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Taking advantage of double tax treaties to reduce withholding taxes (eg Offshore licence/patent companies)

Many countries apply a withholding tax to certain forms of income that derive from within their jurisdiction. The most common examples of this are interest income or royalty income.

The UK for instance applies a 20% tax deduction to UK source interest or royalties paid overseas.

The tax deducted at source needs to be accounted for to HMRevenueCustoms quarterly on a form CT61.

However, one of the main exceptions to this requirement to deduct basic rate tax applies where the overseas recipient is located in a country with which the UK has a suitable double tax treaty.

Most tax treaties reduce the withholding tax that needs to be deducted. You can view the relief provided by various double tax treaties in the HMRevenueCustoms DTT digest at:

 http://www.hmrc.gov.uk/cnr/dtdigest-may2011.pdf

Interest paid to a Cyprus recipient for instance is restricted to just 10% tax in the UK. Most royalties to a Cyprus recipient wouldn’t suffer any UK tax.

In the case of a Danish recipient there would be no UK tax on interest or royalties.  It very much depends on the particular treaty in question.

Using an overseas company

Therefore using an overseas company can be attractive to reduce or avoid UK (or other countries) withholding taxes.

This is why large multinationals frequently have group finance companies or group IP companies located in suitable jurisdictions.

Beneficial interest

It’s not just a case of establishing a foreign company and having that receive UK interest or royalty income though.

Establishing who holds the beneficial interest in an asset is crucial when assessing the tax implications. It's also important to assess who holds the beneficial interest for the purposes of double tax treaties. When HMRevenueCustoms processes any claims for relief they will generally only allow a claim from the beneficial owner of the assets or income in question.

It is though vital to distinguish between aspects of the legislation which depend on:

  • the beneficial ownership of the asset, and
  • those which depend on the beneficial ownership of the income which flows from that asset.

For example:

  • the majority of double taxation agreements provide for relief to the beneficial owner of the income, whilst
  • the FOTRA regulations provide for relief to the beneficial owner of the asset. (This applies to interest payments on UK Government securities issued 'Free Of Tax to Residents Abroad'.)

It's therefore important to look at each treaty to assess what this states in terms of the beneficial owner requirement. In some countries, no distinction is made between the concepts of legal and beneficial ownership, so beneficial ownership as a condition for relief would not appear in a double taxation agreement between the UK and one of those countries.

However in such cases, the agreement usually requires the income to be subject to tax in the other country. The person who is subject to tax on the income in question can usually be treated for practical purposes as if they were its owner.

What is beneficial ownership?

Beneficial ownership can be defined as:

'the sole and unfettered right to use enjoy or dispose of the asset or income in question'

When you're making a claim under a double tax treaty (eg for reduced withholding taxes on interest or dividends) you will need to sign the claim form and confirm that you are the beneficial owner of the income/assets as required under the treaty. If you’re using a company you’d need to sign on behalf of the company.

Therefore you would need to ensure that the overseas company:

  • Was the true owner of the asset / income stream in question
  • That it receives the income
  • Can direct how the income is used.

You should ensure that it not only receives the income but also benefits from it. Therefore merely acting as a cipher for income which was passed onto another individual would mean the company would not be the beneficial owner.

In practice when you sign the form HMRevenueCustoms will usually accept this unless there is additional evidence that you/the company aren't actually the beneficial owner.

So providing the name of the claimant, the signatory, and the name on any vouchers supporting the claim are all the same, they would not usually question the fact that the claimant was the beneficial owner.

If the name on any royalty voucher for instance had a different name they would then look into the situation.

Example of the beneficial owner requirement

The UK-Spain treaty for instance states:

'Interest arising in a Contracting State which is derived and beneficially owned by a resident of the other Contracting State may be taxed in that other State.'

It then goes on the provide for a reduced withholding tax however it's clear from this that the interest needs to be beneficially owned by the person making the claim. It's not the asset that needs to be beneficially owned - just the interest. So you could have a case where the capital and income was split but provided the interest was beneficially owned relief would still be available.

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