The UK holding company regime

The UK has an attractive tax regime for holding companies. It boasts a generous participation exemption, exclusions from withholding tax, tax-free dividend receipts for corporates and an extensive double tax treaty network. Such features are compelling reasons to establish an international headquarters in the UK.

In this article we explain how a holding company is taxed in the UK and highlight some key advantages.

Tax on profits

A UK holding company would not necessarily have significant profits to report, given the opportunity to deduct interest and the tax exemption for in-bound dividends. Such profits as are made, would subject to corporation tax as explained below.

UK corporation tax is charged to a UK resident company on its worldwide profits and gains. There is no distinction between income profits and capital profits.

1. A company with profits of £250,000 or more is taxed at a flat rate of 25 per cent.
2. The small profits rate of corporation tax of 19 per cent applies to companies with profits up to £50,000 (with some exceptions).
3. If profits are over £50,000 but do not exceed £250,000 a marginal relief applies to produce a bespoke rate of tax between 19 per cent and 25 per cent.

Note that the profit thresholds of £250,000 and £50,000 are reduced to take into account companies which are grouped or associated with the holding company.

Tax on funding

Debt funding

Where investment in the business is made by way of debt, a corporation tax deduction should be available to a UK holding company with respect to the interest it pays. This is subject to various restrictions (see below) and to anti-avoidance provisions (see Anti Avoidance ).

If the interest expense of a corporate group exceeds £2m per year, tax deductions will be restricted to a fixed ration of 30 per cent of the company’s earnings before interest, taxes, depreciation and amortisation (EBITDA). Further restrictions may also apply although in practice these are not usually in point.

A UK holding company generally has a duty to withhold tax (currently at a rate of 20 per cent) from payments of interest to investors who fund the holding company by way of loan finance. The withheld tax is then paid by the holding company to the UK tax authority (HMRC) with some lenders eligible to claim a refund.

However, in many cases no tax withholding on interest payments is required to be made. The main withholding tax exemptions are summarised below.

1. A holding company with non-UK resident investors should not be required to withhold tax on interest payments if the investor is based in a country which has a double tax treaty with the UK which includes an interest exemption. Alternatively, the relevant tax treaty may provide for a lower rate of withholding tax. A clearance should be obtained from HMRC permitting the UK holding company to make gross interest payments.
2. Payments of interest to UK banks and UK corporation taxpayers can be paid free from withholding tax.
3. Quoted Eurobonds (interest bearing debt securities listed on a “recognised” Stock Exchange) are exempted from UK withholding tax.
4. Certain private debt placements (unlisted debt instruments sold to a limited number of investors and not exceeding a 50-year term) are also exempt from UK withholding tax.

Equity funding

There is no withholding tax on dividends paid by a UK company, regardless of the country of residence of the recipient. As a corollary, no tax deduction is available for the holding company for dividends paid to its investors.

Tax on income from subsidiaries

Dividends received by a UK holding company from either UK or non-UK companies should benefit from the “dividend exemption” from corporation tax as explained below.

1. If the UK holding company is “small” then the dividend exemption will apply to dividends paid by UK companies or by companies resident in (most) countries with whom the UK has a double tax treaty, provided certain conditions are satisfied. See table below for definition of a “small” company.
2. If the holding company is not a small company, then the dividend exemption may still be available if the dividend is paid by a company which the holding company controls, or if the shares are ordinary shares, or in other cases, in each case provided certain conditions are satisfied.

If the subsidiary is resident in a jurisdiction which has a double tax treaty with the UK, the rates of local withholding taxes on dividends may be reduced under the treaty terms.

Interest paid to a UK holding company is generally taxable for UK corporation tax purposes but can be offset by deductions in respect of interest payments made by the company.

Taxation of shareholders

Non-UK resident shareholders are not subject to UK tax on dividend receipts. These shareholders may be taxed on UK dividend income in their home country.

As a general rule, the UK will not charge capital gains tax on a disposal of shares in a UK holding company by non-residents (unless the company holds UK real estate and is “property rich”). A company is property rich if 75 per cent or more of the gross asset value of the company is UK land.

A UK resident shareholder who is an individual would pay tax on dividends received at 39.35 per cent if their annual income is more than £125,140 (or at 33.75 per cent or 8.75 per cent if their income is lower). There is a tax-free dividend allowance of £1,000 per year. These shareholders will pay capital gains tax on share disposals at a rate of 10 per cent or 20 per cent, depending on whether they are basic or higher rate taxpayers.

