International Tax Landscape shake-up for Multinational Businesses
Contributed by Flag Theory
06 March, 2019
During the last weeks, we have been writing and reviewing significant amendments to corporate laws and tax laws in offshore jurisdictions to satisfy their commitments made pursuant to the OECD's Base Erosion and Profit Shifting (BEPS) Inclusive Framework and the European Union Code of Conduct Group (EUCoCG) agenda.
Offshore jurisdictions have overhauled their tax and company regimes in accordance with international tax transparency standards and best practices. International Business Company (IBCs) regimes are being phased out or removing its ring-fencing features, and economic substance and physical presence are now required within the jurisdiction of domicile for certain business activities. You can read more about it here and here.
However, not only offshore jurisdictions have been required to amend their legislation to comply with BEPS and EU standards. A number of onshore and midshore jurisdictions have also adopted their legislation towards this end.
For instance, certain foreign-investment tax incentives now require economic substance to qualify for tax incentives. Intellectual property preferential tax regimes will now require companies to meet the so-called 'nexus approach', whereby companies are required to have economic substance and have adequate R&D expenditures within the country to qualify for tax exemptions.
We have also seen jurisdictions modifying or implementing additional transfer pricing rules and country-by-country reporting requirements.
Certain preferential tax regimes such as those for holding companies and businesses mainly deriving foreign-source income are in the process of being eliminated or have already been phased out.
In addition, European Union members have been required to implement anti-tax avoidance provisions in their tax laws – mainly transposing the EU Anti Tax Avoidance Directive 2016/1164 (ATAD) into local law. This mainly means that all EU countries have implemented controlled foreign company rules provisions, exit taxation, and limitation on interest deductibility, among others.
In this article, we have reviewed some of these recent tax legislation developments in some of the most relevant 'onshore' international business centers. Note that this article is intended for general information purposes and it is not tax, legal or financial advice of any kind.
Throughout modern history, Switzerland has been a safe haven for the wealthy to store their assets and an attractive destination for multinational corporations to set up their headquarters due to the country's politically and financially stable environment alongside a relatively low tax regime.
In Switzerland, taxes are levied at both the Federal (effective 7.8% tax rate) and cantonal/municipal levels (from 4% to 16% depending on the canton or municipality). This allows for competition between cantons to attract businesses via tax policies which have led to massive inbound of international businesses.
Certain multinationals have also benefited from preferred tax regimes. Specifically holding companies, which are currently exempt from cantonal/municipal taxation provided that 2/3 of its assets consists of shareholdings and 2/3 of its income consists of dividends and capital gains. Given that at the federal level dividends and capital gains are usually not taxed under the participation exemption – in most cases, holdings are not taxed at all.
Companies fully or partially doing business abroad and deriving income from foreign sources are also enjoying significant tax breaks, specifically the administrative regimes and the trading mixed company regimes. Businesses carrying out administrative functions and not commercial activities in Switzerland and trading businesses with more of 80% of their activities abroad are only taxed on a small portion of their foreign-sourced income, from 0% to 15% and from 0% to 25% respectively.
Administrative and Trading mixed companies are benefiting from reduced effective rates from 5% to 8% approximately.
In addition, through the Swiss finance branch taxation regime, branch offices providing intra-group financing are effectively taxed at even lower rates, from 2% to 3%.
To understand the magnitude of these regimes – it has been reported that tax paid by companies under these tax regimes amount for approximately 50% of direct corporate income taxes collected in Switzerland at the federal level.
However, these regime's days may be numbered, as we will see below.
During recent years, Switzerland has faced pressure from the OECD and the EU to repeal these regimes. The OECD urged Switzerland to undergo several tax reforms to be compliant with BEPS. Also, the EU Commission claimed that the aforementioned regimes represent prohibited State Aid and are against their 1972 free trade agreement.
This led Switzerland to develop a corporate tax reform, CTR III, in 2015 which, without going into much detail, was rejected by Swiss people in a public referendum in 2017.
