By Lowtax Editorial
15 September, 2014
To listen to United States President Barack Obama and members of Congress rail against "unpatriotic" companies using corporate "inversions" to escape America's high 35% rate of corporate tax, you'd think that tax was the sole factor in a company's decision-making process when deciding the ideal place to locate its headquarters. It isn't. Although tax plays a major part, it is a great deal more complicated than that. Indeed, the jurisdiction in which a multinational decides to place its global or regional HQ is sometimes not the same jurisdictions in which it is incorporated for tax purposes.
As a tax publication, we will of course pay a great deal of attention in this feature to the tax aspects of having a headquarters in one place over another. But given that, contrary to popular opinion, not all inversions by US companies are motivated by a desire to mitigate tax, these other factors are also touched upon in an attempt to shed some light on what is increasingly becoming an ill-informed debate.
What Is a Company HQ?
Traditionally, in a multinational group, the headquarters is the office where its senior executives are located and the place where key decisions about the current operations of the company, its investment strategies and future direction are decided. Multinational HQs are usually located in large cities with financial centres, such as London, New York, Chicago, Tokyo, Frankfurt, Paris, and Hong Kong. However, an HQ may also take on more of a financial role, directing the flow of income and expenses between foreign subsidiaries and branches, in which case the jurisdiction's tax laws become a much more significant consideration. Indeed, some countries have special tax incentives schemes in place to encourage multinational companies to establish global or regional HQs within their borders.
Some of the tax factors which influence the decision-making process include:
- Corporate income tax
- Taxes on dividend income
- Withholding tax on incoming and outgoing dividend distributions
- Withholding taxes on interest and royalty payments
- The number of double taxation avoidance agreements the country has entered into
- Taxes on share disposals
- Capital duties
- Controlled foreign company (CFC) legislation and other anti-avoidance laws such as transfer pricing and thin capitalisation rules
- Tax compliance costs
- Tax incentives
- Individual tax rates and employment taxes, particularly on executives and senior management positions
Non-tax factors might include:
- The availability of skilled workers
- Employment law
- Prevailing wages and salaries
- Proximity to established or growing markets
- Internal factors, such as clustering (alongside peers), history (a company may have a historical connection to a certain city), prestige (expression of the corporate ethos) and human preferences (ego, comfort etc).
In summary, corporate inversions have been used by US companies when bidding for (generally smaller) foreign companies, as a means of moving away from the high American 35 percent corporate tax rate. A company that merges with an offshore counterpart can move its headquarters abroad (even though management and operations may remain in the US), and take advantage of the lower corporate tax rates in foreign jurisdictions as long as at least 20 percent of its shares are held by the foreign company's shareholders after the merger.
According to US Treasury data, about 50 corporate inversions have taken place over the last 10 years, although there has been a perceptible increase in the number of US corporations seeking to undertake inversion transactions this year. It has been noticeable that the intended outcome of several of these inversions is to end up with a corporate structure with the HQ based in the United Kingdom or Ireland. Others will see companies headquartered in Switzerland and Canada, among others. The tax and other advantages of these and other popular HQ jurisdictions are summarised in the next sections.
When it assumed power in 2010, the Conservative/Liberal coalition Government pledged to transform the UK into the most competitive place in the G20 in terms of tax. It has gone some way towards achieving this objective thanks to deep cuts to corporate tax and modifications to CFC legislation. Indeed, many companies that uprooted their HQs from the UK in the latter stages of the Labour administration in protest at increasingly onerous tax rules are now coming back. One of them is WPP, the advertising giant, which relocated its HQ to Ireland in 2008.
Corporate tax: The UK corporate tax rate has fallen from 28% in 2010 to 21% in 2015. It will decrease to 20% in April 2015.
Dividend tax: Generally the UK does not apply withholding taxes to dividend payments.
Other withholding taxes: Interest and royalty payments to non-residents are usually subject to withholding tax of 20%, although royalty payments made between resident companies are not subject to withholding tax. Exemptions apply to interest and royalty payments that fall under the EC interest and royalties directive.
