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Interest, Royalties and Dividends: what a “no-deal” Brexit could mean for your business
As you may be aware, current European law allows EU companies to make certain interest, royalty and dividend payments to associated companies within the EU without requiring a tax deduction. The only requirements are that your company must be:
- subject to corporate taxes in the EU
- a tax resident in an EU Member State
- incorporated under the law of the UK
The payments must be between two “associated companies”. This means that one company must have a direct minimum holding of 25% of the capital (or voting rights) of the second, or a third company must have 25% of the capital (or voting rights) in two other companies. The legislation covering these provisions are the EU Interest and Royalties Directive (IRD), for interest and royalties, and the EU Parent Subsidiary Directive (PSD), for dividends.
If the UK leaves the European Union without a deal, then both the IRD and PSD will cease to apply to the UK. Consequently, some Member States may begin deducting tax from the interest, royalty and dividend payments that were formally exempt. If no new legislation is brought forward, then the nature of the UK’s relationships with Member States will be laid out via the terms of the individual Double Taxation Agreements (DTAs) that the UK has previously signed with those individual states. This may impact the profitability of your business, depending on the different countries in which your associated companies operate, the nature of your business, and whether you make payments to companies in the EU from the UK or receive them in the UK from associated companies in the EU.
Payments to the EU
If your UK-based company pays interest, royalties, or dividends to an associated country within the EU, then the good news is that you will not need to start deducting tax from those payments.
In terms of royalties and interest, sections 757 and 767 of the Income Tax (Trading and Other Income) Act 2005 grants an exemption, and this law will continue to apply post-Brexit. However, the process is not automatic and you will need to fill out an EU Interest and Royalties form to apply for the exemption.
In terms of dividends, there is no obligation under UK law to pay tax on dividends and so leaving the EU will have no effect in this instance.
Payments from the EU
If your UK-based company receives interest, royalties, or dividends from an associated country within the EU, then the situation becomes a little more complicated. As mentioned above, every country has a different DTA with the UK, and it is these individual agreements that will govern taxation of interest, royalties and dividends following a no-deal Brexit.
Fortunately, many of the DTAs currently in place also make exempt the interest and royalty payments that are currently exempt from domestic taxes under the IRD. For example, the DTAs between the UK and France, Spain, and Germany will ensure that royalty and interest payments from these countries will remain exempt.
There are exceptions, however. For example, the DTA between the UK and Italy means that interest and royalty payments from Italy are not exempt from taxes, but there is provision to limit the amount deducted due to tax on the payment to be proportional to the size of the payment in this case.
When it comes to dividends, the same is true in respect of some countries being able to tax payments made and some keeping them exempt. Caution must be exercised as the list of countries that keep dividends exempt is not the same as those that keep royalties and interest payments exempt! For example, for a payment from Germany, it will exempt if it is a royalty or interest, but not if it is a dividend.
Bearing all of this in mind, if your UK-based company receives payments in the form of royalties, interest, or dividends from associated companies within an EU Member State, then checking the terms of the DTA between the UK and that Member State is vitally important. This is because the company in Europe may well have to submit a new or revised claim to the relevant tax authorities or else be in breach of the law.
If the UK leaves the EU without a deal, then the EU Interest and Royalties Directive and the EU Parent Subsidiary Directive will no longer apply.
For UK-based companies who pay royalties, interest, or dividends to their associated companies based in EU Member States, not much will change as UK law will continue to keep those payments exempt from tax.
For UK-based companies who receive royalties, interest, or dividends from their associated companies based in EU Member States, the situation may become more complicated. We recommend checking the terms of the Double Taxation Agreement that exists between the UK and the countries in which your associated companies are based to establish whether they will need to submit a new or revised claim to their local tax authorities.
If you or your business fall into the latter category, or you would like any further advice on matters relating to this topic, please contact us.