After public rejection, the Federal Council released the Federal Act on Tax Reform and AHV Financing' (TRAF proposal) which was approved by the Swiss parliament in late September 2018. On January 18, 2019, left-wing parties successfully collected enough signatures to bring the TRAF proposal to put to the people's referendum on May 19, 2019.
If Swiss people positively vote the TRAF proposal in May, the aforementioned holding company, administrative company, trading mixed company, and branch finance tax regimes will be abolished starting January 2020. These companies will then be taxed at regular tax rates.
A number of counter-measures will be put in place to reduce the tax burden on affected entities and avoid Swiss companies from migrating overseas.
Foreign-source hidden reserves that will flourish due to the repeal of the preferential tax regimes would be subject to a special low tax rate determined by each Canton for 5 years. This will also apply for foreign companies that relocate to Switzerland. Cantons will also be able to lower the taxable equity on patents and other IP rights, on certain participations and intra-group loans.
The TRAF proposal also includes several other modifications to be compliant with OECD BEPS Action 5 standards, such as the patent box. 90% deduction on net profits derived from patents and certain IP rights will only be available for companies that had R&D expenditures taxed in Switzerland and have economic substance within the country, the so-called 'nexus approach'. Cantons will also be able to introduce an R&D deduction of up to 50% of costs to companies that meet the nexus approach.
Like Switzerland, Hong Kong has also been a magnet for global businesses due to its stability and business-friendly policies. Like other jurisdictions, Hong Kong has also gone through several tax-related legislation amendments to comply with OECD's BEPS agenda.
On July 4, 2018, Hong Kong passed The Inland Revenue (Amendment) (No. 6) Ordinance 2018 (IRO), which codifies transfer pricing rules (Fundamental Rule) and requires transactions between affiliates to be carried out at an arm's length basis for tax purposes.
The Fundamental Rule entitles Hong Kong's taxman, the Inland Revenue Department (IRD), to adjust profits or losses of a company if compensations arisen from transactions with associated persons differ from compensations which would have been made between independent actors, and have led to a tax advantage.
The Fundamental Rule applies to transactions involving sale/transfer/use of assets and provision of services, and financial and business arrangements within a group structure.
The IRO Amendment also codifies transfer pricing documentation requirements. Hong Kong companies transacting with affiliates are required to prepare a master file and local file transfer pricing documentation, and HK ultimate parent entities (UPE) need to prepare country-by-country (CbC) reports (CbCR).
The local file typically includes documentation on the local entity intercompany transactions, whereas the master file includes high-level information about the group's global business operations and transfer pricing policies.
A CbCR is an annual return that includes the key elements of the financial statements of a given multinational group by jurisdictions. It provides information to tax authorities about revenue, tax paid and accrued, employment, capital, retained earnings, tangible assets, and business activities, among others.
These transfer pricing reporting requirements are becoming a worldwide standard international tax practice in line with OECD's BEPS anti-avoidance requirements.
Companies that meet certain conditions, such as total revenue of not more than HKD 400 mil or total assets of not more than HKD 300 mil, among others, might be exempted from preparing the local file and master file documentation. For its part, an HK UPE with consolidated group revenue of less than HKD 6.8 Bil may not be required to file a CbCR.
Companies subject to prepare the master file and local file documentation, and fail to do so may face a fine of HKD 50,000, and may be ordered by the court to prepare such documentation within a specified time. Failure to comply with that order may entail an HKD 100,000 fine on conviction.
The IRO amendment also provides for enhanced economic substance requirements to benefit from HK tax treaties; and modifications to certain preferential regimes.
Specifically, the ring-fencing feature on the 50% profits tax exemption for corporate treasury center (CTC), reinsurance and captive insurance activities has been removed. Domestic transactions can also qualify for the aforementioned preferential tax regimes.
In a similar fashion, on December 7, 2018, the Hong Kong government gazetted the Inland Revenue (Profits Tax Exemption for Funds) (Amendment) Bill 2018, covering open-ended fund companies (OFC) and repealing OFC tax rules enacted earlier in 2018.
The amendment removes the ring-fencing feature that excluded onshore funds and funds' investments in HK private companies from benefiting from tax breaks.