Tax Treaties: In cases where withholding taxes cannot be reduced under EU legislation, they may be mitigated or eliminated under the UK's extensive network of double tax treaties, which numbers about 120 countries.
Anti-Avoidance: The UK has CFC legislation to prevent the artificial diversion of profits to low-tax jurisdictions. However, these were recently amended to make them less onerous. The major innovation in the legislation is the provision of a 'Gateway' system, which will specifically identify circumstances where artificial diversion has taken place. This is broadly defined as an instance where there is a significant mismatch between key business activities undertaken in the UK and the profits arising from those activities which are allocated outside the UK. Business profits within the Gateway, including 'foreign to foreign' profits, will be outside the scope of the new regime. The legislation also provides a partial exemption on profits from overseas intra-group financing.
Transfer pricing rules are well established and based on OECD guidelines. However, the UK has strengthened its oversight of transfer pricing rules recently in response to the public outcry over corporate tax avoidance.
Thin capitalization rules are also in place.
Individual taxes: The top rate of tax, at 45%, is on the high side, but is by no means the highest in Europe. Foreign company executives can claim "non-dom" status, which means they are resident in the UK for tax purposes, but not domiciled there (basically, not born in the UK). As a result they are not charged tax on foreign income as long as it is not remitted to the UK. However, there is now an annual charge for the privilege of being classified as a non-dom.
Non-tax factors: In addition to being an international city, London is of course one of the world's premier financial and business centres, an international city, and has a major stock exchange. It is already home to many hundred multinational HQs. It is possible to reach most places on the planet from London's airport, although the domestic transport system and infrastructure generally leaves something to be desired.
Since a highly competitive business tax regime was installed in Ireland over a decade ago, the country has seen an influx of foreign companies, particularly from the US, establishing HQ and other operations. According to the American Chamber of Commerce in Ireland, over 115,000 people are directly employed by over 700 US firms in Ireland, and collectively, US companies have USD204bn in foreign direct investment in Ireland – more than the total invested in the much-hyped 'BRIC' economies (Brazil, Russia, India, China).
One of the latest additions is Medtronic Inc, although the company's chief executive Omar Ishrak has insisted that the company's USD42.9bn deal to acquire Dublin-based Covidien Plc, and, thereby, move its tax residence from the United States to Ireland in a "corporate inversion," is based on business logic and not corporate tax reduction.
Nevertheless, there are many other fiscal advantages to be had in Ireland which aren't available in neighbouring Britain.
Corporate Tax: A very obvious advantage that Ireland has is its low 12.5% rate of corporate tax, which alongside Cyprus is the second-lowest in the EU after Bulgaria.
Withholding Taxes: Payments of dividends, interest and royalties to non-residents are generally subject to withholding tax at 20%. However, these can be reduced to 0% in many circumstances, such as through the application of a double tax treaty, or by meeting the requirements of the EU parent/subsidiary and interest/royalties directives.
Tax Treaties: Ireland has a good network of tax treaties including over 60 countries.
Anti-Avoidance: Like many countries suffering fiscal troubles in the aftermath of the financial crisis, Ireland has strengthened its anti-avoidance legislation in recent years. Transfer pricing rules are in place and have been based on OECD guidance since 2011. There is also a statutory GAAR. However, unlike the UK, Ireland has no CFC legislation and no specific thin capitalisation rules.
Individual Tax: The top rate of tax is 41%, but there is also a 'universal social charge' of up to 7%.
Non-Tax Factors: Dublin, Ireland's capital city, is now a vibrant and cosmopolitan business and financial centre, with direct links by air to North America and most of Europe. Recent investment in the wider domestic transport network has helped raise Ireland's profile, and there is a well-educated English-speaking workforce.
Due to its relatively low rate of corporate tax and the 'fiscal deals' on offer from cantonal (local) governments, Switzerland has long been an enticing prospect for multinationals looking for a tax efficient base in Europe. For the same reasons, Switzerland has for many years been the bane of European governments and the EU as they attempt to stem such corporate tax 'leakage' from their tax bases.
