European Holding Company — Choosing the right jurisdiction

At a broad level, the key factors to be considered while
selecting an appropriate holding company jurisdiction are :

The Netherlands has participation exemption which exempts
dividend and capital gains on qualifying participation. Participation Exemption
covers not only cash dividends, but also stock dividends, bonus shares,
dividends in kind, and hidden profit distributions, as well as foreign exchange
gains and capital gains realised on the disposal of a qualifying shareholding.
The participation exemption is not only limited to resident shareholders but
may, in principle, also apply to a Dutch permanent establishment to which the
shareholding can be attributed.

There are certain qualifying conditions which need to be
fulfilled so as to avail the participation exemption benefit. The following
tests need to be satisfied in this regard :

The ownership test essentially requires a participation of at
least 5% in the nominal paid-up share capital of an active investee company. A
participation of less than 5% may also be considered as a qualifying
participation, provided another group entity owns a stake of at least 5% in the
active investee company.

The asset test provides that the participation exemption does not apply to low-taxed investment participations. A low-taxed investment participation is a participation which fulfils the following conditions :

Portfolio investments are generally considered free if the investments are not used in the course of the business of the company.

It is, therefore, essential to evaluate that both the aforesaid tests are satisfied so as to avail the benefit of participation exemption in the Netherlands.

Withholding tax:

Dividend:

Dividend  paid by a Netherlands resident  company to a non-resident shareholder is subject to withholding tax in the Netherlands. The standard rate of withholding tax on outgoing dividend is 15%, unless a lower rate is prescribed under the relevant tax treaty. The aforesaid withholding tax rate could be reduced to 0% under the EU Parent Subsidiary Directive.

This Directive is aimed at eliminating tax obstacles in the area of profit distributions between groups of companies in the EU by :

The Netherlands, being an EU member state, is eligible to avail the benefit of the aforesaid Directive. This, effectively, means that dividend received by a Netherlands holding company from its EU subsidiary may not be subject to any withholding tax in the source country. However, as mentioned herein-above, it is essential that all conditions as agreed between the Netherlands and the respective country for granting benefit of the Directive are fulfilled.

Interest:

There is no withholding tax on interest in the Netherlands. However, it is essential to evaluate the features of the loan instrument so as to ensure that it does not qualify as equity. In case, it is considered as equity, interest payment could be considered as deemed dividend liable to withholding tax, if applicable.

Thin capitalisation  rules:

There are thin capitalisation rules in the Netherlands. Thin capitalisation rules effectively restrict the deductibility of interest paid to related entities if the company is excessively debt financed. The safe-harbour debt: equity ratio in the Netherlands is around 3 : 1. The net interest attributable to the debt that is more than this ratio is treated as non-deductible, up to a maximum of the interest paid to related entities.

Alternatively, the company can elect to apply for the group ratio. Under this alternative, the company can look at the consolidated debt to equity ratio of the group of which it is a member. If the company’ debt to equity ratio does not exceed the consolidated ratio, the interest paid to related party is not disallowed.

Controlled Foreign Company (CFC) :

CFC regulations are aimed at eliminating the benefits of deferral, by currently taxing income in the parent country even when the income has not been repatriated or remitted to that country. The Netherlands does not currently have specific CFC regulations.

Capital duty:

Capital duty is a duty levied on capital contribution. Currently, there is no capital duty in the Netherlands.

Cyprus:

General:

As a former British colony, Cyprus follows the common law system and is, in many ways, influenced by the legal system of the United Kingdom. Resident companies are taxed on worldwide income. Cyprus has tax treaty with around 35 countries. Among others, it has tax treaties in force with Canada, Germany, India, Mauritius, Russia, the US and the UK.

The standard rate of (Corporate) income-tax on taxable income realised by Cypriot corporate taxpayers is 10%. In addition to income-tax, there is also a. levy of Special Contribution for the Defence of the Republic (‘Defence Tax’) on certain types of income. The rate of Defence Tax varies from 3% to 15% de-pending on the nature of income. Defence Tax is a tax -levied on income rather than on profits and as such (business) expenses incurred for the production of the income are not deductible for Defence Tax purposes.

Capital Gains Tax at a rate of 20% is levied on profits from disposal of immovable property situated in Cyprus or of shares in companies which have immovable property situated in Cyprus (unless the shares  are listed  on a recognised stock exchange).

