International Tax Services (ITS)

December 2010

Welcome to your International Tax Services Newsalert.

Hot from the news:

  • United Kingdom – To restore the UK's tax competitiveness, HM Revenue & Customs issued a substantial consultation document (“condoc”) on corporate tax reforms.
    The “condoc" sets out a series of corporate tax (CT) reforms in a single program and confirms the UK Government's intention to move toward territorial taxation by proposing positive reforms designed to create a more attractive tax environment for investors. Read more…
  • Ireland – Irish Government Re-affirms Commitment to the 12,5% Corporate Tax Rate
    To encourage and promote increased investment and competition.Read more…
  • Switzerland – Tax Improvements Boost Attractiveness of the Swiss Canton of Nidwalden
    The main changes for Corporations are that the canton of Nidwalden reduces its fixed corporate income tax rate from 9% to 6% as well as its fixed income tax rate applying to foundations and associations to 1%. Read more…
  • Austria - Proposed Changes in Austrian Tax Law
    From 2011 onwards interest expenses relating to the acquisition of shares from related parties or controlling (direct and indirect) shareholders shall generally be non-deductible for tax purposes. Read more…
  • Cyprus/Russia – Cyprus soon to be removed from the Russian “black list”
    The economic relations between the two countries are gaining even greater momentum as the Joint Declaration signed by the two presidents in November 2008 in Moscow has now been promoted into a Three-Year Action Plan aimed at enhancing the cooperation between the two countries at all levels. Read more…

  

United Kingdom – To restore the UK's tax competitiveness, HM Revenue & Customs issued a substantial consultation document (“condoc”) on corporate tax reforms.

On November 29, 2010 Her Majesty's Revenue & Customs and Her Majesty's Treasury issued a substantial consultation document ("condoc") setting out a series of corporate tax (CT) reforms in a single program.
The condoc confirms the UK Government's intention to move toward territorial taxation by proposing positive reforms designed to create a more attractive tax environment for investors. Specifically, the condoc covers the taxation of Controlled Foreign Companies, provides an exemption for foreign branches of UK companies and introduces a "Patent Box". The condoc also confirms that there are no significant changes planned to the rules on interest deductibility as a result of the move towards a more territorial system of tax.
As with any consultation process, however, there are areas of uncertainty and the Government will address these areas with the business community.

Controlled Foreign Company ("CFC") Rules

As highlighted in previous Newsalerts, the UK will introduce full reform of the CFC rules in Finance Bill 2012. The condoc provides additional guidance on both the full reform and the interim measures to be introduced in Finance Bill 2011. The interim measures will seek to implement initial changes consistent with the Government's aim to enhance the UK's competitiveness as a holding location.

Full reform

The new CFC rules will primarily utilise an entity-based system in a targeted way by taxing only the proportion of overseas profits that are viewed as having been artificially diverted from the UK. Note that the reform will introduce a number of exemptions, but little detail is given, except to state that industry specific exemptions will be included (e.g., banking, insurance and property).
The proposals set out in the condoc focus on the two key areas for main CFC reform: monetary assets and intellectual property ("IP").
The proposals for monetary assets (e.g. instruments that give rise to an interest-like return including cash, debt and their equivalents) fall into two categories: finance companies and treasury companies. New exemptions are being proposed for both.
A finance company partial exemption would apply where the CFC is funded with an appropriate ratio of debt-to-equity. If the equity exceeds an indicated level (to be determined through consultation), a proportionate CFC charge will arise. A finance company that is fully equity funded should have an effective tax rate under 10%. These rules should also be extended to companies holding excess cash.
The Government will seek to exempt treasury companies that manage monetary assets on a day-to-day basis and make only a small return, thus posing only a limited risk to the UK tax base.
The January 2010 proposals on IP received a mixed response and certain unfavorable proposals have been dropped. Alternatively, the Government intends to introduce rules that target high risk areas, namely:

  • IP developed in the UK and then transferred to a low tax jurisdiction in the last 10 years;
  • IP held offshore but where significant amounts of activity to maintain or generate the IP value are undertaken in the UK; and
  • IP that is effectively held as an offshore investment.