It was probably because of Switzerland's controversial reputation that drug store chain Walgreens's decision against moving its tax residence from the United States to Switzerland by way of a "corporate inversion" in exercising its option to purchase the remaining 55 percent stake in Alliance Boots.
Although Walgreens presently has an effective tax rate close to the headline US corporate tax rate of 35 percent, it will forgo the reported USD4bn in tax savings over five years that could have been available to it by moving the company's base to Switzerland, where Alliance Boots is headquartered. A new holding company will now be formed, to be named Walgreens Boots Alliance, Inc., domiciled in the US and headquartered in the Chicago area.
Corporate Tax: There are corporate taxes at both federal and cantonal level. The federal corporate income tax rate is 8.5% flat. Since income and capital taxes are deductible in determining taxable income, the effective tax rate that a company pays on its profits before deduction of tax is 7.83%. When cantonal tax rates are added, the overall tax rate is between 12% and 22%, depending on the canton of residence.
There are a number of specialised forms of the basic Swiss Stock Corporation which offer tax-privileged treatment equivalent to that obtainable in offshore jurisdictions, including the domiciliary company, the holding company and the mixed company (which have the characteristics of both domiciliary companies and holding companies but which do not qualify as either). However, these require that companies have little physical presence in Switzerland and are primarily used to reduce tax on foreign income.
Dividend Taxes: A federal tax of 35% must be withheld on dividend payments. However, under an agreement with the EU, Switzerland is granted benefits similar to those provided under the EU parent subsidiary directive. Under this agreement, withholding tax on cross-border payments of dividends between related companies resident in the EU and Switzerland is reduced to 0% provided the capital participation is 25% or more and certain other conditions are satisfied. Relief from dividends taxation is also available for payments received from resident and non-resident companies under Switzerland's participation exemption regime. A participation is qualifying if the company owns at least 10% of the capital of the company paying the dividends or the participation has a value of at least CHF1m.
Other Withholding Taxes: There is no withholding tax on interest, but interest derived from deposits in Swiss banks and bonds are subject to a federal withholding tax of 35%. This tax can be reduced to 0% or 10% under certain tax treaties.
Tax Treaties: Switzerland has double taxation treaties with over 80 other countries.
Anti-Avoidance: There are no CFC laws in Switzerland, but thin capitalisation rules apply. There are no formal transfer pricing laws, but related party transactions must be carried out at arm's length and the OECD guidelines are generally followed.
Personal Tax: This tax is levied at federal, cantonal and communal level. Personal income tax is progressive in nature. The total rate does not usually exceed 40% and in most cases, the maximum tax rate is much lower than this – around half in the case of some cantons.
The 'fiscal deal' or 'lump sum assessment' method can be used by an individual who is prepared to be resident in Switzerland but who is not a Swiss national and who has never engaged in any substantial economic activity in Switzerland. Traditionally, this method, which couples a residence permit with the tax deal, involves a negotiation with the canton in which residence is planned. The individual's income might, for instance, be deemed to be the amount of expenditure he incurs on certain items. From 2016, the tax base for calculating direct federal and cantonal tax will be seven times the cost of living, compared with five times currently.
Non-Tax Factors: Switzerland is a wealthy, clean, efficient and fiercely independent nation at the heart of Europe, but outside the EU so not subject to some of the EU's stifling tax and regulatory rules. It is also a major banking and financial centre. With stunning landscapes, Switzerland offers a high quality of life to affluent expats and foreign executives. However, its major cities are among the most expensive in the world in terms of cost of living. But then, in order to take fiscal advantage of Switzerland, most foreign companies tend not to have a major physical presence in the country anyway.
Canada is not automatically thought of as a jurisdiction where foreign multinationals flock to put their headquarters. However, on August 26, 2014, Tim Hortons and Burger King announced that a definitive agreement to merge their businesses, with the new publicly-listed company to be headquartered in Canada, is to be a "corporate inversion" for the latter company.
The current and previous Canadian governments have gone some way to making Canada more competitive with regards tax. A series of corporate tax cuts have brought Canada's headline rate down to 15%, the lowest in the G7 and a full 20% lower than the federal statutory rate in the US. However, according to some reports, people close to the deal, which includes USD3bn in financing from Warren Buffett's Berkshire Hathaway, deny this has any to do with tax, and Buffett's well established position on taxation would appear to support this assertion. Indeed, some say that Burger King's effective tax rate will be about the same after the transaction and the deal is more about positioning the new company in the right market.
