Comparative analysis of European holding company jurisdictions

Location, Location, Location! It is well known that the value of a property depends more on its location than on the quality of the building. The same can be said of a holding company as its value to the group will depend largely on its place of residence. The quality of its substance is also important but the amount of substance required will depend on the purpose for which the holding company is to be used. This article looks at typical holding company jurisdictions in Europe and explains why some are better suited to certain functions than others.

I begin by outlining the different uses to which we might want to put our holding company. Essentially, these are as: the ‘ultimate’ holding company of the group; an ‘intermediate’ holding company; or an ‘intangible property’ (IP) holding company.

The ultimate holding company

The ultimate holding company will own investments (typically subsidiaries), it might have borrowings and it might partly finance its subsidiaries with debt. Its shares may be quoted on a stock exchange or held privately. The company will have a board of directors who meet to set strategy and who effectively manage the holding company and the group. An ultimate holding company's location will ideally be one with:

• no CFC provisions - to enable the group to invest funds overseas without tax penalties;
• no withholding tax - on dividends payable to its shareholders;
• a good tax treaty network or be in an EU member state - to reduce / eliminate withholding tax on the receipt of dividends / interest;
• no tax on dividends received / capital gains qualifying for a participation exemption - i.e. we are looking for some form of participation exemption or substantial shareholding exemption;
• no stamp duty / transfer tax on the sale of shares of the ultimate holding company by its shareholders.

Other helpful features of the location of an ultimate holding company might include:

• a low rate of corporate tax - although not critical if dividends are not taxed; and
• a low rate of personal income tax for staff relocating to the holding company jurisdiction - however, this is only really important if significant headquarter operations are also being transferred with a substantial number of staff. For a stand alone holding company, only few jobs are likely to move and therefore this may not be a significant consideration.

European tax jurisdictions that are likely to be on your checklist of possible locations for your ultimate holding company will include Luxembourg, the Netherlands, Switzerland, Ireland, Malta and Cyprus. None of these countries have any substantial controlled foreign company (CFC) provisions and, with the exception of Ireland, all provide an exemption from tax in respect of dividends and capital gains. This means that there should be no tax on the operations of the holding company. Although Ireland does not provide a tax exemption for dividends it does give a foreign tax credit for tax paid by subsidiaries (broadly, 5% owned) against Irish tax on dividends meaning that any tax liability on the receipt of group dividends is typically eliminated. Ireland also has a participation exemption meaning that most gains on the disposal of 5% shareholdings in trading groups that are held for 12 months should be tax free.

The intermediate holding company

The second type of holding company is an intermediate holding company. This is used as a vehicle to collect dividends, to refinance other subsidiaries owned by the same intermediate holding company and to make acquisitions without the need to repatriate dividends directly to the ultimate holding company.

The requirements for such intermediate holding companies are similar to those of an ultimate holding company except that in this case its shares will not be regularly traded and so we do not need a stamp duty exemption. Suitable locations for an intermediate holding company will include Luxembourg, the Netherlands, Switzerland, Ireland, Malta and Cyprus. However, other locations may be used if they have good tax treaties with the country of residence of your subsidiary. These might include Mauritius, for investments into India and Madeira for investments into Angola etc.

The IP holding company

The third use of a holding company is to own intangible property (IP) such as trade marks, patent rights, intellectual property or other similar rights. For such holding companies the important features of a suitable tax jurisdiction will be:

• tax treaty network to minimise withholding taxes on royalty income;
• low rate of tax on royalty income or a regime that only taxes a portion of the royalty income, or one that provides for a tax deduction for the amortisation of the IP;
• no withholding tax on dividends paid to shareholders.

These are really two different types of tax jurisdictions that are suitable for holding IP. One will have a ‘low rate’ of tax on royalty income (eg, Ireland and the Netherlands) and the other will have a ‘low base’ on which tax will be levied. For example, Luxembourg taxes only 20% of certain IP income. Both types of tax jurisdiction will have good tax treaty networks and in some countries, such as Ireland, you can claim a tax deduction for the amortisation of the IP against taxable income.

Your choice of location of a holding company will, of course, depend on the particular circumstances of the group including where its businesses are located and where its staff are employed. Other relevant issues will include the group's view on the political stability of a particular location. For example, there would be little point in forming a company to own the group's IP in a low tax jurisdiction that was about to increase its effective tax rate significantly. In this respect you might prefer a country that taxes a ‘low base’ of income in preference to one that has a ‘low rate’. If both countries double the tax rate, the one that only charges tax on a ‘low base’ (i.e. on only a proportion of the royalty income), will still have a low(ish) effective tax rate, whereas the one that simply increases the tax rate may now be very expensive.

For IP, your choice of location will also depend on whether this is fully developed IP for which you will simply receive a steady royalty or whether the IP will be further developed and will increase in value in future years. For fully developed IP, the country that allows an amortisation against taxable income, such as Ireland, might be a good choice. However, for IP that has a modest value now but which is expected to increase significantly in value in the coming years with royalty income similarly increasing, then a country which taxes only a low base of income rather than one which provides for a low rate of tax, might be best.

