HOLDING COMPANIES

by

Milton Grundy

 

Material in this article appears in the author’s Offshore Business Centres (Sweet & Maxwell, 7th Edition, 1997) and the Offshore Taxation Review (Keyhaven Publications, vols.3 and 7).

The establishment of a holding company is not always or necessarily tax-driven. A holding company may be - and often is - used for the ownership of shares in companies operating in various countries: these may be concentrated in a single holding company for a variety of reasons - historical in some cases, or in others for the purpose of enabling assets and income to be consolidated. Or a group operating in countries perceived as politically unstable may establish a holding company in a politically more acceptable jurisdiction.

However, the decision, whether or not to establish a holding company, and if so in what jurisdiction, will in general be largely influenced by tax considerations. These may come in many forms. If the investing company is located in a high-tax country, the rules relating to controlled foreign companies and credits for foreign taxes may be of paramount importance. But in order to focus on the tax effect of the holding company itself, it is perhaps convenient to postulate an investor with no such preoccupations - e.g. an individual living in Saudi Arabia, or a trust established in the Cayman Islands.

The needs of such an investor may be well met simply by the formation of a holding company in a zero-tax jurisdiction. In this context, nothing really turns on which zero-tax jurisdiction is chosen. However, if a quotation on a stock exchange is envisaged, Bermuda may be a first choice, simply on the grounds that a number of Bermudian companies are already listed. There seems no reason in theory, however, why other zero-tax jurisdictions should not be utilised in the same way and indeed it is understood that some BVI companies are quoted on exchanges in Canada.

When it comes to investing within the European Union, a holding company in the EU is to be preferred, if only in order to reduce the level of investigative attention to which the operating companies may suffer at the hands of their respective tax authorities. For years it has been broadly accepted that the alternatives were the Luxembourg company established under the 1929 legislation (“the old Luxembourg Holding Company”) and the Netherlands company enjoying the participation privilege - the latter being appropriate where treaty benefit was required, the former when it was not (see page 92). Switzerland presented itself for a time as a (after Netherlands and Luxembourg) third possible jurisdiction, but the Swiss holding company has the well-recognised disadvantage of the 35% Federal tax on distributions, and once it became clear that Bern was determined to put obstacles in the way of a Swiss holding company using the treaty with the Netherlands to avoid this tax, there seemed (in the kind of circumstance we are presently considering) no reason not to dispense with the Swiss company and to have the interests in the operating companies held directly by the Netherlands company. Whether the Swiss authorities will take the same attitude to the use of the Swiss-Danish treaty is not clear; if that treaty can be used, dividends from the Swiss company can pass without withholding tax to a Danish company; they will not be taxed in Denmark, and if the Danish company is thinly capitalised the bulk of them will be absorbed by outgoing interest.

 

Other solutions to the Swiss distribution problem may be investigated, e.g. where the project has a limited time scale, so that the assets of the Swiss company reduce themselves to cash and the shares can be sold to a Swiss bank or other local purchaser; or using a company which is incorporated elsewhere but a resident of Switzerland for treaty purposes by reason of its being managed in Switzerland.

In June of this year, proposals for federal tax concessions for Swiss companies were published, and these are now under discussion. These included the proposed introduction of a flat rate of corporate income tax, the abolition of capital tax and a reduction in stamp duty.

But there is no reason to limit one’s horizons to Luxembourg, the Netherlands and Switzerland. Comparable facilities for holding companies are offered by other countries - by Austria, Belgium, Denmark, France, Germany, Hungary, Malta, Singapore, Sweden and Spain and (in Madeira) by Portugal. In Luxembourg, the SOPAFI also presents itself as an attractive alternative to the Netherlands holding company. What all these jurisdictions essentially offer is little or no domestic tax on incoming foreign dividends, and a lower rate of, or exemption from, foreign withholding tax on such dividends, in accordance with the tax treaties to which they are respectively parties. In some cases they offer also treaty exemption from capital gains tax on any disposal of the holding in an underlying company. In addition to and quite separately from treaty benefits, tax-paying companies in the European Union are entitled under the Parent/Subsidiary Directive to receive dividends from “subsidiaries” in other EU countries free of withholding tax. A “subsidiary” is a company in which at least 25% of the equity is held by the recipient of the dividend. The Directive does not prevent the application of any domestic rules directed against fraud or abuse. Such rules are presently in force in France, Italy and Spain.

Belgium may also be considered as a candidate, particularly where the level of “on the ground” activity is high. A Belgian holding company receiving dividends from foreign subsidiaries is entitled to treat 95% of such receipts as exempt from Belgium tax. This exemption is subject to certain conditions, including a minimum holding of 5% or a cost of the holding of at least 50 million BFr, and this treatment does not apply to dividends from subsidiaries in tax havens or holding or financing companies which benefit from favourable foreign tax regimes.