Corporate Tax: As stated, the federal corporate income tax rate is 15%. Corporate tax is also levied at the provincial level, adding another 10% to 16% on top of the federal burden.
Withholding Taxes: Interest, dividend, rental and royalty payments made to non-residents are generally subject to withholding taxes. Rates are generally 25% (or 10% or 15% in the case of dividends), although rates may be reduced or nullified where a double tax treaty applies.
Tax Treaties: Canada has a wide network of double tax treaties including over 90 countries.
Anti-Avoidance: Canada has formal transfer pricing rules which follow the OECD guidelines. Thin capitalisation rules also apply. Canada doesn't not have a controlled foreign company regime as such, but the foreign accrual property income regime is designed to tax the passive income of a controlled foreign affiliate in low-tax jurisdictions. The Federal Government has also tightened other aspects of international tax law in recent years.
Individual Tax: Federal income tax is progressive up to a rate of 29%. Individual income tax is also applied at provincial level at progressive rates, to as high as 21% (Nova Scotia). Therefore, individual tax can be steep for those with high incomes in certain provinces.
Non-Tax Factors: Canada is a wealthy country with a well-educated workforce, although the Government has recently improved visa regulations to allow highly skilled migrants to be recruited more easily. Toronto is an important financial and business hub, although it doesn't quite have the kudos of New York or Chicago for example, as a location for corporate HQs.
Foreign companies are drawn to Hong Kong because of its location in the centre of the Asia-Pacific region and on the door step to China, its status as a major international financial centre, its liberal regulatory regime and its stable a low taxes.
Hong Kong was ranked fourth in terms of global foreign direct investment (FDI) inflows in 2013, behind only the United States, Mainland China, and Russia, according to the United Nations Conference on Trade and Development's (UNCTAD) World Investment Report 2014.
The UNCTAD report added that Hong Kong had been "highly successful" in attracting multinational companies (MNCs), with almost 1,400 such regional headquarters operating in Hong Kong as at 2013. It confirmed that Hong Kong continued to be one of the "major destinations" for the headquarters of MNCs targeting Asia Pacific markets.
InvestHK – the department established by the Government to attract FDI and support overseas and Mainland businesses to set up or expand in Hong Kong – has disclosed that it helped a record 223 overseas and Mainland companies to set up or expand in Hong Kong in the first half of 2014, marking a 4.7 percent year-on-year increase. The Mainland continued to be the largest single source of growth with a total of 55 completed projects, followed by the US with 30 projects, Japan with 20, France with 19, and the UK with 18.
Invest HK said that Hong Kong's status as an international business hub and its geographical location has continued to make it an ideal platform for Mainland companies to go global. Companies in asset management, e-retail, and enterprise solutions were particularly attracted to set up and expand in Hong Kong.
Corporate Tax: 16.5% for incorporated companies. A major advantage of Hong Kong's tax regime is that it is fully territorial, meaning that only income derived in the territory is taxed there.
Dividend and Withholding Taxes: There are no withholding taxes in Hong Kong as such, but there are certain circumstances in which a company making a payment to a foreign associate (subsidiary or holding company) which is deemed to be Hong Kong source income needs to needs to withhold the tax. For instance, when a Hong Kong entity pays royalties for the use of intellectual property to its own offshore licensing affiliate, then tax is due of 30% of 16.5% = 4.95% (4.5% for an unincorporated business) and this must be withheld by the Hong Kong paying company.
Tax Treaties: Until June 2001, the territory had no comprehensive double taxation agreements in place. Since under the "territorial principle" only Hong Kong source income is taxable the double taxation of income does not usually occur thereby obviating the need for double taxation treaties. However the government is now entering an increasing number of tax treaties of various types, and there are currently about 30 in force.
