the conditions for each of these routes are generally easy to satisfy for a UK holding company. For example, there is an exemption from corporation tax on dividends received from a company that is controlled by the holding company (subject to a few additional conditions).

Interest paid to a UK holding company is generally taxable for UK corporation tax purposes but can be offset by deductions in respect of interest payments by the company.

The United Kingdom also has one of the widest double taxation treaty networks in the world. These treaties can help to mitigate local withholding taxes on payments of dividends and interest to a UK holding company.

Other useful benefits of the United Kingdom as a holding company jurisdiction are low or minimal withholding taxes on returns to investors and the availability of tax deductions on those returns. The nature of the returns will dictate the specific tax rules that apply in the United Kingdom, and these returns are typically either interest on debt funding from investors, or dividends in respect of equity funding from investors.

Interest – deductibility
Corporation tax deductions are generally available to a UK holding company on the payment of interest to investors, although these payments may be subject to anti-avoidance provisions. These anti-avoidance rules are complicated and may apply to deny any tax deductions for the UK holding company.

There is a general rule restricting the ability of a UK company to deduct interest expenses from its taxable profits. This general restriction operates to restrict tax deductions for interest by reference to a fixed ratio of 30% of a company’s earnings before interest, taxes, depreciation and amortisation. The rule only applies where a group’s interest expenses exceed £2 million per annum – known as the “de minimis threshold”. There is also a narrowly drawn exemption for third-party interest expenses on certain public benefit infrastructure projects. Other anti-avoidance rules that may apply are discussed later in this article, but particular care should also be taken with regard to the United Kingdom’s hybrid rules (which may apply, for example, if the holding company is treated as a partnership in the investor’s jurisdiction), which may deny interest deductions.

Interest – withholding tax
Generally, a UK holding company has a duty to withhold tax (currently at a rate of 20%) on UK source payments of interest to investors. Where tax is withheld, it will have to be paid to His Majesty’s Revenue & Customs (HMRC) to account for the investor’s liability for UK tax. Investors may then be able to claim a repayment from HMRC of the tax withheld.

Notwithstanding the above, there is currently no withholding tax on payments of interest to UK banks and UK corporation taxpayers.

For non-UK resident investors there are three (main) routes to exemption from withholding tax on interest payments. There may be no (or a reduced) requirement to withhold tax if the investor is based in a country that has a double tax treaty with the United Kingdom. As in relation to receiving payments from foreign subsidiaries, the UK’s wide tax treaty network is useful here in relation to interest payments to foreign shareholders. This network is extensive. Even if a double tax treaty does apply, the holding company cannot make the payments without deducting tax or with tax withheld at less than 20% unless and until it has received a clearance from HMRC to pay investors without withholding tax.

“Quoted Eurobonds” also benefit from an exemption from UK withholding tax. A “quoted Eurobond” is a debt security issued by a company that carries a right to interest and is listed on a recognised stock exchange (ie, a stock exchange designated as such by HMRC).

An exemption is also available for certain “qualifying private placements”. The “qualifying private placement” exemption enables the payment of interest gross where the debt is unlisted and meets the other conditions (that apply to the creditor, the debt and the debtor) to constitute a “qualifying private placement”.

Distributions
No tax deduction is available for a UK holding company paying a dividend to investors.

However, and in contrast to most holding company jurisdictions, the United Kingdom does not levy withholding tax on dividends. This, in combination with the general lack of tax in hand on dividends, gives rise to a distinguishing benefit to the United Kingdom as a holding company jurisdiction: the ability to distribute profits through a UK holding company to its investors without any UK tax.

The United Kingdom (like most jurisdictions) has a comprehensive system of anti-avoidance rules to prevent artificial diversion of profits. These rules can deny the deductions and exemptions described above and include the following.

CFC rules
A “controlled foreign company” (CFC) is essentially a non-UK company controlled by one or more UK resident persons and set up in a low tax jurisdiction to escape UK corporation tax. The rules will – subject to exemptions – attribute profits of the CFC up to a UK holding company to pull them back into the United Kingdom’s corporation tax net.

Transfer pricing regime
These rules broadly substitute a market price for the price actually charged between connected persons, to counteract any attempt to inflate tax deductions available to a UK holding company. Generally, these rules are relevant to UK holding companies in relation to the tax deductibility of interest.

Diverted profits tax
Diverted profits tax is a complex regime aimed at multinational groups that are operating in the United Kingdom but diverting profits abroad trying to escape UK tax, by applying penal rates (6% above the normal rate).

A key tax consideration in choosing a holding company jurisdiction is whether there will be material taxable capital gains accruing to the investors and/or the holding company on disposal of their interest in the subsidiaries and/or the holding company. The United Kingdom has some useful exemptions in this regard.

Sale of subsidiaries
The UK holding company may wish to sell its shares in its subsidiaries and distribute the money to its investors. The disposal of the shares may trigger a capital gain. The United Kingdom has a relief called the “substantial shareholding exemption” (SSE), which has the effect of making the entire gain exempt from corporation tax on chargeable gains (irrespective of whether the subsidiary is a UK company or not). Where the SSE applies, it is automatic.

Various conditions need to be satisfied for a UK holding company to benefit from the SSE. These conditions are complex, but the principal conditions are:

• the UK holding company must have held at least 10% of the shares continuously for at least one year in the six years prior to the sale; and
• the subsidiary must also be a trading company (or the holding company of a trading group), which broadly means its activities (or the activities of its group) cannot to a substantial extent include activities other than trading activities.

The conditions for SSE can also be relaxed for holding companies that are partially owned by “qualifying institutional investors” (such as pension or life assurance investors, among others).

Sale of the UK holding company
Any UK resident corporate investors may be able to avail themselves of the SSE in respect of any gain on the sale of the UK holding company. UK resident individual investors will not be able to utilise the SSE, but other reliefs or exemptions may be available to mitigate any capital gains tax due on the sale of the UK holding company. Non-UK investors will be subject to tax according to the regime applying in their local jurisdiction.

The United Kingdom has some significant advantages as a holding company jurisdiction, such as:

• the general exemption from tax on dividends received from subsidiaries;
• the lack of any withholding tax on dividend payments to investors; and
• the SSE, which can exempt capital gains on the sale of subsidiaries from corporation tax.

These rules can lead to the favourable situation of utilising a UK holding company throughout its lifespan without any UK corporation tax arising. However, this must be weighed against an increasingly complex and shifting tax system that can be difficult to navigate, particularly in relation to anti-avoidance. This might make setting up in the United Kingdom more hassle and cost than it is worth operationally.