In recent years, the United Kingdom has become an increasingly attractive holding company jurisdiction and, in the context of inversions, arguably a fashionable one.  In the last year in particular, several U.S. groups have sought to merge with foreign groups or spin off divisions to them, with the resulting group sitting under a new non-U.S. holding company.  UK-resident holding companies have also been adopted or considered in structuring European cross-border mergers.

Previously, however, the United Kingdom had experienced the other side of this coin: in 2008 and 2009, several UK-based multinationals inverted to Ireland and Switzerland.  Critics of today’s U.S. tax system will recognize some of the criticisms leveled at the UK tax system in 2008 by multinationals seeking to escape it—namely, that the United Kingdom taxed worldwide profits with credit relief for foreign taxes, rather than applying a territorial exemption system, and had ill-focused and overly broad controlled foreign company (CFC) rules, which the then-government initially proposed to expand in scope as a quid pro quo for exempting foreign dividends from tax.

As a member of the European Union, which prohibits restrictions on businesses’ ability to establish themselves in other EU Member States, the United Kingdom did not have the option of adopting U.S.-style anti-inversion rules.  This ultimately led the UK government to adopt more focused CFC rules, exemptions for foreign dividends and the profits of foreign branches, and aggressive cuts to the headline rate of corporation tax (which will reach 20 percent in 2015).  These reforms supplemented the UK tax system’s existing attractive features, such as the absence of a dividend withholding tax, generous relief for interest expense and a broad tax treaty network. 

The basics of the United Kingdom’s corporate tax system now stand in comparison with those of other holding company jurisdictions.  From a non-tax perspective also, the United Kingdom is a credible holding company jurisdiction in which many multinationals already have a substantial presence or will be able to locate some substantial activity without too much difficulty. 

Companies considering adopting a UK holding company structure should, however, be aware of potential complications that must be addressed as part of any inversion, as well as potential developments in the UK tax regime over the next few years.

Issues to Be Considered as Part of an Inversion

One frequently cited disadvantage of using a UK-incorporated holding company is that transfers of its shares are subject to stamp duty, a transaction tax charged at a rate of 0.5 percent of the consideration paid for the shares.  Where the shares are traded on the London Stock Exchange, the duty is collected through the electronic settlement system, but there is no such mechanism for shares traded on foreign exchanges, which led the UK government to impose duty at a rate of 1.5 percent when shares are transferred into a clearance system or depositary receipts to enable them to be traded on a foreign exchange.  Although the European Court of Justice (ECJ) has curtailed the scope of this charge in practice, the charge remains on the statute book and is thus a complicating factor when listing the shares of a UK company on a foreign exchange. 

Because the stamp duty legislation only applies where the company is UK incorporated, some inverting groups have adopted the simple expedient of establishing a holding company that is managed and controlled (and thus tax resident) in the United Kingdom but incorporated in Jersey or another similar jurisdiction that does not impose a corporate income tax.  Where a UK-incorporated company is used, however, it is often possible to obtain a ruling from HM Revenue & Customs (HMRC) that the reorganization will not attract a significant stamp duty charge.

Depending on the precise structure adopted, an inverting group might need assurance that the transaction as structured does not inadvertently trigger a taxable capital gain in the United Kingdom.  Additionally, if any party to the transaction has significant UK-resident shareholders, that party should consider whether the transaction can be structured as a tax-free exchange for such shareholders.

With respect to the post-acquisition structure, the group may wish to seek assurance from HMRC with respect to the deductibility of interest on any debt taken on by UK group companies as part of the restructuring.  It may also wish to obtain clarification as to how the CFC rules will apply to it in the future.  While the new rules are intended to focus on profits diverted away from the United Kingdom, they are not necessarily straightforward to apply, although groups moving to the United Kingdom can take advantage of a one-year exemption from the application of the CFC rules to enable them to undertake any necessary restructuring.

HMRC is generally efficient and cooperative in providing clearances on these issues but is also wary of being perceived to endorse tax avoidance or of providing tax planning services.  Any application for clearance is more likely to receive a positive reception if it is submitted as part of an arrangement that will result in more substantive economic activities being undertaken in the United Kingdom.

Potential Future Developments

In recent years, perceived tax avoidance has been subject to much public and parliamentary scrutiny in the United Kingdom.  The United Kingdom is also an enthusiastic participant in the Organisation for Economic Co-operation and Development’s base erosion and profit shifting (BEPS) initiative.  These factors are likely to result in further changes to the corporate tax regime in coming years, regardless of the government’s political complexion after the 2015 election.

It is reasonable to assume that the United Kingdom’s territorial tax system and modified CFC rules are here to stay, largely because it would be difficult to strengthen them in a way that is consistent with EU law.  No major political party is advocating substantial increases in the rate of corporation tax, and ECJ case law has placed strict limits on the ability of Member States to impose “exit charges” on departing companies.  The government has, however, recently indicated its intention to implement more comprehensive anti-arbitrage rules as contemplated by the BEPS project, and (in line with other major European economies) may also introduce tighter restrictions on the deductibility of interest in the future.

Groups should bear in mind the risk of these types of changes when considering their optimum structure.  Equally importantly, they should consider how their tax structuring will be perceived: in the United Kingdom today, tax planning can be as much about reputation and brand management as it is about tax efficiency.