Tax on Exit

Sale of subsidiaries by the UK holding company

A UK holding company may choose to dispose of the shares in its subsidiaries and distribute the proceeds to its investors. In this case, the company may be able to take advantage of the UK’s participation exemption, known as the substantial shareholding exemption (SSE). Where the SSE applies, it is automatic, and no election is required. The effect of SSE that the holding company can sell its participation free from UK corporation tax.

SSE will be available if certain specific conditions are met, which include two key requirements:

1. The selling company must have held at least 10 per cent of the shares in the subsidiary continuously for at least 12 months during the six-year period prior to sale.

2. The subsidiary must either be a trading company (or itself a holding company of a trading group) and the extent of any non-trading activities must not be “substantial”. Generally, if the non-trading turnover (assets, expenses and management time) does not exceed 20 per cent of the total, this will not be considered substantial.

The conditions for SSE are relaxed for holding companies that are partially owned by “qualifying institutional investors” such as pension or life assurance companies.

Capital and transfer duties

In the UK there is no capital duty on paid up or issued share capital. Stamp duty at 0.5 per cent would, however, payable (by the purchaser) on a subsequent transfer of shares.

Anti avoidance

Like most jurisdictions, the UK has a suite of anti-avoidance rules designed to prevent abuse of the UK’s tax regime. These rules can deny the deductions and exemptions described above.

Controlled foreign company rules

A Controlled Foreign Company (CFC) is a company that is tax resident outside the UK and controlled by one or more UK resident persons. The CFC rules prevent the artificial diversion of a UK company's profits to subsidiaries or other corporate entities in low tax jurisdictions to avoid UK corporation tax. If applicable, certain profits of the CFC are attributed up to a UK holding company and will become subject to UK corporation tax.

However, before the rules can apply, one of a number of “gateways” must be passed through. In addition, there are several exemptions that prevent a CFC charge applying. For example, subject to certain conditions, there is an exemption for CFCs resident in a jurisdiction with a headline rate of corporation tax that is more than 75 per cent of the UK corporation tax rate. There is also a time-based exclusion and exclusions relating to profit levels and profit margin levels.

Hybrid mismatch rules

Hybrid mismatches are arrangements that exploit a difference in the tax treatment of an entity or instrument under the laws of two or more jurisdictions to produce a mismatch in the tax treatment of a payment made under the arrangement (for example, if the holding company is treated as a partnership in the investor's jurisdiction). The UK hybrid mismatch rules can deny a UK holding company from taking deductions against corporation tax for interest payments.

Transfer pricing

Where services or transactions take place between connected parties for a price which is set at a level which confers a UK tax advantage, transfer pricing rules will treat the goods or services as supplied for an “arm’s length” price, rather than the amount charged. The rules also apply to the terms of loans between connected parties and can prevent or restrict a tax deduction for interest paid by the holding company to its investors.

Transfer pricing rules apply to transactions which are cross-border, and to transactions between UK residents, however they only apply to large companies - small and medium-sized companies are exempt.

An entity qualifies as either small or medium if it meets the staff headcount ceiling for that class and one (or both) of the financial limits as set out in the following table.

*Where the entity is a member of a group, or has an associated entity, these limits apply to the whole group.

Diverted profits tax

The diverted profits tax (DPT) is a UK tax aimed at multinational organisations operating in the UK that are considered to be diverting profits from the UK to avoid UK corporation tax. It can apply to companies which are not small or medium (see above) and generate UK related sales of at least £10m or UK related expenses of £1m. The current rate of DPT is 31 per cent of the diverted profit.

Maintaining substance

It will be important to ensure that the holding company maintains “substance” in the UK, to defend against any claim that it is also resident in another jurisdiction of the group. A dual resident company can be denied tax treaty benefits - creating the potential for double taxation. This risk will be greater if the UK holding company has few staff.

Companies can become tax resident where they are “managed and controlled” rather than where they are incorporated. A company can take steps to demonstrate UK substance including:

1. engaging one or more UK-resident directors,
2. requiring non-UK resident directors travel to the UK for board meetings and reporting any taxable emoluments relating to their time in the UK,
3. keeping records to demonstrate that board members regularly involve themselves in the strategic decisions of the group. In testing this, tax authorities increasingly scrutinise whether decisions at board meetings are merely rubber stamped.

Comment

The UK offers meaningful tax benefits to a business with foreign income and investors. Specifically, a UK holding company can often pass profits from its foreign subsidiaries to its overseas investors without suffering any UK tax. This is due to the fact the UK does not impose withholding tax on dividends and no UK tax is charged on the receipt of UK dividends by non-UK investors.

The choice of where to locate a holding company will be driven by a range of fact specific criteria. It should include a balanced review of the other jurisdictions involved. Given the importance of achieving fiscal efficiency, we would recommend tax advice is sought at an early stage.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, July 2023