Taxation of holding companies:

Dividend    income:

Cypriot (Corporate) Income Tax law provides for an exemption of dividends received by Cyprus resident corporate taxpayers, irrespective of the holding period. Thus, dividend income is not liable to tax in Cyprus corporate tax.

In addition, Defence Tax is levied at a rate of 15% on dividends received by resident companies from foreign companies. However, there is a participation exemption from levy of Defence Tax on fulfilment of the following conditions:

Investment income mentioned hereinabove normally includes (portfolio) dividend income, licensing income, interest income (unless the dividend paying company is a financial institution or a group financing company), rental income from immovable property (unless a real estate portfolio is actively and professionally managed) and certain capital gains.

Capital  gains:

There is no capital gains tax in Cyprus except on gains derived from sale of immovable property or sale of shares, which derives underlying value from immovable property in Cyprus (unless such shares are listed). This exemption applies irrespective of the holding period, number of shares held or trading nature of the gain. Capital losses resulting from the sale of securities are not tax deductible.

Withholding tax:

Dividend  and  interest:

Cyprus does not levy any withholding taxes on dividend or interest payments from Cypriot tax resident companies to non-tax residents.

Thin capitalisation    rules:

There are no thin capitalisation rules in Cyprus. Thus, there is no safe-harbour rule which prescribes the permissible debt: equity ratio of the Cypriot company.

Controlled Foreign Company  (CFC):

Cyprus does not have CFC regulations. This means that the earnings of the passive subsidiary of Cypriot holding company need not be included in the income of Cypriot holding company, unless such earnings are actually distributed.

Capital  duty:

There is a capital duty (registration fee) payable upon incorporation of a Cypriot company. The registration fee payable is calculated at around 0.6% of the registered authorised share capital. It is possible to optimise the capital duty incidence through appropriate structuring of the capital structure.

Switzerland:

General:

Switzerland is located in the heart of Europe. It has become an attractive destination for holding company due to its favourable tax regime. Switzerland has extensive tax treaty with around 70 countries. It has concluded tax treaties with most of the European and developed countries. It has concluded tax treaties with the US, the UK, Russia, India, Canada, etc.

Switzerland is a confederation of 26 cantons. Swiss corporations are generally taxed on their income at federal level as well as at cantonal level. As a result of this multilayer tax’ rates, no standard cantonal tax rates exist. The tax rate could vary from 12.5% to 24.5% depending on the canton. This rate includes the effective federal tax rate of 7.8%.

Taxation  of holding companies:

Dividend  and capital gains:

In Switzerland, companies of which  assets consist mostly of participations can benefit from lower income taxes on federal as well as on cantonal! communal level if certain requirements are met.

Cantonal level:

The tax laws of all Swiss cantons have a special privileged tax regime (holding privilege) for companies whose main objective is to hold substantial investments in the capital of other corporations.

Hence, their income essentially comprises dividend income and their main assets are participations.

The following conditions need to be fulfilled to qualify as a holding company for cantonal income tax purposes:

Federal  level:

At a federal level, no holding privilege is available. All income is subject to an effective federal income tax rate of 7.8%. However, income derived from qualifying participations is subject to the participation deduction. The participation income is not exempt, but the income tax is decreased according to a certain percentage. The participation exemption is not a special tax status, but has the aim to avoid economical double taxation.

The following conditions need to be satisfied to avail the participation deduction:

If one of these requirements is met, the profit tax is reduced in proportion to the net income from these participations and the total income. Net income is computed in the prescribed manner.

For dividend income purposes there is no minimum holding period requirement. However, the following additional conditions need to be satisfied for participation deduction on capital gains:

Dividend:

Dividend paid by a Swiss resident company to a non-resident shareholder is subject to withholding tax in Switzerland. The standard rate of withholding tax on outgoing dividend is 35% unless a lower rate is prescribed under the relevant tax treaty. Most of the tax treaties entered into by Switzerland provide for 5% or 10% tax rate on dividend income.

The aforesaid withholding tax rate could be reduced to 0% under the EU Parent Subsidiary Directive benefit. Though Switzerland is not a member of EU, certain EU member countries have extended the benefit of the EU Parent Subsidiary Directive to Swiss resident companies. On remitting dividend to another EU member state, it is essential to evaluate if the aforesaid Directive is in force with respect to that country and the conditions prescribed therein are fulfilled.

