UK and International Tax news

No Deal Brexit And Changes To Deduction Of Tax On Interest, Royalties And Dividends

Thursday 18th April 2019

HMRC has recently issued guidance on potential changes to tax deductions on interest, royalties and dividends if the UK leaves the EU without a deal.

Where the UK leaves the EU without a deal, the way that interest, royalties and dividends are paid between UK and EU companies may change and tax may have to be deducted from some payments.

Under UK domestic law and existing double taxation agreements with EU member states, full or partial exemption, or reclaims of all of the tax paid may be possible.

The EU Interest and Royalties Directive (IRD) allows EU companies to make certain interest and royalties payments to associated companies and permanent establishments within the EU without needing to deduct tax from them.  If the UK leaves the EU without a deal, from 11pm UK time on 31 October 2019, the IRD will no longer apply to the UK.

For payments from the EU, some EU member states may start to deduct tax from interest and royalty payments that used to be exempt under the IRD.  The amount of tax deducted will depend on the double taxation agreement (DTA) between the UK and the EU member state.

For UK resident companies receiving royalties and interest from an associated company in an EU member state, full or partial exemption or reclaim or all of the tax already paid under the relevant DTA may be possible.

Interest and royalty payments that are exempt from domestic withholding taxes under the IRD may also be exempt under the DTA, for example, those payments made to the UK from France, Germany or Spain.

The terms of the DTA may state that the amount of tax to be deducted from interest and royalty payments cannot exceed a specific amount, but the payments are not entirely exempt, for example, payments made to the UK from Italy.

It will therefore be important to check the terms of the DTA between the UK and the EU country where the person paying the interest or royalties is resident. New or revised claims to the tax authorities of the EU country may be needed.

UK companies and EU companies that have a permanent establishment in the UK, who make payments of interest and royalties to associated companies in the EU will not need to start deducting tax from these payments [per s.757 – 767 ITTOIA 2005]. This legislation will continue to apply if the UK leaves the EU without a deal.

However, for payments of interest this exemption is not automatic. A person receiving interest payments will need to apply for the exemption by filing an EU Interest and Royalties form. This form may also be used to claim a repayment of tax that has been deducted from payments of interest or royalties. If an exemption already applies, this will stay the same.

UK companies that pay royalties will still be able to make these payments without deducting tax from them if they reasonably believe that the payment is exempt under s.758 ITTOIA 2005.

The EU Parent-Subsidiary Directive [PSD] provides that profits distributed by a subsidiary in one member state to its parent company located in another member state will be exempt from withholding tax provided that parent company holds at least 10% of the subsidiary.

If the UK leaves the EU without a deal, then from 11pm UK time on 31 October 2019, the PSD will no longer apply to the UK.

As UK law does not impose an obligation to deduct tax from UK dividends, this will have no effect on dividends paid by UK companies to companies resident in the EU.

However, for dividend payments from the EU, the amount of tax to be deducted from these dividend payments will depend on the DTA between the UK and the EU member state. Often dividends payments that are exempt from domestic withholding taxes under the PSD are also exempt under the DTA, for example, payments made to the UK from France or Spain.

Some DTA’s specify limits to the amount of tax to be deducted from dividend payments, but the payments are not entirely exempt, for example, payments made to the UK from Germany or Italy.

In summary, if the UK leaves the EU without a deal, some EU member states may start to deduct tax from some dividend payments that used to be exempt under the PSD.

It will therefore be important to check the terms of the DTA between the UK and the EU country where the person paying the dividends is resident. New or revised claims may be required to be sent to the tax authorities of the EU member state.

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