The key directives for direct taxation are:
- Interest and Royalties Directive
- Parent Subsidiary Directive
- Mergers Directive
There is also a requirement to report certain transactions (primarily in relation to avoidance) under the Directive on Administrative Co-Operation.
The UK has implemented these directives into its domestic law, so will generally continue to apply the provisions where the UK is one party to a transaction with an EU company. However, the other country will now regard the UK as a non-EU country, and so will not give a UK entity the benefit of favourable treatment.
Interest and Royalties Directive
Payments of interest and royalties between two EU companies, which share at least a 25% common shareholding, can be made free of withholding tax.
This will continue to apply for payments made by a UK company to an EU-related party. However, in the case of interest, formal clearance must be obtained from HM Revenue & Customs (HMRC). If payments are made without clearance, Income Tax of 20% should be withheld, and this will be refunded to the recipient once clearance has been given.
For payments by an EU company to the UK, withholding tax is now likely to apply. This will depend on the local rules in each country, and whether a Double Tax Agreement (DTA) applies to reduce the rate of withholding tax. Key countries which are likely to impose withholding taxes on interest are Belgium, Malta and Portugal, all of which impose tax at 10%.
The tax withheld can be credited against the UK tax on the same income, so in most cases this will only be a cash flow cost.
Parent Subsidiary Directive
Dividends can be paid between EU-related companies without withholding tax.
As the UK does not impose withholding tax on any dividends, there will be no change for UK dividend payments when the UK transition period ends.
However, where an EU subsidiary pays a dividend to the UK, withholding tax may be imposed. The rate will depend on local laws and the relevant DTA, but key countries which are likely to impose withholding taxes are Ireland (5% but reduced to nil if certain conditions are satisfied), Belgium (10%) and Luxembourg (5%).
Most dividend receipts are exempt in the UK, so any tax imposed by the paying country will be a permanent extra cost.
Groups may wish to consider paying dividends on or before 31 December 2020, where this would be permitted under local company law.
As the UK does not impose withholding tax on any dividends, there will be no change for UK dividend payments when the UK transition period ends.
Mergers Directive
The mergers directive permits certain cross-border EU mergers and reorganisations to be accomplished on a tax-free basis.
However, as the UK company law position on mergers is generally more complex than in other EU countries such as France, Italy or Germany, the Mergers Directive has only rarely been used in practice.
For cross-border reorganisations from 1 January 2021, the UK will be regarded as a third country. It may still be possible to achieve a tax-free transaction, but detailed advice will be needed.
Directive on Administrative Co-operation (DAC6)
DAC6 requires information about certain cross-border transactions to be disclosed to local tax authorities. The main types of transactions are structured transactions which may give rise to a tax advantage, or transactions which seek to avoid EU disclosure rules.
The UK has already implemented DAC6 and has confirmed that it will continue to require transactions to be reported after the end of the transition period.
What should companies do now?
Companies should review any flows of funds (dividends, interest and royalties) between the UK and EU countries and consider whether any action is needed before 31 December 2020.
Would you like to know more?
If you would like to learn more about how Brexit may impact you, please visit our Practical Guidance: Brexit hub here.
And if you have any questions or would like to discuss your specific circumstances, please get in touch with your usual Blick Rothenberg contact or one of the partners on this page.