Newsletter UK Tax Update 2009

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1 May 2009 Ernst & Young Shinnihon Tax JAPAN Newsletter UK Tax Update 2009 Contents 1. Dividend exemption 2. Worldwide Debt Cap ( WWDC ) 3. Tax and Risk Management The UK Government has recently published the Finance Bill 2009 which includes the draft laws to implement proposed changes to UK tax law. These laws are expected to receive final approval of Parliament in late July However, some laws will be effective from an earlier date. The Finance Bill legislation, combined with other recent changes to tax and the approach adopted by HM Revenue and Customs ( HMRC ), represent the most significant changes to the UK tax regime in recent years. The two key areas of change are the treatment of foreign profits (along with related debt cap measures) and tax risk management. Both areas will be of significance to Japanese multinationals with operations in the UK, particularly when one considers the significant changes to the Japanese tax regime. In this brief summary we highlight three key areas of interest to Japanese owned companies.

2 1. Dividend exemption The Budget confirmed, and the Finance Bill includes, a dividend exemption for dividends payable on or after 1 July This is a 100% exemption, on most types of dividend received by a UK company, with no minimum shareholding period or percentage. The key attributes of the system can be summarised in the following diagram: Dividend Exemption Exemption for dividends (UK and overseas) Overseas dividends Payer obtains tax deduction for dividend; or Recipient is a small company (without a tax treaty) and directly/indirectly controls at least 10% of voting power in payer* Dividend exemption will not apply; existing double tax relief rules continue Dividend falls within an exempt class Exempt classes dividends in respect of: Controlled companies Non-redeemable ordinary shares Portfolio holdings (<10% holding) Transactions not designed to reduce tax Shares accounted for as liabilities *The small company definition applies to groups not individual entities so most Japanese companies will not be small. Targeted anti-avoidance rules may mean the exemption does not apply 100% exemption to corporate tax replaces current tax credit system. No Minimum % shareholding requirement Commencement date: 1 July 2009 Targeted anti-avoidance rule Dividend part of scheme with main purpose of obtaining tax advantage and Prescribed scheme relates to distribution The dividend exemption, combined with the Japanese dividend exemption, should mean that for Japanese MNC s with a UK holding company, the overall tax burden on repatriation of low tax overseas profits will no longer be a minimum of approximately 41%, under the current tax and credit regime. Rather, where there is no tax haven apportionment at the Japanese or UK level, and no withholding tax on payment of dividends to the UK, the effective rate will be reduced from 41% to the local rate + (41% x 5%). This combined with the UK domestic exemption to withholding tax on dividends should make the UK a more attractive location for a European holding company for Japanese groups. 2

3 One area to consider is that there may be Japanese tax haven implications of the lack of a minimum shareholding. Analysis of the impact of this should be undertaken based on the facts of each group, and where issues arise, planning can be considered to manage the potential exposure. The Finance Bill includes the possibility of a company electing out of the exemption. This means that a company can elect to be taxed on the dividend income and to claim double tax relief for underlying tax and withholding taxes. The rationale for opting out of the exemption should be considered along with the tax implications to the overall group. 2. Worldwide Debt Cap ( WWDC ) The UK tax authorities acknowledge that they will be reducing tax receipts by introducing the dividend exemption. They have therefore introduced a debt cap rule, in addition to the existing UK thin capitalisation rules, to balance out this reduction to tax revenues. The new rules are designed to prevent groups with low finance requirements from pushing debt into the UK. The key characteristics of the debt cap are summarised in the diagram below: Worldwide Debt Cap Tested amount less Available amount = Total disallowed amount Sum of net financing expense for every relevant group company. A relevant group company can only be a member of one worldwide group at a time. Sum of total debits less total credits in respect of: Loan relationships, excluding impairment losses and foreign exchange gains/losses ( Amount A ) Derivative contracts in intra-group hedging relationships that only impact one company and only affect interest amounts payable/receivable ( Amount B ) Financing cost in all finance leases ( Amount C ) Financing cost on intra-group debt factoring ( Amount D ) Gross worldwide consolidated finance expense of group (including finance expenses capitalised in accounts under J GAAP) If net amount is negative = nil Commencement date: period of account beginning on or after 1 January 2010 Government Intention: The measure prevents a group putting a greater amount of debt into the UK part of its group than the group as a whole has borrowed The legislation regarding this area is still draft and changes and additions are expected during the committee stage of review by parliament. However for the purposes of Japanese MNCs the proposed rules can be summarised as follows: 3