The Profits Tax Exemptions for Funds Amendment also implements a series of anti-tax avoidance rules – profits derived from holdings of private companies that hold more than 10% of their assets in HK real estate are not eligible for a tax exemption. For holdings of 10% or less, a holding period of two-year must be met, among other conditions.
Dutch companies have traditionally been powerful tax avoidance tools within multinational structures. It is of public knowledge that large tech companies have used Dutch companies in combination with Irish incorporated companies to channel funds to offshore jurisdictions – the 'Double Irish with Dutch Sandwich' is the one that drew the most attention.
Like other jurisdictions, the Netherlands has also implemented certain tax law modifications to meet OECD's BEPS standards and has conscripted to local law the EU Anti-Tax Avoidance Directive 1 (ATAD1) which entered into force on January 1, 2019.
New anti-avoidance measures include the introduction of controlled foreign company (CFC) rules – certain non-distributed income of a CFC, namely dividends, interests, royalties, certain capital gains, and other income, will be subject to Dutch corporate tax.
CFC rules are applicable to the aforementioned income type accrued by foreign subsidiaries located in low-tax jurisdictions, in which a Dutch company has a 50% or more interest, or by a low-taxed foreign permanent establishment.
Low-tax jurisdictions are those that have no corporate income tax or have corporate income tax lower than 9%, or jurisdictions that are considered non-cooperative jurisdictions for tax purposes by the EU. The Dutch Ministry of Finance will publish a list every year of jurisdictions to which CFC measures apply.
The 2019 list consists of the EU's list of non-cooperative jurisdictions: American Samoa, USVI, Guam, Samoa, Trinidad & Tobago; and a Dutch list of low-tax jurisdictions: Anguilla, Bahamas, Bahrain, Belize, Bermuda, BVI, Cayman Islands, Guernsey, Isle of Man, Jersey, Kuwait, Qatar, Saudi Arabia, Turks & Caicos, UAE and Vanuatu.
Certain exceptions will apply if a subsidiary's passive income is less than 30% of its total income or if the subsidiary meets certain economic substance requirements in its jurisdiction of establishment – such as salary expenses of over EUR 100,000 and office space for a period of 24 months. Note that Dutch tax authorities will no longer grant tax rulings for transactions with companies established in the aforementioned low-tax jurisdictions.
New anti-avoidance provisions also include the so-called 'earnings stripping rule' for groups, which limits the deductibility of net interest expenses (interest revenue – borrowing costs) up to 30% of taxable profits. Net interest expenses up to EUR 1,000,000 (lower than EU standards) are not caught by the earnings stripping rule. Non-deductible interest expenses will be allowed to be carried forward indefinitely.
In addition, the Dutch government has already announced a legislative proposal for Q3 2019 that will apply a 20.5% withholding tax on royalty and interest payments to low-tax jurisdictions included in the aforementioned list. This withholding tax is expected to come into force by January 1, 2021.
Luxembourg is commonly known as the go-to EU jurisdiction for private wealth management structures and investment funds, which are generally exempt from taxation. The Grand Duchy has also welcomed large and well-known multinational corporations via 'double-taxation treaty' tax rulings providing low taxes, or no taxes at all. It also attracted a number of businesses to set up its IP holding companies deriving royalty income due to an advantageous patent box.
However, back in 2016, the IP regime was abolished due to concerns by the OECD and businesses under the regime were grandfathered until June 30, 2021. A few months ago, a new BEPS-compliant IP regime was introduced into the Income Tax Law.
The new IP regime implements the nexus approach, whereby qualifying companies are required to conduct substantial economic activities within the jurisdiction and have adequate R&D expenditures that contribute to the income generated by the IP.
The percentage of net income eligible for exemption is determined based on the ratio of expenditures. To that end, a company is required to track income and expenditure to determine the nexus ratio.
The IP regime provides for an 80% tax exemption on income derived from the exploitation of IP rights, as well as a 100% exemption from net wealth tax. Patents, utility models, copyrighted software, and other IP rights qualify under the regime. Unlike the previous regime, trademarks and other market-related IP are not eligible.
Qualifying income includes royalty income, IP income embedded in the sales price of products and services, capital gains related to the IP rights and indemnities obtained through an arbitration ruling.
