By Srinivasa Rao, Rajendra Nayak, Lubna Kably, Chartered Accountants
Article
The business environment is increasingly dominated by complex
corporate group structures. This brings forth the desire to tax a group by
reference to its overall performance and not merely along its legal structure.
To meet this need, a few countries have in place a ‘fiscal consolidation’ or a
‘group taxation’ regime, which taxes the group as a whole.
There is no uniform basis adopted by various countries in
their approach. However, the underlying object is to permit offsetting of losses
against the profits of the group. While group taxation is popular within the
confines of a particular jurisdiction, in a few instances, foreign subsidiaries
are also covered. For success of such a regime, it is essential that it must be
simple to administer, flexible enough to take into consideration business
exigencies such as intra-group transactions and corporate restructuring, and
have low compliance costs. Additionally, anti-abuse provisions may also need to
be built into the provisions, especially if this regime provides for
cross-border consolidation.
Broadly, the mechanism of the group taxation regime can be
classified into three distinct categories :
à
Consolidation system : Here, the income at the level of each member
company is considered and the results are combined at a group level. As the
group operates as a single entity for tax purposes, the parent company is
liable to pay the tax on behalf of the entire group.
à
The group contribution system : Here, profitable companies within the
group are permitted to make tax deductible contributions to group companies
that have incurred losses. Usually each company in the group remains liable
for its own tax obligations and files its own returns.
à
Group relief model : This system enables transfer of tax losses from
one company in the group to another. Even though these models allow for the
netting of profits and losses within the group, each company in the group
files its own tax return and pays its own tax.
Some countries adopt the ‘all-in or all-out approach’ whereby
all member companies that come within the group definition have to be included
for the purpose of group taxation. However, in some other countries, ‘cherry
picking’ is allowed, where companies within a group can elect participation.
In the following paragraphs we have provided a broad and
general overview of the group taxation regime or its variant as it exists in a
few countries.
Austria :
Definition of a group :
A new group taxation regime has been introduced in Austria
from 2005. It permits the parent Austrian company to consolidate its taxable
income with that of its subsidiaries, provided the parent Austrian company holds
directly or indirectly at least 50% of the voting rights in the subsidiary
companies, since the beginning of the subsidiary’s fiscal year. Only
corporations (not partnerships) qualify as group members.
Mechanism :
In such instances, where the shareholding criteria is met,
the entire taxable income (profit or loss) of domestic subsidiaries is allocated
to the taxable income of the parent Austrian company, regardless of the
percentage of shareholding in the subsidiary. Thus, even if 50% or 75% is held
in the subsidiary company, the entire taxable income of the subsidiary is
allocated to the taxable income of the Austrian parent. An application that is
binding for three years must be filed with the tax authorities.
Cross-border tax consolidation is permitted, but it is
limited to first-tier subsidiaries, provided that the foreign entity is
comparable to an Austrian corporation from a legal perspective. Losses from
foreign group members can be deducted from the Austrian tax base, but only in
proportion to the shareholding. Profits of a foreign group member are generally
not included in the Austrian parent’s income. Provisions exist for prevention of
dual utilisation of foreign losses. For instance, foreign losses that have been
deducted from income of the Austrian group shareholder are added in Austria, if
the losses can be offset in the foreign jurisdiction at a subsequent time.
Consequently, if the foreign country takes into account the losses in the
sub-sequent years (as a part of a loss carry forward), the tax base in Austria
is increased by that amount in order to avoid a double dip. Foreign losses must
also be added to the Austrian income tax base if the foreign subsidiary leaves
the group. Relief is provided only in the event of a liquidation or insolvency.
Italy :
Definition of a group :
The group taxation regime was introduced in 2004. To qualify
for consolidation, more than 50% of the voting rights of each subsidiary must be
owned, directly or indirectly, by the common Italian parent company. Italian
parent corporations can elect consortium relief if they hold more than 10% but
less than 50% of the voting rights in their Italian subsidiaries.
Mechanism :
This regime allows the offsetting of profit and losses of
members of a group of companies. Italian tax consolidation rules provide two
separate consolidation systems, depending on the residence of the companies
involved. A domestic consolidation regime is available for Italian resident
companies only. A worldwide consolidation regime, with slightly different
conditions, is available for multinationals.
Where more than 50% of the voting rights of each subsidiary are owned, directly or indirectly, by the common Italian parent company, the tax consolidation includes 100% of the subsidiary company’s profits and losses, even if the subsidiary has other shareholders. For a domestic tax consolidation, the election is binding for three fiscal years. However, if the holding company loses control over a subsidiary, such subsidiary must be immediately excluded from the consolidation. To prevent abuse, tax losses realised before the election for tax consolidation can be used .only by the company that incurred such losses. For groups of companies linked by more than a 50%direct shareholding net value-added tax (VAT) refundable to one group company with respect to its own transactions may be offset against VAT payable by another, and only the balance is required to be paid by, or refunded to, the group.
Cherry picking is permitted. The domestic tax consolidation may be limited to certain entities, leaving one or more otherwise eligible entities outside the group filing election.