The taxation of IP is one of the most complex areas to be tackled by the CFC reform. This area will require detailed consultation to reach a solution that not only interacts with transfer pricing rules but is also acceptable to business.
The exemption available to CFCs with chargeable profits below a de minimis level will be extended and simplified by increasing the threshold from £50.000 to £200.000. In addition, the threshold level will be tested by referring to accounting profit rather than the taxable profit calculated under UK principles.
Other issues raised in the January consultation for the full reform, including a "white list" for high tax territories, will be considered in the ongoing consultation.

Interim improvements 

The Government intends to publish draft legislation, along with other draft clauses of Finance Bill 2011, on December 9, 2010. The main change is the introduction of a new exemption for a CFC which carries on a range of ‘foreign to foreign’ activities involving transactions wholly or partly with other group companies, provided there is little or no risk of UK tax base erosion.
The new exemption is designed to allow UK multinationals to manage overseas operations more efficiently. 
The draft legislation also introduces a narrow exemption for IP where there is no or minimal connection with the UK. While narrowly focused, this exemption is a first step towards full reform of IP in Finance Bill 2012.
In addition, the interim legislation will introduce a statutory exemption (of up to three years) for foreign subsidiaries that fall within the scope of the CFC regime for the first time due to a reorganisation or change to UK ownership. Unlike current non-statutory arrangements, a change in business or activities of the CFC will not affect the new exemption unless, and to the extent that, it erodes the UK tax base.

Foreign branch exemption

Consistent with its move to a territorial system, the Government proposes to provide companies with an opt-in exemption regime for foreign branch taxation. The exemption should be included in Finance Bill 2011, with draft legislation expected to be published December 9, 2010.
This will be an irrevocable election that a company makes for all of its branches. The effect of the election will be to exempt foreign branch profits and will mean that there will be no relief for foreign branch losses. Although not without issues, the overall reform seems an attractive package.
The main features are set out below.

  • The opt-in exemption regime will apply to foreign branch trading profits and investment income which is "effectively connected" to the branch.
  • The regime will be extended to all countries and territories including those where the UK does not have a tax treaty.
  • Exempt profits will be defined with reference to the definition in the individual tax treaties. Where there is no treaty in place exempt profits will be defined by reference to the Organisation for Economic Development & Cooperation (OECD) model tax treaty.
  • The regime is not extended to small companies (it applies to medium and large companies only).
  • The exemption will include chargeable gains, calculated in accordance with the relevant tax treaty or OECD treaty where there is not a treaty in place.
  • There will be a transitional rule for branches that incurred tax losses in the preceding six years.
  • The new regime will be available for accounting periods starting on or after a specified date in 2011, yet to be determined.

The full CFC reform in 2012 will include anti-diversion of profits rules for foreign branches. In the meantime, a CFC-type regime will be introduced for foreign branches with more limited carve-outs.

Patent Box

The Government has confirmed its intention to introduce a patent box regime effective April 1, 2013 as part of a strategy ‘to encourage companies to locate high value jobs and activities associated with the development, manufacture and exploitation of patents in the UK’.
As the name suggests, the patent box regime will only apply to patent rights and will not cover other technological intellectual property or brands.
The optional patent box regime will provide for a 10% tax rate on patent income, net of associated costs.
Patents commercialised after November 29, 2010 will qualify for the patent box regime. There may be a claw back mechanism for patents commercialised prior to that date, for which tax deductions on the related expenses have been claimed at the standard rate.  As part of the regime's anti-avoidance measures, the Government is considering linking the amount of income attributable to the patent box to the level of associated R&D or manufacturing.

Interest deductibility 

There have been suggestions that the UK should adopt a fully territorial approach to both CFC and interest deductibility in the UK. The Government has concluded that this is unlikely to result in a more competitive system, could be more disruptive and remove one of the more attractive aspects of the UK tax regime, i.e., the UK’s interest deductibility rules. The condoc therefore expressly states that the Government does not intend to pursue significant changes to the interest deductibility rules.

Conclusion

Through the condoc proposals, the Government has demonstrated greater appreciation of the commercial realities of multinational companies, including how they operate and the issues to address to encourage them to invest in the UK. While the rules may not appear to meet the Government's stated objective of "simplicity" in the tax law, hopefully, through consultation with taxpayers and tax professionals, the rules will be made workable for business, thereby enhancing the UK's competitiveness. Taxpayers affected by the proposals should consider the submission of representations or self-nominations for participation in the relevant working groups to help shape the new legislation.