Anti-Avoidance: As a low-tax jurisdiction, anti-avoidance rules are quite thin on the ground in Hong Kong. There are no CFC laws or thin capitalisation rules, and only very limited application of transfer pricing rules governing transactions between related entities.
Personal Tax: Income tax on individuals is low compared with most jurisdictions, and individual taxpayers also benefit from Hong Kong's territorial tax regime. In Hong Kong personal income tax is known as salaries tax. Individuals are only assessed on annual employment income. The salaries tax rate is the lower of either: 15% of "assessable income" after the deduction of allowances; or a progressive rate of between 2% and 17% levied on "assessable income" after the deduction of allowances.
Non-Tax Factors: A major business, trade and finance centre, Hong Kong is a cosmopolitan city with a very flexible, well-educated and entrepreneurial workforce. Language has not historically been seen as a problem for international companies locating in Hong Kong as English and Chinese are both official languages. Most people in Hong Kong speak some English, and nearly all business people speak English. Hong Kong's location means that it is daytime there when it is night in North America and early morning in Europe. This means that firms with offices in both places can actually be available to their clients 24 hours a day - important for Internet, communications, media and financial services companies. Hong Kong also has one of the world's busiest airports and largest ports.
Singapore's aim is to become a major financial hub in the Asia-Pacific region, and judging by its recent performance in the wake of the global recession it appears to be achieving this goal. The city state is striving to encourage international finance and other businesses to locate there, and offers generous tax incentives to companies that locate their global or Asia-Pacific regional headquarters there.
Corporate Tax: The corporate income tax rate in Singapore is 17%. However, capital gains are generally not subject to tax, and there are many tax incentive schemes on offer that can reduce income tax liability substantially, including the Headquarters Programme.
The Headquarters Programme: Under the Headquarters Program qualifying companies pay a concessionary corporate income tax rate of 15 percent or less, depending on their level of investment in Singapore. In order to be eligible to apply for incentives under the Headquarters Program, the applicant company should meet the following criteria:
- The applicant should be, or belong to a group that is, well established in its respective business sector or industry and has attained a critical size in terms of equity, assets, employees and business share.
- The applicant should be the nerve center in terms of organization reporting structure at senior management levels for its principal activities with clear-cut management and control for the activities.
- The applicant should have a substantial level of headquarters activities in Singapore
With Singapore's reputation as a trade and financial hub in the region, the top three industry sectors with the largest number of business formations were wholesale trade, financial services, and head office and management consultancy activities in the second quarter of 2014. The British Virgin Islands, the United States, China, Japan and India were among the top investing countries in Singapore during the quarter.
Withholding Taxes: In Singapore, there are no withholding taxes on domestic dividend, interest and royalty payments. There is also no withholding tax on dividend payments to non-treaty countries, although interest and royalty payments to non-treaty countries are taxed at 15 percent and 10 percent respectively. Management fees are normally subject to withholding tax at 17 percent. Withholding taxes on incoming dividends can be reduced under one of Singapore's tax treaties.
Tax Treaties: Singapore has a fairly extensive network of double tax treaties which includes approximately 70 countries, under which some forms of income are exempt from tax or qualify for reduced rates. Notably though, the United States is not one of them.
Anti-Avoidance: There are no thin capitalization provisions within Singapore tax legislation, but the tax authority applies transfer pricing rules. Although Singapore is not a member of the OECD, it generally follows OECD transfer pricing guidelines, and the Inland Revenue Authority of Singapore endorses the arm's length principle as the standard to guide transfer pricing.
Personal Tax: Income tax rates are progressive up to 20%. The income tax rate for non-residents' employment income is either 15% or the relevant resident tax rate, whichever produces the highest sum.
Non-Tax Factors: Singapore is a famously well-organised and orderly place which offers the best quality of life in Asia for expat workers, according to annual rankings compiles by consultancy firm Mercer. Like Hong Kong, Singapore is at the opposite end of the clock from Europe, which has advantages for firms needing to offer round-the-clock services, such as Internet, communications, media and financial services companies. Telecommunications liberalisation is well advanced in Singapore, and costs are low. Internet penetration is comparatively high for the region. Singapore is also well-connected both by air and by sea.
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