As in Luxembourg and the Netherlands, the more intractable problem is presented by a withholding tax of 25% on outgoing dividends from a Belgian company. Belgium has no equivalent of the Netherlands Antilles (though, again, one may nowadays consider a parent company in Malta), and the scope for reducing dividends by interest charges is reduced by the existence of a 10% withholding tax on outgoing interest. Belgium does, however, offer a favourable tax regime for seconded expatriates (as to some extent does the Netherlands), and it also offers facilities for a Co-ordination Centre, which may be used to supply treasury and other services to a group and is taxed on a favourable cost plus basis (see page 21).

 

Austria, France, Germany and Spain also offer the kind of holding company found elsewhere in Europe, i.e. where incoming dividends are not taxed but outgoing dividends are. As elsewhere, capital gains arising from the disposal of participations in other companies are untaxed, a rule to which France (like Switzerland) is the exception. An Austrian company can be particularly attractive when its shares are held by an Austrian Private Foundation. Austria is remarkable in having no requirement that the subsidiary be itself liable to local tax and in having a treaty with Cyprus which enables outgoing dividends to be declared in favour of a Cyprus offshore company at a modest rate of throughput tax. Cyprus itself offers no specific regime for holding companies, but its ordinary form of offshore company can function well as a holding company, and the country has a special tax regime for seconded expatriates. It is understood that the French regime for holding companies has attracted a small amount of business, but Germany, Spain and Sweden appear to be - so far at any rate - of minor importance.

The Directive and treaties provide very straightforwardly for favourable treatment of dividends paid by the operating companies to the holding company. What is much less straightforward is achieving favourable treatment for the outgoing dividends of the holding company itself. The superimposition of a Netherlands Antilles company can reduce to a very low level the tax cost of passing dividend income from the operating companies through a Netherlands company to the shareholder of the Antilles company (let us call it “throughput tax”).

Luxembourg and the Netherlands impose no tax on outgoing interest, but the tax authorities in Luxembourg will tolerate a much higher debt/equity ratio than is permitted in the Netherlands; this can in an appropriate case reduce the throughput tax below Netherlands/Netherlands Antilles levels, even though Luxembourg has no equivalent of the Antilles (though Malta is nowadays a contender for that role). Denmark has no interest withholding tax and no concept of debt/equity ratio, so higher gearing can make the Danish holding company route the lowest of all in throughput tax, even though any residual income distributed by way of dividend suffers the full rate of withholding tax.

Where the underlying activities of the group are not capital intensive, it can be difficult to provide enough debt to achieve any significant reduction in throughput tax. In such circumstances it is sometimes possible to create debt by selling one group company to another. If such a transaction is contemplated, shares in one or more operating companies may first be vested in a zero-tax company. When they have risen in value, and before any dividend has been declared, they are sold to the intended holding company partly for equity and partly for loan. This technique may be applied to a holding company itself, e.g. by the sale of, say, all the shares in a Netherlands holding company to a Danish holding company, 1% of the price being satisfied by an issue of shares and the rest remaining outstanding and carrying interest.

However, if the level of throughput tax remains, despite everything that can be done by way of interest charges, unacceptably high, the possibility needs to be considered of vesting the holding company shares in a company which will benefit from treaty- or Directive-relief without itself being liable to any significant tax on incoming or outgoing dividends. At present, Madeira offers the most favourable regime within the Community, and its SGPS is enjoying a large measure of success. This company is in principle fully liable to Portuguese tax, but is temporarily exempt from tax on non-EU dividends and enjoys a special low rate of tax, amounting to 1.8%, on dividends derived from companies in other European Union countries. Dividends paid by an SGPS are free of tax, except where the shareholder is a resident of Portugal or where they arise from non-exempt activities. This is a bold manoeuvre, enabling the non-E.U. investor to take advantage - indirectly - of the E.U. Parent-Subsidiary Directive. Countries in the European Union have recognised the right of the SGPS to receive dividends from 25% owned subsidiaries free from withholding tax, though anti-abuse legislation may impose additional requirements - e.g. in France, where a company taking advantage of the Directive must be under the ultimate control of E.U. residents. Exceptionally, it appears that the Dutch authorities are not at this stage prepared to recognise this right; this may not be altogether surprising, given the Dutch interest in holding companies of their own, but the Portuguese government has questioned the Dutch attitude through diplomatic channels and is understood to be prepared to take legal and political action if need be.

 

Whatever the position of the SGPS under the Directive, there seems little doubt that it is a “resident of Portugal” for treaty purposes. However, the U.S.-Portugal tax treaty has a limitation of benefits clause regarding the eligibility of companies incorporated in Madeira; and the new treaty with Spain applies to Madeira companies only if their activities are of a genuine industrial or commercial nature or if they are under the control of Portuguese residents. Under certain tax treaties - e.g. Italy - an investor in a Madeira company may be able to claim a tax credit by virtue of a tax-sparing clause. Disagreements with Denmark about various treaty matters - including the eligibility of Madeira companies to take advantage of the Portugal/Denmark treaty - led to the Danes terminating the treaty, but the Directive still applies. It is also useful to remember that a Madeira company is not a non-resident from the point of view of Portugal, so that the Portuguese CFC legislation does not apply to it.