Ireland – Irish Government Re-affirms Commitment to the 12,5% Corporate Tax Rate

On October 1, 2010 the Irish Government confirmed its commitment to Ireland’s 12,5% corporate tax rate. The statement was issued in response to EU Commissioner Olli Rehn's comments which indirectly suggested that Ireland's 12,5% corporation tax regime may be under threat.

Statement

While Commissioner Rehn’s comments did not directly refer to the 12,5% rate, recognising the importance of avoiding any uncertainty over the issue, the Irish Government has moved quickly to reassure the multinational community as to its position.

Finance Minister Brian Lenihan issued the following statement on behalf of the Irish Government:
"Commissioner Rehn made comments this morning in relation to taxation levels generally in Ireland. The Minister has acknowledged that taxation will form part of the solution to our fiscal problems and stabilising the deficit. With regards the corporation tax rate, the Government has always made it clear that the corporation tax rate will remain at 12,5% as set out in the Programme for Government. This is still the case. This commitment is protected, in an EU context, by the principle of unanimity in taxation matters. That was further enhanced by the insertion of a legal guarantee in the Lisbon Treaty. The 12,5% corporation rate is a cornerstone of the Irish industrial policy."
A low corporate tax regime to encourage and promote increased investment and competition has been a fundamental part of the Irish tax landscape since the 1950s and is just as relevant today in achieving those aims. Therefore, it is helpful to dispel any possible uncertainty about the impact of Ireland's budgetary position on the 12,5% corporation tax rate.

Switzerland – Tax Improvements Boost Attractiveness of the Swiss Canton of Nidwalden

The legislative body of the canton of Nidwalden recently adopted a further partial revision of the cantonal tax law becoming effective January 1, 2011. The revised law introduces numerous amendments to individual and corporate taxation.

License Box Rule

The most significant innovation is the introduction of the so called “license box rule” for corporations, which will enter into force as per January 1, 2011.
According to the new law, net licensing income from Swiss and foreign sources resulting from the right to use intellectual property rights (IP) will be taxed separately at 20% of the ordinary cantonal and communal income tax rate. Considering that Nidwalden will introduce a flat income tax rate of 6% for ordinary income, qualifying license income will only be taxed at a flat rate of 1,2%. As a consequence, a pure license company may be taxed at an effective tax rate of some 8,8% considering direct federal and cantonal and communal taxes.
It is expected that the definition of the qualifying income will be linked to the OECD model tax convention. The law is taking into account the net income as calculation basis for the reduced rate. Thus, costs that are directly linked to the IP such as R&D expenses are deductible. It is further expected that also capital gains on the disposal of IP can benefit from the reduced rate.
Furthermore the license box will also be applicable to IP created and acquired prior to the law entering into effect.
Further details on IP definitions and possible applications of the described rule in connection with other cantonal tax regimes are currently under discussion and will be published in a separate guideline by the end of this year.

Main Changes for Corporations

The canton of Nidwalden reduces its fixed corporate income tax rate from 9% to 6% as well as its fixed income tax rate applying to foundations and associations to 1%. As a further measure the fixed capital tax rate will be reduced from 0,1% to 0,01%. As a consequence the effective tax rate for ordinarily taxed companies in the canton of Nidwalden will be reduced from currently some 15% to some 12,7% as of January 1, 2011.

 

Austria - Proposed Changes in Austrian Tax Law

The Austrian Ministry of Finance recently published a government bill, the “Budgetbegleitgesetz 2011 - 2014” (BBG 2011 - 2014). It includes numerous amendments having significant impact on Austrian tax law.

Interest Deduction

According to the current tax law interest expenses resulting from the debt financed acquisition of shares are tax deductible even if the Austrian participation exemption regime would be applicable with regard to dividend income to be received out of the shareholding or capital gains to be generated out of the disposal of the shares.
From 2011 onwards interest expenses relating to the acquisition of shares from related parties or controlling (direct and indirect) shareholders shall generally be non-deductible for tax purposes. The disallowance of the interest expenses shall also apply in case the entity acquiring the shares has received the required funds by way of a debt-financed equity contribution. The amendment will also affect interest expenses resulting from intra-group share acquisitions conducted prior to January 1, 2011.
The BBG 2011 - 2014 does not impact the deductibility of interest expenses incurred in connection with the acquisition of shares from a third party.