4 The limitation on interest will apply, if relevant, for accounting periods beginning on or after 1 January The WWDC rules will apply to a group where UK net debt of the group exceeds 75% of the worldwide gross debt of the group for an accounting period. The UK net debt is the sum of the net debt of amount of all relevant UK companies in the group. Where the provisions apply, UK tax deductions will be disallowed to the extent that the tested expense amount (broadly financing expenses relating to loans, finance leases and debt factoring) exceeds the available amount (broadly, the sum of the worldwide group s debits on amounts borrowed from third parties, including where the borrower is a UK company). The draft legislation does not yet include an exemption for financial services businesses this is to be introduced later. An exemption will be provided for companies with net financing income / deduction of less an 500,000 these companies will not be included in the overall debt cap calculations. A group treasury company (as defined) can elect for its financing income / expense to be excluded. Overall the UK tax authorities are seeking to streamline their approach to corporation tax. By identifying the tax-payers who they see as higher risk, putting the burden on the corporate taxpayer to self certify their tax reporting systems, transfer pricing documentation and level of debt, and by identifying tax planning which they wish to target, they will be more targeted in their operations in future. Some Japanese MNCs will need to develop their tax function in the UK if they wish to avoid increased attention from the UK Inspectors of Taxes, for others there is already sufficient tax resource in-house in the UK to deal with these changes, and indeed the changes may allow a welcome acknowledgement of overall compliance with UK tax requirements and a corresponding reduction in future enquiries into their tax affairs. The changes to the foreign profits rules, combined with this year s changes in Japan, should mean opportunities for Japanese MNCs to increase bottom line profit after tax results, through reduction of the overall tax burden on overseas profits. The benefit of reducing overseas tax will be of increasing importance to groups going forward, although it will be necessary to keep a careful eye on the potential to create tax haven issues in Japan. Most Japanese MNCs with UK presence are already considering what their tax charge will look like under the new rules, and where tax risks lie. This should help them to avoid unwelcome surprises and to maximise post tax profits in these challenging times. 4

5 3. Tax and Risk Management The traditional system of interaction between the UK corporate taxpayer and HMRC saw tax returns submitted to HMRC, with enquiries made by the Inspector of Taxes dealing with that specific case and being dealt with by tax advisors or the company directly. This system is quite different to the system of tax audit in Japan. In an effort to make companies dealings with HMRC more standardised and to create more transparency, HMRC has made a number of significant changes to the way in which this relationship operates. The interactions between HMRC, the taxpayer and the advisor can now be summarised in the following diagram: Tax and risk management H REPORTING ANNUAL CERTIFICATION COMPANY SAO M R C RISK RISK ASSESSMENT AND REVIEW COMPLIANCE AND CONTROVERSY CORPORATE TAX RETURNS VAT RETURNS WWDC HMRC ENQUIRIES PLANNING TAX AVOIDANCE DISCLOSURE UK COMPANY TAX ADVISOR Tax Avoidance Disclosure The system of disclosure was introduced in 2004, under this system arrangements which give rise to a tax effect with certain hallmarks are reported to HMRC by advisors and companies. In this way HMRC can understand tax planning ideas and adopt their stance on areas of interpretation where they determine tax avoidance to be taking place. This system is being updated in 2009 and changes regarding the timing of reporting and notification methodology have effect from 1 April

