Ticklish issue of whether or not to migrate to another tax jurisdiction

Financial Times (www.ft.com) has just published a very interesting article entitled "Ticklish issue of whether or not to migrate to another tax jurisdiction", wrote by Vanessa Houlder:

Amid this Autumn’s financial turmoil, WPP, the world’s second largest advertising group, unveiled big tax savings from a small but significant change in its corporate structure.

It joined a handful of businesses – Shire, United Business Media, Regus, Charter and Henderson – in moving its holding company and tax base out of the UK.
More companies could follow suit. Richard Lambert, director general of the CBI, recently told a conference “any independent director worth her salt” would be asking whether the company should move headquarters for tax reasons.

Ashley Almanza, chief financial officer of BG and chairman of the Hundred Group, the influential lobbyist, says factors such as the judicial framework, the benefits of agglomeration and reputational issues ensure that any decision to move would not be taken lightly. “There are powerful reasons to stay,” he says.

But companies with large overseas operations could make big savings by moving their tax base to small, business-friendly regimes such as Ireland or Luxembourg.

The classic emigration route is via an “inversion”: setting up an overseas holding company, typically in Ireland, that acquires the old UK company on a share-for-share basis.

The company is usually incorporated in Jersey to ensure no stamp duty is payable. The UK company then sells its foreign subsidiaries to the new Irish holding company.
Provided the activities are mainly trading in nature, the gains should be exempt from capital gains tax under the “substantial shareholding exemption”.

The main reason why an inversion would save tax lies in the “controlled foreign companies” (CFC) rules, under which the UK taxes offshore passive income, such as royalties and interest. By contrast, it normally only taxes foreign profits when dividends are paid back to the UK.

These CFC rules have been tightened in successive Budgets. That has curtailed the ability of companies to do international tax planning.

For some companies intending to expand their overseas operations, the UK’s CFC regime is a powerful incentive to move to a country such as Ireland that has no CFC rules.

Another powerful force driving some multinationals to change their domicile is a fear that the CFC rules will become even tougher.

This prospect was raised by the Treasury’s consultation, launched last year, on how to reform the taxation of foreign profits.

The Treasury is sympathetic to a longstanding business request to allow the tax-free repatriation of foreign dividends. But it fears this concession will be used to find new ways to avoid tax.

As a result, it is considering adopting tougher CFC rules. After an outcry, it told businesses in July that it had dropped proposals to sweep all their overseas income relating to intellectual property into the British tax net through a new “controlled companies” regime.

The Treasury is also considering tightening up on the ability of businesses to inject debt into their UK operations, reducing their taxable profits. It has proposed a worldwide debt cap, which would stop UK entities having more debt than required to finance the worldwide group.

This proposal worries some multinationals, although the Treasury has said it would set it aside when a group was cash-rich for a temporary reason, such as completing a sale.

Henderson, the fund manager, estimated changing its domicile would cost £4.5m. Smaller or less profitable businesses or those with significant tax losses are unlikely to make big tax savings by moving.

Moreover, inversions carry risks. There is ample scope for a political backlash against businesses avoiding tax, particularly when taxpayers are having to bail out the financial sector.

There is also a risk of a change in the tax regime in the new domicile. Ireland has underlined its commitment to preserving its low corporate tax rate, even though it has announced other tax rises.

Another risk could flow from a Revenue & Customs’ investigation into whether the control of a business has genuinely left the UK.

The costs and risks mean inversions are not a sensible option for all international companies. The UK continues to attract the lion’s share of headquarters set up in Europe, according to Oxford Intelligence research for Ernst & Young. Peter Lemagnen, its managing director, suggests that smaller companies are still being drawn to Britain but the tax regime is a deterrent for some larger, more sophisticated companies.

Historically, the UK won more than 40 per cent of headquarters investment in Europe; last year it fell to 30 per cent.

Philip Cox, chief executive of International Power, which owns power stations in 20 countries, says his group’s ability to compete will be severely hampered if foreign interest income is swept in the British corporate tax net. “For us, the treatment of overseas profits is critical. It can be a deciding factor on winning or losing a bid.”

Copyright The Financial Times Limited 2008