Financing Instruments

Another important change in the Corporate Tax Act relates to hybrid instruments used for cross-border financing activities. Income derived from financing instruments qualifying as equity style investments for Austrian corporate tax purposes will not be exempt under the Austrian participation exemption if the corresponding payments are tax deductible at the level of the foreign company. The envisaged amendment aims at eliminating double-dip structures which provide for a deduction of payments in the source state and a corporate tax exemption of the income resulting therefrom in Austria.

Research and Development Incentives

Currently an R&D premium of 8% or alternatively an allowance of 25% to 35% of qualifying R&D expenses can be claimed for R&D activities in Austria.
The draft law stipulates an increase of the R&D premium to 10% from 2011 onwards while the R&D allowances will be abolished. In addition, the R&D premium shall be limited to R&D activities performed in Austria.

Stamp Duty

Entering into loan agreements currently triggers Austrian stamp duty at a rate of 0,8% - 1,5% of the loan amount.
The BBG 2011 - 2014 shall abolish stamp duty on loan agreements to be entered into from January 1, 2011 onwards. Stamp duty will thus only apply for loan agreements made and signed prior to January 1, 2011.

Bank Tax

The BBG 2011 introduces a new bank tax: The bank tax shall be levied on banking activities of financial institutions.
The tax base shall be equal to the amount of the unconsolidated total assets less equity and secured bank deposits. For the period 2011 - 2013, the bank tax shall be computed based on the 2010 balance sheet figures, from 2014 onwards based on the figures as per the respective preceding balance sheet date.
The tax rate is 0% for an assessment basis up to EUR 1bn, 0,055% between EUR 1bn and EUR 20bn and 0,085% for any exceeding amount.

Other Changes

Other major changes relate to

  • Austrian foundations (immediate taxation of investment income at 25%)
  • Taxation of investment income of individuals being tax resident in Austria (withholding tax of 25% will also be levied on capital gains out of portfolio investments)
  • Taxation of investment funds (the taxation of realised capital gains will be changed substantially)

A special excise duty shall be introduced for passenger flight tickets. The duty will be in the range of EUR 8 to EUR 35 per passenger and shall apply for all flights from April 1, 2011 onwards.
 

Prospect

If and to what extent the government bill will be passed depends on the outcome of the debate in the Austrian parliament scheduled for December 20, 2010. Coming-into-force of the proposed legislation has to be observed.

Cyprus/Russia – Cyprus soon to be removed from the Russian “black list”

The Protocol to the Double Tax Treaty between Russia and Cyprus was signed in Nicosia on
October 7, 2010 during Russian president Medvedev’s official visit to Cyprus.

The economic relations between the two countries are gaining even greater momentum as the Joint Declaration signed by the two presidents in November 2008 in Moscow has now been promoted into a Three-Year Action Plan aimed at enhancing the cooperation between the two countries at all levels.

As a result of these developments, the government of Russia is expected to announce the removal of Cyprus from the Russian “Black List”, such removal coming into effect simultaneously with the provisions of the Protocol.  Formal ratification is expected to happen before the end of 2010 so that the Protocol could come into effect on January 1, 2011.

As from the effective date of the removal from the black list, dividends received by Russian shareholders from eligible equity participations in Cypriot subsidiaries will be eligible for the Russian participation exemption.

I.I - Withholding Tax rates – no changes

One of the most beneficial as well as key aspects of the Tax Treaty is the favourable withholding tax rates applying to cross-border payments of dividend, interest and royalties.
The business community has welcomed the very positive and important decision not to bring any changes to the current withholding rates which will continue to apply as follows:

  • Dividends         -  5%*
  • Interest             -  0%
  • Royalties          -  0%

* The current provision that a direct investment in the capital of the Russian entity of less than USD 100.000 results in a 10% withholding tax rate to apply, is amended such that the 10% withholding tax applies if the direct investment is less than EUR 100.000.

I.II - New definition for dividends

The Protocol clarifies that distributions from mutual funds and similar collective investment vehicles (other than real estate investment trusts or real estate investment funds or similar vehicles primarily investing in immovable property) will be subject to the normal withholding tax rates applying to dividends i.e. 5%/10%. This clarifies an uncertainty that existed regarding the withholding tax rates that should apply on such distributions.
The definition of dividends has also been extended to cover distributions from shares held in the form of Depositary Receipts.