6 Large and Complex Risk Ratings As part of an ongoing process HMRC is determining a tax risk rating for all large and complex UK companies. This will be based on an analysis of all taxes, not just corporation tax and the result will determine how the company is to be treated for tax purposes going forward. It will therefore impact the amount of enquiry and potential speed of obtaining certainty on tax in transactions. Potential areas of difficulty for Japanese groups have been the potential for a higher risk rating based on complexity of the business, lack of coherent UK tax function and strategy and lack of UK based tax resource. A higher risk rating will result in more interventions by HMRC in more areas involving more Inspectors of Taxes. Senior Accounting Officer (SAO) certification In future an SAO will have to be responsible for the tax reporting and returns of his employer. The precise details of these arrangements are now subject of a period of Consultation. However, in summary, the Finance Bill requires that companies take reasonable steps to ensure that appropriate tax accounting arrangements are in place. The SAO is to be required to provide a certificate that the appropriate accounting arrangements are in place. The SAO will be the most senior person whose responsibility for the company s accounting arrangements. In most cases, this will be the Chief Financial Officer or equivalent. These rules will also apply to VAT and PAYE returns. The SAO individually, could be liable to three types of penalty of 5,000 each for either or all of failing to comply with their duties of maintaining appropriate tax accounting, providing explanations of accounting arrangements and providing certification to HMRC. These penalties are in addition to any penalties on the company. More detailed guidance regarding SAO certification is expected from HMRC by the end of July Publication of the names of companies deliberately understating tax Under existing law, a company may be charged a penalty for deliberately understating tax due, or overstating claims or losses. The Finance Bill includes a clause allowing HMRC to publish the names of such companies where the potential lost revenue is more than 25,000. This will represent some reputational risk in future for companies which have misstated tax or losses. 6

7 Overall the UK tax authorities are seeking to streamline their approach to corporation tax. By identifying the tax-payers who they see as higher risk, putting the burden on the corporate taxpayer to self certify their tax reporting systems, transfer pricing documentation and level of debt, and by identifying tax planning which they wish to target, they will be more targeted in their operations in future. Some Japanese MNCs will need to develop their tax function in the UK if they wish to avoid increased attention from the UK Inspectors of Taxes, for others there is already sufficient tax resource in-house in the UK to deal with these changes, and indeed the changes may allow a welcome acknowledgement of overall compliance with UK tax requirements and a corresponding reduction in future enquiries into their tax affairs. The changes to the foreign profits rules, combined with this year s changes in Japan, should mean opportunities for Japanese MNCs to increase bottom line profit after tax results, through reduction of the overall tax burden on overseas profits. The benefit of reducing overseas tax will be of increasing importance to groups going forward, although it will be necessary to keep a careful eye on the potential to create tax haven issues in Japan. Most Japanese MNCs with UK presence are already considering what their tax charge will look like under the new rules, and where tax risks lie. This should help them to avoid unwelcome surprises and to maximise post tax profits in these challenging times. 7

8 Contact Ernst & Young Shinnihon Tax Kasumigaseki Bldg. 32nd Floor, 3-2-5, Kasumigaseki, Chiyoda-ku, Tokyo About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 135,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. For more information, please visit International Tax Services (ITS) Kazuhiro Mukaida, Partner Joachim Stobbs, Senior Manager Shaun De Boo, Director Hiroshi Nakagawa, Manager Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. About Ernst & Young Shinnihon Tax Ernst & Young s tax professionals in Japan provide you with deep technical knowledge, both global and local, combined with practical, commercial and industry experience. Our highly regarded tax and M&A advisory, compliance and transfer pricing professionals, consistent methodologies as well as unwavering commitment to quality service help you to build the strong compliance and reporting foundations and sustainable tax strategies that help your business achieve its ambitions. It s how Ernst & Young makes a difference Ernst & Young Shinnihon Tax All Rights Reserved. Comments or general inquiries regarding this newsletter may be directed to our Corporate Communication team at: This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither Ernst & Young Shinnihon Tax nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.

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