Luxembourg also approved legislation that conscripts the EU Anti-Tax Avoidance Directive (ATAD 1) into domestic law in December 2018, and in force since January 1, 2019. Anti-avoidance measures adopted include a limitation of the deductibility of interests, controlled foreign company rules (CFC), among other measures such as adapting the general anti-abuse rules (GAAR) to EU standards.
The interest limitation rule provides that a given company is only able to deduct net interest expenses up to 30% of its EBITDA or up to EUR 3 mil, whichever is higher. This rule covers any financing transactions, regardless of whether is conducted with affiliates or with a third-party. Non-deductible interests can be carried forward.
Financial institutions, insurance companies, investment funds, and certain securitization vehicles, among others, are not subject to the interest limitation rule.
With respect to controlled foreign company (CFC) rules, Luxembourg will tax CFC undistributed income arising from 'non-genuine' arrangements to create a tax advantage. A CFC could be deemed to conduct a non-genuine arrangement if it would not own the assets or undertake the risks that generate its income if it were not controlled by the parent company which people is instrumental to generate CFC income.
CFC are foreign permanent establishments (PE) or subsidiaries which are taxed lower than 9% (50% of Luxembourg corporate tax), and where the Luxembourg parent entity together with any of its associate enterprises holds 50% or more interest (capital, right to receive income or voting rights). An associated enterprise is a company where the Luxembourg entity holds 25% or more interest.
CFC rules do not apply to subsidiaries or PE those with accounting profits of EUR 750,000 or less, or with profits that amount to no more than 10% of their operating costs.
Operating costs arising from goods sold out of the country where the subsidiary is resident and payments to associated enterprises are specifically excluded.
During 2018, Andorra also implemented several amendments to its tax legislation to comply with OECD requests.
To begin with, the special regime for international trading companies, intra-group finance companies, and investment companies that provided an 80% exemption on income from foreign source has been abolished.
Companies that were under the regime before July 1, 2017, are grandfathered until December 31, 2020. However, for 2019 exemption is reduced to 40% and 20% for 2020.
The special regime for holding companies that provided tax exemptions for dividend income and capital gains has been amended, removing its ring-fencing features. Now, participating resident companies also qualify for the exemption, along with non-resident companies.
To qualify for the dividend and capital gains exemption, the holding must hold at least 5% of the underlying subsidiary, and non-resident subsidiaries must be subject to a tax rate of not lower than 4%. Resident subsidiaries must be subject to tax in Andorra.
Capital gains and income derived from holdings acquired before July 1, 2017, are grandfathered under the previous regime provisions up to December 31, 2020.
The intellectual property special regime has also been amended to include the nexus approach.
The 80% tax exemption on IP derived income will be subject to a nexus ratio, calculated as the proportion of IP development expenditure (with a 30% uplift) over the total development expenditure. Income from patents, utility models and copyrighted software is eligible.
Grandfathering provisions for companies that were under the previous IP regime are the same as for the international trading companies regime.
Like Netherlands and Luxembourg, last December Malta conscripted into local law the EU Anti-Tax Avoidance Directive (ATAD 1) via the L.N. 411 of 2018 – which is now in force since January 1, 2019.
Under the L.N. 411 of 2018, Malta has implemented controlled foreign company (CFC) rules.
Under Maltese law, a CFC may be a Malta's company foreign permanent establishment (PE) or a subsidiary in which the parent company holds directly or indirectly more than 50% of its voting rights/capital or is entitled to receive more than 50% of the profits – which corporate tax paid is lower than half of the tax that would have been charged on the company or PE under the Malta Income Tax Act.
Like Luxembourg, Malta will only tax non-distributed income of the CFC if this is derived from a non-genuine arrangement to create a tax advantage.
CFC rules don't apply to subsidiaries and PEs with no more than EUR 750,000 of trading profits and non-trading income of EUR 75,000 or less, or companies which profit amount does not exceed 10% of its operating costs.
Malta has also transposed into law the interest deductibility rule, whereby a company can only deduct net interest expenses up to the higher of 30% of its EBITDA or EUR 3 mil.