The table below highlights the major features of likely tax jurisdictions.

Although it is beyond the scope of this article to discuss each of the above countries in detail, it is worthwhile drawing attention to a few specifics in relation to some of the countries mentioned.

Cyprus has a good tax treaty network with countries in central and eastern Europe and is therefore a good jurisdiction from which to invest into those countries. Having no withholding tax on dividends also makes it a good location for an intermediate holding company. Although it is not noted as a country from which to own IP, gains from the disposal of IP may be exempt from corporate income tax. However, the exemption will not apply if the gain is deemed to be as a result of the company's trading activities. However, in such a case the cost of the IP may be written off over its life but the income receivable from the sale of the IP and royalties will be taxed as ordinary income (currently 10%). Therefore, you might not have an easy exit strategy from Cyprus if your IP is held as part of a trading activity.

Ireland, an island less noted for its hours of sunshine than for its low rate of corporation tax, does have an attractive regime for developed IP and has a good tax treaty network. An Irish company can depreciate its IP and claim a tax deduction either for the profit and loss charge or it can elect for a 7% rate on a straight line basis (with 2% in the final year). The maximum tax amortisation and interest expense is capped at 80% of the royalty income arising, effectively reducing the tax rate from 12.5% to as low as 2.5%. In later years when the royalty income increases or after the asset is fully amortised, the effective rate of tax will increase back to 12.5%. Under current law, there are ways of subsequently moving IP out of Ireland in a tax free manner and so there is an exit strategy. Ireland is also the location of choice as an ultimate holding company for a number of major groups that have migrated from the UK in recent years. These include Shire, UBM, Charter, Henderson and WPP. Ireland also has stamp duty on share transactions and consequently Jersey incorporated Irish resident companies are typically used to avoid Irish stamp duty - but you must keep your register of members outside of Ireland.

Madeira is part of Portugal and therefore benefits from being an EU country and from Portugal's small but growing number of tax treaties. Dividends received from EU subsidiaries are essentially tax exempt provided the Madeira holding company owns at least 10% of the shares (or acquisition cost of Euro 20 million) for a minimum period of one year. Other foreign dividends are taxed at the normal rate of 4% (to 2012) or 5% (from 2013 to 2020). However, dividends from the African Portuguese speaking countries of Angola, Cape Verde, Guinea Bissau, Mozambique, São Tomé & Príncipe and East Timor will also be exempt from tax where, broadly, the company owns at least 25% of the shares for a minimum period of two years and the payer's profits have been subject to tax of at least 10% and they are not passive. This, together with its 0% withholding tax on dividend payments makes Madeira an ideal intermediate holding company location for investing into the above named African countries.

Malta has an effective tax rate of just 5% (ie, 35% less 85% refund of tax on a dividend payment), no withholding tax on dividend payments to shareholders and a participation exemption for gains (10% shareholding, or a minimum Euro 1,164,000 investment, to be held for 183 days). ‘Non-dom’ companies (i.e. non-Malta incorporated Maltese resident companies) are taxed on foreign income solely to the extent it is remitted to Malta and foreign gains are not taxed in Malta. These provisions make Malta an attractive place from which to own IP as well as shares.

Luxembourg and the Netherlands were holding company locations of choice many years before other countries introduced participation exemptions. Both countries impose withholding tax on dividends to non-qualifying shareholders. However, in Luxembourg, preferred equity certificates are often used rather than shares because the distribution is treated for Luxembourg tax purposes as a payment of interest and so both deductible and not subject to withholding tax. In the Netherlands there is no withholding tax on a distribution by a Dutch Co-op and so such companies are often used as the holding company. Both countries are also attractive as locations for owning IP. Luxembourg excludes 80% of the income from certain IP from its tax base and the Netherlands has a 5% rate of tax for income qualifying for the ‘innovation box’.

Switzerland has become a popular holding company location in recent years with companies such as Informa plc and ACE Limited having relocated their holding companies to Switzerland. There is a 35% withholding tax on dividends paid to shareholders. Some groups have been established with large share premium accounts and then repay the share premium instead of paying dividends. Others have issued income access shares to shareholders from a lower tier UK subsidiary and pay dividends to shareholders from such a company where there is no withholding tax. Switzerland also has a ‘mixed company tax privilege’ whereby a ruling can be obtained to apply a lower cantonal rate of tax (typically between 10% and 25% of the normal rate) on income where 80% or more of the income and expenses of the company are from non-Swiss sources. Such a ruling can make Switzerland an attractive location from which to own IP.

So the choices are many and countries are competing for your business. The tax savings can be significant so choose carefully. But remember, if you do incorporate a company abroad make certain that its central management and control is not exercised from the UK and that it does not have a UK permanent establishment. Otherwise your good planning will be undone.

 Paul Smith