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International groups of companies often use special purpose vehicles established in foreign jurisdictions for group financing/treasury operations.
One is a structure under which the main source of financing is a lowly taxed onshore company, based in a low (effective) tax country such as Cyprus or Malta or in a high tax country such as The Netherlands or Luxembourg benefiting from a special tax regime for group financing and treasury companies in such country. Under this scenario the group financing company directly loans to its global debtors (in case of group financing companies these will be affiliated companies), making use of the low tax rate for the related (group) financing income and the network of double tax treaties of the country of establishment, which treaties enable the financing company to receive its income against reduced withholding tax rates.
Another structure is a structure under which the main source of financing is an offshore company, not liable to any taxation over its income. The offshore company loans funds to an affiliated company, established in a country with a wide double tax treaty network (The Netherlands is a good example). The onshore company then sub-lends the funds to global debtors (in case of group financing companies these will be affiliated companies). The onshore company receives all the relevant income and pays the vast majority of such income to the offshore company, after deduction of an arm’s length ‘spread’ for its own services.
A benefit of a scenario of using the onshore company as intermediary versus a scenario under which the offshore company directly loans the funds is that, in the latter scenario, due to the lack of availability of double tax treaties of the country of establishment of the offshore company, payments to such company may suffer significant withholding taxation in the countries of its debtors. The onshore intermediary company would then be interposed to make use of the double tax treaty network of this company’s country of establishment with (still) low taxation over the overall income (taxation, albeit at high rate, over a relatively small spread due to the limited functions and risks of the onshore intermediary).
1. Reasons for setting up foreign (group) financing companies
There are various reasons for the set up of foreign financing companies. From organizational point of view, multinational groups often want to centralize financial know how and expertise in one location. But tax motives are often even more important.
If properly structured, the set up of group finance companies may create the possibility:
to centralize a multinational group ‘s excess cash in one jurisdiction
to loan the funds to various group companies in order to finance the latter companies’ operations
to obtain deduction from high-tax profits for interest payments at the level of the debtor companies, and
to collect the related interest income at low taxation rate, at the level of the group financing company
2. Important characteristics for a country to be regarded as tax advantageous jurisdiction for group financing activities
A country should meet the following criteria in order to be regarded as tax efficient group financing jurisdiction:
it should either have a low general corporate income tax rate or a special low effective tax rate for (group) financing activities. The latter can be based upon special legislative facilities, but it can also be based upon the treatment as (tax exempt) ‘deemed dividend income’ under the country’s legislation, of interest received on loans with certain ‘capital characteristics’, such as sub-ordination of the loan to regular creditors, profit dependability of interest payments etc.
it should have a large double tax treaty network, in many cases providing for reduction of (and preferably exemption from) withholding tax over interest payments made to creditor companies established in such countries by debtors of such companies. Many countries levy withholding taxes. These taxes are usually levied over payments of dividends, interest and/or royalties made by residents of those countries. The rates of these taxes vary, but in some countries they may rise to 30%. The availability of double tax treaties, which may provide for reduction of such withholding taxes in case of payments to companies in countries that have tax treaties with the countries of residence of the paying parties, is an essential element in international tax planning.
in EU-context, establishment of the company in an EU jurisdiction may lead to important fiscal benefits, since the so-called ‘EU Interest and Royalty Directive’ may under circumstances provide for exemption from withholding tax over interest payments between affiliated EU-companies.
it should not levy withholding tax over interest payments.
it should not have so-called ‘thin capitalization rules’, limiting deduction of interest if and to the extent the debt to equity ratio of a company established in such country would exceed a certain level.
ideally, the country of establishment of the financing company would not have withholding taxation over dividend payments (or it should be relatively easy to circumvent such taxation).
3. Issues to consider
Before deciding to incorporate a foreign group financing company, other issues need to be considered as well. Below you will find an overview of some of these issues.
It is not only important to consider the possibility of so-called ‘debt-equity rules’ (rules that limit interest deduction if and to the extent the level of a company’s total debt exceeds its equity multiplied by a certain factor, e.g. 3) in the jurisdiction of the group financing company, it is also important to consider the possible presence of restrictions of interest deduction in the countries where the debtors are based. This obviously must be investigated by tax specialists in the respective countries.
Another issue to consider is the possible blacklisting of certain jurisdictions in the debtor countries. Such blacklisting may have as consequence that interest payments to companies based in blacklisted jurisdictions will be denied deduction in the former countries. This is also an issue that must be discussed with tax specialists practicing locally in the debtor countries.
Furthermore, the issue of transfer pricing is of outmost importance. At the risk of (partial) denial of interest deduction in the debtor countries, it has to be ascertained that the conditions of the loan agreements between the group financing company and the debtor companies meet the so-called ‘arm’s length standard’; in general terms this means that these conditions should be equal to those that would have been agreed between independent parties under comparable circumstances. This is also an issue that must be considered by local tax experts in the respective debtor countries.
Furthermore, the investor’s home country may have so-called ‘CFC (controlled foreign corporation) legislation’, under circumstances leading to immediate taxation over profits realized by foreign group financing companies (even without distribution of such profits) in certain countries (these may be so-called ‘blacklisted countries’) owned by such investor. Therefore, it is always advisable for investors to liaise with local tax specialists before setting up foreign group financing structures.
Investors should also be prepared for a possible challenge of the financing company structure by the tax authorities in their home countries. The risk of such challenge depends on various factors, such as the attitude of these authorities in general towards foreign financing structures, their available audit tools and policy etc. Tax authorities could argue that the management and control of a foreign financing company is de facto exercised in the country where the investor/ultimate owner of the company is based. A way to reduce the risk of success of such challenge usually is the creation of as much ‘substance’ (office space, qualified employees etc.) in the financing company’s jurisdiction as possible.
Finally, especially in case of so-called ‘back to back financing structures’ (structure 2 under 1.6.), there is in certain countries the risk that tax authorities of such countries deny double tax treaty based reduction of withholding tax over the interest payments in question, as they may disregard the creditors as ‘beneficial owners’ of the income for treaty purposes. This has to be judged on a case by case basis.
4. What we can do for you
Consulco has a significant number of group financing- and treasury companies amongst its clientele.
This includes Cyprus based head-quarter companies of major West European stock exchange quoted Groups and group financing companies of Fortune 100 Groups. We have also extensive experience in rendering tax advice on financial instruments such as ‘interest swaps’ and other financial derivatives.
Consulco has offices in two of the most prominent and favorable jurisdictions for the establishment of group financing companies in the entire EU, Cyprus and Malta. Both countries have extensive double tax treaty networks and, being members of the EU, companies in those countries may be entitled to the benefits of the EU Interest and Royalty Directive, which may lead to withholding tax exemption for interest payments between EU-companies.