The generally very puritanical tax regime in Singapore may offer a favourable location for the holding company in the Far East. Dividends from overseas subsidiaries do not generally attract tax, and capital gains arising from their disposal are not taxable. Approved operational headquarters are taxed at a special tax rate of 10% on fees and other income derived from foreign subsidiaries. A 10% rate can also apply to interest from overseas associates and royalties from intellectual property where the R and D has been carried out in Singapore. Credit for foreign tax is available. There is no tax on outgoing dividends, and where the company is involved in treasury or fund management activities, exemption from withholding taxes on outgoing interest may be obtained.

A much more radical approach was initiated by Malta in 1994. Their new tax regime provides, among other things, for the use by a non-resident investor of a Maltese company as a vehicle for foreign direct investment on what is essentially a zero tax basis. Although the holding company is fully liable to Maltese tax on its income, dividends are not taxed in the hands of a non-resident shareholder, and the non-resident shareholder is entitled to a repayment of the tax paid by the Company when distributing, with the result that, so long as the profits are promptly distributed - the net tax cost will be zero. When one bears in mind that Malta currently has twenty-two tax treaties, it is evident that treaty shopping in Malta can have very spectacular results. Perhaps a little too spectacular: the ingenious offshore regime adopted by Malta prompted the United States to rescind its treaty in December 1996. There are fears that other countries may follow suit but a number of new and potential treaty partners appear to accept the regime.

There has also been activity in the European Union. In order to stimulate the development of the economy in less prosperous areas, the European Commission seems prepared to give its blessing to the establishment of low-tax regimes. The pioneer in this area was the International Financial Services Centre in Dublin. This is now being followed by the Centro di Servizi Finanziari ed di Assicurativi in Trieste. The Italian law is in place, but the Centre will not be effective until the Italian Treasury, together with other ministries, promulgates the necessary administrative regulations. When this is done, Trieste will present an extremely favourable location for a holding company, paying no Italian direct taxes but entitled to the benefit of the numerous treaties to which Italy is party.

A similar facility is to be available in the Canary Islands. There the tax rate will be 1% (on non-Spanish income), and no withholding tax will be levied on outgoing dividends or other payments to non-residents. A Canary Islands company is nevertheless a “resident of Spain” for treaty purposes and is entitled to the benefit of the parent/subsidiary directive. This regime is understood to have the blessing of the European Commission, but its formal approval has yet to be given.

Perhaps the most interesting jurisdictions to have come to the fore in recent years are Spain and the United Kingdom.

A new regime for the Spanish holding company - the Entidad de Tenencia de Valores Extranjeros (the “ETVE”) was created in December of last year by Law 10/1996. In many respects, the ETVE is quite similar to holding companies found in other parts of Europe, with an exemption from tax on incoming dividends arising from a “participation” in a company which is carrying on business in another country and paying a similar tax there. The ETVE has also a number of features found elsewhere (but not all in the same country) - some relief from tax on capital gains realised on the disposal of the participation, deductibility of interest payments, absence of capital duty on share issues (in certain provinces only), entitlement to the benefit of tax treaties and the EU Parent/Subsidiary Directive and availability of advance rulings. But the special feature of Spain - and one not found anywhere else in the “participation exemption” countries - is an absence of withholding tax on the distribution of non-Spanish source dividends. This does not apply when the recipient is resident in a tax haven (paraiso fiscal); accordingly, when one is considering the investment needs of a zero-tax investor (typically, as I said in my earlier article, the individual living in Monte-Carlo or the trust established in the Cayman Islands) consideration may be given to holding the ETVE share through (for example) a Costa Rica company.

The United Kingdom legislation for the International Holding Company (“IHC”) proceeds quite differently from that of its continental counterparts - offering no reduction in the tax payable by the company on its income (nor, which is perhaps more serious, any reduction in the tax payable on its capital gains), but effectively eliminating tax on outgoing dividends. The prime use of the IHC, therefore, is in cases where there is sufficient credit for foreign taxes (including underlying taxes) to absorb the UK corporation tax charge on incoming dividends - e.g. where the holding is a direct investment is in a United States corporation. If there is a possibility that the investment may at some stage be sold at a profit, one way of avoiding corporation tax on the capital gain is to have two classes of shares in (in this case) the United States corporation, only the dividend-bearing ones being owned by the IHC.

I have no doubt that, even as - dear Reader - you peruse these pages, some government department is contemplating some change in the law to facilitate the use of its country as a base for a holding company, and I have no doubt that, if I contribute to this Review another article in a further five years’ time, there will be other changes to report on this topic. Holding company business is good business, and it is not surprising that several countries are setting out to attract

   

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