Further, Italian parent corporations can elect consortium relief if they hold more than 10% but less than 50% of the voting rights in their Italian subsidiaries. Under this election, the subsidiaries are treated as look-through entities for Italian tax purposes and their profits and losses flow through to the parent company in proportion to the stake owned. These profits or losses can offset the shareholder’s losses or profits in the fiscal year in which the transparent company’s fiscal year ends. Tax losses realised by the shareholders before the exercise of the election for the consortium relief cannot be used to offset profits of transparent companies.
In general, in Italy, intra-corporate dividends are 95% exempt (i.e., 5% of the dividends are taxable). In this context, it is pertinent to note that dividends distributed by an eligible transparent company are not taken into account for tax purposes in the hands of the recipient shareholders. As a result, Italian corporate shareholders of a transparent company are not subject to corporate income tax on 5% of the dividends received.
The election does not change the tax treatment of dividends distributed out of reserves containing profits accrued before the exercise of the election. Another benefit from consortium relief is that an eligible transparent company does not pay corporate income tax. The consortium relief election is binding for three fiscal years and requires the consent of all the shareholders.
Netherlands:
Definition of a group:
The group taxation regime was revised, effective from January 1, 2003. To elect for the same, a parent company must own at least 95% of the shares of a subsidiary. Both Dutch and foreign companies may be included in a fiscal unity if their place of effective management is located in the Netherlands. A permanent establishment (PE) in the Netherlands of a company with its effective management abroad may be included in a fiscal unity. A subsidiary may be included in the fiscal unity from the date of acquisition.
Mechanism:
This group taxation regime permits losses of one subsidiary to be offset against profits of other members of the group. As a Dutch parent company and its non-resident subsidiary cannot apply for a group tax consolidation if that subsidiary does not have a PE in the Netherlands, the Dutch Supreme Court has on July 11, 2008, requested a preliminary ruling from the European Court of Justice (ECJ).
The ruling relates to whether the group taxation regime is compatible with the freedom of establishment principle in the EC Treaty.
We need to trace back the reason for such referral. In Marks & Spencer’s case, the UK-based group sought to offset the losses incurred by subsidiaries in several member states against the profits derived in the UK. As the UK group relief system only allowed for surrender of losses from UK resident companies, Marks & Spencer was denied the offset of the losses incurred in the non-resident subsidiaries. Even though the UK restriction was justified based on merits of the case (requirement to preserve a balanced allocation of taxing powers between the member countries; the need to prevent a double use of losses and the right to counter tax avoidance), the ECJ held that its objectives could be attained by less restrictive measures.
Even as ECJ’s ruling in the Marks & Spencer case suggests that the restriction that limits the fiscal unity regime to companies with their place of effective management located in the Netherlands does not violate EU law, it now remains to be seen how the ECJ will view the Dutch regime.
United Kingdom (UK) :
Definition of a group:
UK laws do not provide for group tax consolidation. However, a voluntary group relief system is available. In short, UK companies in a 75% or more economic relationship can opt to offset certain losses with profits for the same period realised by another UK company within the group.
Mechanism:
As mentioned above, a trading loss incurred by one company within. a 75%-owned group of companies may be grouped with profits for the same period realised by another member of the group. Similar provisions apply in a consortium situation; for this purpose, a UK resident company is owned by a consortium if 75% or more of its ordinary share capital is owned by other UK resident companies, none of which individually has a holding of less than 5%. However, the consortium-owned company must not be a 75%-owned subsidiary of any company.
In a 75%-worldwide group, the transfer of assets between group companies does not result in a capital gain if the companies involved are subject to UK corporation tax. This rule applies regardless of the residence status of the companies or their shareholders. The transferee company assumes the transferor’s original cost of the asset plus subsequent qualifying expenditure and indexation. However, under an anti-avoidance provision, if the transferee company leaves the group within six years of the date of the transfer of the asset, that company is deemed to have disposed of the asset at market value immediately after the start of the accounting period of departure or, if later, the original date of the transfer.
United States (U.S.) :
Definition of a group:
A limited consolidation system exists in the US. In general, an affiliated group consists of a U.S. parent corporation and all other US. corporations in which the parent holds directly or indirectly at least 80% of the total voting power and value of all classes of shares (excluding non-voting preferred shares).
Mechanism:
An affiliated group of U.S. corporations (as described above) may elect to determine their taxable income and tax liability on a consolidated basis. The consolidated return provisions generally allow electing corporations to report aggregate group income and deductions in accordance with the requirements for financial consolidations. Consequently, the net operating losses of some members of the group can be used to offset the taxable income of other members of the group, and transactions between group members, such as intercompany sales and dividends, are generally deferred or eliminated until there is a transaction outside the group. Under certain circumstances, losses incurred on the sale of consolidated subsidiaries are disallowed.
Conclusion:
In today’s business environment, a group taxation regime, which permits offsetting of losses against the profits within a group, would provide relief to corporate entities. The above paragraphs provide a bird’s-eye view of the group taxation regime, as it exists in a few developed tax economies.
Keeping in mind the factors which need to be considered in designing such a regime, it would be much simpler to initially introduce a domestic consolidation regime in India. At a later stage, after giving consideration to anti-abuse issues, the mechanism could be extended to cover cross-border situations.
