Substance requirements a threat to overseas susidiaries? tax breaks
Companies operating subsidiaries overseas and benefiting from lower taxes in those countries should take note of new international guidelines on so-called substance requirements.
Many international companies establish subsidiaries in low-tax jurisdictions to enjoy the advantages that this can provide. But substance requirements are becoming important to tax authorities worldwide, and should therefore be high on the agenda of companies operating overseas, or thinking of doing so.
As part of the global fight against tax fraud and a crackdown on ‘treaty shopping”, companies are being challenged to show their overseas operations are genuine subsidiaries being run from the host countries – or risk losing the tax breaks.
In broad terms, this means companies must show that the management, control and day-to-day decisions concerning business activity are taken in the country where the subsidiary is based.
European Court of Justice
This principle was put in the spotlight by a landmark case involving Cadburry Schweppes, brought by the UK tax authorities. The court ruled that the parent Cadburry Schweppes company would not have to pay UK taxes on the profits of its subsidiaries if genuine activity could be shown to be taking place in the countries of the subsidiaries. The question raised by the case was whether a structure lacking substance can be considered ‘artificial’ and therefore disregarded for tax purposes.
The big question since then has been what constitutes genuine activity, or substance requirements.
New OECD (Organisation for Economic Co-operation and Development) transfer pricing guidelines give useful pointers by referring to the following substance parameters:
- what roles and responsibilities are specifically assigned to what person in what jurisdiction
- does that person have sufficient equity and insurance coverage given the business risks he is exposed to?
- Is there enough skilled staff to carry out a local core business?
From experience, we know that the tax authorities also tends to look at the following:
- are there any local directors and an active bank account?
- are local compliance formalities duly satisfied?
- are meetings physically held locally?
- are the company’s operating expenses recorded in the local P&L?
Bear in mind substance requirements prior to implementing a company structure so that it can successfully pass any tax audit in the host country, the parent company’s country and any other third party countries involved.
In recent years, the importance of substance requirements has also taken hold in the VAT world. Not only as an instrument for the VAT authorities to combat VAT fraud and evasion, but more and more also as an argument for taxable persons to protect them from adverse VAT consequences in case of non-compliance with formal requirements.
For further information, contact:
Kurt De Haen or Wouter Brackx
VMB Accountants & Tax Consultants
Tel: + 32 (0)3 237 65 60