II - New definition for interest

The substantially aligned with the OECD definition of “interest” clarifies, inter alia, that the term “interest” also covers income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor’s profits but it does not include penalty charges for late payment or interest which is reclassified as dividends by virtue of other provisions.
Any interest reclassified by the Russian tax authorities as dividends (e.g. due to Russian thin capitalisation rules) will be subject to the withholding tax rates for dividends.

III - Changes relating to Capital Gains, expected to be effective from 2015

In general, capital gains from the disposal of shares remain under the exclusive taxing right of the country of residence of the seller.
The important change relates to disposals by a resident of one country of shares of companies which derive a substantial part of their value (more than 50%) from immovable property situated in the other country. In this particular case, the country in which the immovable property is situated will also have a right to tax the resulting gain. This change is in line with the OECD Model Tax Convention on Income and Capital.
The following aspects of this change should be noted:

  • This change will come into effect four years after the date the Protocol will come into force i.e. it is expected to be applicable from 2015
  • The exclusive taxing right will remain with the country of residence of the seller if:
    • the disposal qualifies as a corporate reorganisation or
    • the disposed shares are listed on a recognised stock exchange or
    • the seller is a pension fund, provident fund or the government of either of the two countries
  • The Russian Federation has undertaken that, by the time the Protocol will come into force, it will have adopted the OECD Model Tax Convention on Income and Capital provision for capital gains in its tax treaties with all States which are regarded as main investors in the Russian Federation.

IV - Exchange of information - Assistance in Collection – Mutual Agreement

This article has been revised in line with the article 26 of the OECD Model Tax Convention on Income and Capital and reflects the changes that have already been introduced in the Cypriot tax legislation since 2008.
The changes are towards alignment to OECD policy standards on fiscal transparency and exchange of information on taxation matters.
More clarity has been introduced in relation to the powers and obligations of the tax authorities of the two countries which are generally aimed at improving the administrative procedures through which information can be collected and exchanged between the tax authorities of Russia and Cyprus.
It is now clearly provided that the fact that one country may not need information for its own purposes should not prevent it from collecting this information in reply to a request from the other country.
At the same time, it also remains clear that information cannot be supplied which is not obtainable under the laws or in the normal course of the administration of a contracting state.
It is further clearly provided that professional secrecy rules (e.g. by a bank or a person acting in an agency or fiduciary capacity) cannot be used as an excuse for refusing to supply information. However, the circumstances under which such professional secrecy rules can be lifted and the process that must be followed in this respect are subject to the detailed provisions of the domestic legislations of the two countries. In the case of Cyprus, the approval of the Attorney General is needed before any information is exchanged.
The article on “Assistance in Collection” has also been aligned to the OECD Model Tax Convention on Income and Capital. This will come into effect only upon the introduction by Cyprus of the necessary legal framework necessary to provide the Assistance in Collection.
The amendments to the article on Mutual Assistance procedures are also towards bringing this article in line with the OECD standard.

V - Limitation of treaty benefits

The limitation of benefits introduced does not apply to Russia or Cyprus registered companies.
Limitation of benefits applies to tax residents of Russia or Cyprus which are not registered companies in either of the two states and only in cases where the tax authorities of the two countries agree that the main purpose or one of the main purposes of the company was to obtain the benefits of the agreement.

VI - Other changes

  • The Protocol introduces a clarification of the existing “tie-breaker” clause in relation to residency so that in cases where the effective management cannot be determined, the tax authorities of Russia and Cyprus should consult between them and come to a mutual agreement in this respect.
  • The Protocol extends the definition of Permanent Establishment to cover activities of an enterprise resident in one country through services performed by individuals present in the other country for more than 183 days in a 12-month period, with certain specific criteria having to be met prior to such services being deemed to give rise to a Permanent Establishment in the other country.
  • Income from international traffic will be subject to tax in the country where the effective place of management of the person deriving the income is situated.
  • It has been clarified that income received through a real estate investment trust, a real estate investment fund or a similar collective investment vehicle which is organised under Russian laws primarily for the purposes of investing in immovable property would be treated as “Income from Immovable Property” as per article 6 of the Treaty and may be subject to tax in the country where the immovable property is situated.