At 11:00pm on 31 December 2020, the Brexit transition period ended and the tax position for UK companies changed where they pay or receive interest, royalties and dividends to or from related parties that are resident in the EU.
Previously, the tax treatment for the paying entity was typically determined by the EU Parent-Subsidiary Directive and the EU Interest and Royalty Directive. For UK companies receiving interest, royalties and dividends, these Directives ceased to apply from 1 January 2021. The tax treatment of the payments reverted to the domestic law of the paying company and the position set out in the relevant double tax treaty with the UK.
However, for UK companies paying interest or royalties, the EU Interest and Royalties Directive was written into UK domestic law and so continues to apply but only until 1 June 2021 when they will be repealed as announced in the 2021 Budget.
How will this change affect UK companies making relevant payments?
UK domestic law requires a UK payer to withhold income tax of 20% on the payment of interest and royalties to non-residents. There is no withholding requirement for dividend payments.
From 1 January 2021 a UK resident payer of interest needs to consider whether the domestic rate can be reduced or eliminated under a double tax treaty between the UK and the recipient’s territory of residence. Where a reduction is available, the UK payer will need to apply for and seek direction from HM Revenue & Customs (HMRC) to pay the reduced rate before any payment is made.
Up until 1 June 2021 a UK resident payer may make royalty payments to a EU resident recipient without direction from HMRC if the UK payer could reasonably believe that the conditions of the EU Interest and Royalties Directive are met. From 1 June 2021 the payer will need to refer to the relevant double tax treaty and if a reduction or elimination of the domestic rate is available the payer may make such a payment without seeking a direction from HMRC if the payer reasonably believes that the conditions of that treaty of met.
Action may therefore need to be taken promptly to get a direction before making any payment of interest under any reduced rate. Failure to withhold and report income tax to HMRC may result in interest and penalties being charged. Therefore, if direction from HM has not been obtained prior to payment, it will be necessary for the UK paying company to deduct, report and remit income tax at the 20% rate and make a subsequent application to reclaim any overpaid amount where treaty conditions are met.
Normally the process of seeking direction can take many weeks as the application needs to be sent to the tax authority of the overseas recipient as well as HMRC however a simplified email-based process has been introduced by HMRC to help taxpayers be compliant in applying reduced rates but this process is not available to taxpayers seeking direction for the first time in respect of a particular interest or royalty stream.
How will this change affect UK companies receiving relevant payments?
Many EU territories have similar obligations to report and remit tax to their domestic authority where there are payments of interest, royalties and dividends to a UK resident company.
Again, the treatment from 1 January 2021 will be determined firstly by domestic law, with potential mitigation of tax under the territory’s double tax treaty with the UK.
UK companies should check whether their future income may be reduced by overseas withholding taxes and whether there is mitigation available under the double tax treaty. If mitigation is available, the paying company may need to receive clearance from the domestic authority to apply the mitigated rate before payment. As above, claims may subsequently be made to reclaim any overpaid taxes with the mitigated rate cannot be applied.
Where full mitigation of overseas tax is not possible under the treaty, double tax relief may still be claimable in the UK company’s corporation tax return.
Additionally, some EU member states’ treaties with the UK only allow the treaty rate to apply to dividend payments where the dividend is subject to tax by the recipient. UK recipient companies will need to consider if it is beneficial to disapply the dividend exemption for UK corporation tax in order to claim a treaty rate of withholding tax on the dividend.
UK companies should therefore make enquiries with overseas payers whether clearance have been sought and obtained. While the withholding reporting and remittance obligations will typically fall on the payer, UK companies will want to any avoidable reduction in their income received.
How we can help
We can assist in undertaking a review of your businesses’ payments and receipts, exposure to taxes and available mitigations. We can also help prepare applications to tax authorities to seek a reduction, elimination or repayment of withholding taxes as well as managing other ongoing compliance requirements.
This article is based on law and practice as at 27 May 2021 and remains subject to changes pending the outcome of future announcements, including agreements between to the UK and the EU and the individual member states of the EU.