An Exit tax will become effective from January 1, 2020. A Maltese company that transfer assets to a PE outside of Malta, a non-resident operating through a PE that transfer assets or business to outside Malta, or a Malta company that transfers its tax residency from Malta to outside Malta – would be deemed to have accrued a capital gain, which will be subject to tax. The capital gain would be calculated by the market value of the transferred assets less their base cost for tax purposes.
Same as in other EU territories, Gibraltar transposed ATAD1 into local law via the Income Tax 2010 (Amendment No. 3) Regulations 2018 on December 2018.
New regulations set controlled foreign company rules and a limitation on the deductibility of exceeding borrowing costs in a similar fashion to Malta and Luxembourg. The exit taxation rules are expected to be conscripted into the laws before December 31, 2019, and so the Regulation does not make any amendments in respect of exit taxation.
Cyprus is currently in the process of implementing ATAD1 directives in its local laws, which as in other EU jurisdictions will implement interest deductibility limitations, controlled foreign company (CFC) rules and exit taxation, among others. Once the legislation is gazetted, it is expected to apply retrospectively from January 1, 2019. Exit taxation will enter into force by January 1, 2020.
With respect to CFC rules, Cyprus has taken the same approach as Malta, Luxembourg, and Gibraltar, and, unlike the Netherlands, undistributed income from a CFC would be taxed only if it is derived from non-genuine arrangements to create a tax advantage.
Cyprus has become stricter during the last year in regards to companies that lack of economic substance in the island. Increasing tax transparency, exchange of information and substance requirements may prove difficult for these companies to benefit from a tax resident status, the EU Parent and Subsidiary directives, exemptions and DTA network – which could put them at risk to be taxed in Cyprus and also be considered tax resident and taxed elsewhere.
On a different note, a few months ago the Central Bank of Cyprus issued guidelines for financial institutions to stop opening bank accounts, and closing existing ones, for offshore companies with no physical presence and/or economic activity within their country of domicile or without an 'appropriate' tax residency in an 'onshore' jurisdiction.
Restrictions set by the Central Bank do not apply to pure holding companies or companies undertaking intra-group financing, among certain other corporate and financing activities. Although banks are not fully prohibited to engage with an offshore company – they must justify these relationships, conduct a risk-based assessment and inform the Central Bank.
The Bottom Line
The international tax landscape is going through major changes towards more transparency, exchange of information and enhanced anti-tax avoidance policies. Preferential tax regimes have become stricter with increasing qualification requirements.
Reporting requirements for intra-group transactions have also increased. Comprehensive transfer pricing documentation must not only be provided at the local company level but also at the group level via local file, master file, and country-by-country reporting for large multinational groups.
Stricter provisions on double taxation agreements (DTA) between countries are also being implemented to require real commercial substance to benefit from them. Preferential tax regimes are being narrowed – either by requiring physical presence and local expenditures or removing ring-fencing features for offshore income.
Transactions with low-tax jurisdictions could be even more scrutinized and if not properly structured they may become useless or even carry negative effects.
The takeaway is that in current times, optimized tax structures may only be effective if everything is watertight, there is economic and commercial substance and are transparent to tax authorities – providing the sufficient documentation and information about them.
However, despite this new set of requirements and policies, mobile international and multinational businesses can still benefit from an arbitrage of opportunity. One should consider certain key elements to have an effectively optimized corporate structure such as corporate and personal tax residency, corporate governance, commercial substance in business relationships and transfer pricing arrangements within elements of a given group structure, among others.
International structuring opportunities are still there – however, a global approach and jurisdictional comparison intelligence customized to your specific business circumstances to help one benefit from them are more necessary than ever. Structuring is an evolution, and one must adapt and pivot alongside the laws and regulations. It's worthwhile to consult with professional advisors who are aware of these changes and can advise you accordingly.
At Flag Theory, we can help you leverage these global structuring opportunities to ensure smooth and hassle-free business operations, the greatest asset protection, liability limitation, risk mitigation, and tax minimization. Contact us today, it will be a pleasure to assist you.
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