Interest:

Swiss law differentiates between ordinary loans of a Swiss borrower and bonds (for example, cash bonds or money market instruments) issued by Swiss residents or accounts/client deposits at a Swiss bank. Interest payments on ordinary loans are not subject to withholding tax, whereas interest payments on Swiss bonds and on accounts/deposits at Swiss banks are subject to withholding tax. The standard rate of withholding tax on interest is 35% unless the tax treaty provides for a lesser rate.

Further, the aforesaid withholding tax rate could be reduced to 0% under the EU Interest & Royalties Directive. As mentioned hereinabove, though Switzerland is not a member of EU, certain EU member countries have extended the benefit of the EU Interest & Royalties Directive to Swiss resident companies. On remitting interest to another EU member state, it is essential to evaluate if the aforesaid Directive is in force with respect to that country and the conditions prescribed therein  are fulfilled.

Thin capitalisation rules:

There are no specific thin capitalisation rules in Switzerland. However, the tax authorities have issued a circular specifying the maximum allowable debt. The circular defines the maximum permitted amount of debt financing per asset evaluated at market value. For example, 85% on participations, 70% on intangibles, etc.

Exceeding debts are reclassified as so-called hidden equity if and to the extent that they are granted by related parties. Interest on debt reclassified as hidden equity is not tax deductible for income tax purposes and qualifies as deemed dividend distribution, subject to Swiss withholding tax.

Controlled  Foreign Company  (CFC):

Switzerland does not have any CFC legislation. Thus, income from foreign subsidiaries is not subject to tax in Switzerland before actual distribution. Participation deduction on dividend income and on capital gain does not require any minimum taxation of the subsidiaries’ profits.

Capital  duty:

Switzerland levies capital duty on infusion of capital. Capital duty is assessed at an ordinary rate of 1% on the fair market value of any capital in excess of CHF 1 million. There are ways to optimise the capital duty incidence in Switzerland e.g., re-organisation exemption mechanism, etc.

Luxembourg:

General:

Luxembourg is the smallest of all BENELUX countries. In fact, Luxembourg was one of the first to introduce ‘holding’ companies back in 1929. Although the 1929 holding companies can no longer be incorporated due to pressure from the EU, Luxembourg continues to be an attractive jurisdiction for holding companies. Luxembourg has concluded tax treaties with almost 50 countries. Among the prominent countries, Luxembourg has concluded tax treaties with the US, the UK, Canada, Russia, and Germany. Luxembourg has recently signed tax treaty with India.

The corporate tax rate varies from 20% to 22% depending on the income level. In addition, a surcharge of 4% is payable to the unemployment fund.

A local income tax i.e., Municipal Business Tax (MBT)is also levied by different municipalities. MBT rate varies from municipality to municipality.

Taxation  of holding  companies:

Dividend  & Capital gains:

Dividends and capital gains received by a Luxembourg tax resident company are in principle subject to Corporate Income Tax (hereafter ‘CIT’) and MBT at an aggregate rate of approximately 30%. However, such income could be exempt from crr and MBT under the participation exemption regime in Luxembourg.

The conditions to be met for availing of participation exemption are as follows:

(i)    The recipient  is one of the following:

1.    A resident capital company or a qualifying entity fully subject to tax in Luxembourg;

2.    A Luxembourg branch (permanent establishment) of a company which is a resident of another EU state that is covered under Article 2 of the EU Parent Subsidiary Directive;

3.    A Luxembourg branch of a capital company which is a resident of a tax treaty country.

(ii)    The recipient owns at least 10% of the share capital of the distributing company or the cost of acquisition of the shareholding is Euro 1.2 million (for capital gains participation exemption, the requirement is Euro 6 million);

(iii)    Shares have been held for 12 months. If this period has not been completed as on the date of dividend distribution, the recipient should commit to fulfilling the holding period.

As regards international participation exemption, i.e., dividends/ capital gains received/ arising from non-resident companies, participation exemption is available, if in addition to the above conditions, either of the following two conditions is met:

(i)    The distributing capital company must be subject to a tax comparable to Luxembourg corporate tax in its home country. This condition should be met if the foreign company is subject to tax at an effective rate which is at least equal to half of the CIT (excluding unemployment surcharge); or

(ii)    The distributing entity is a resident of another EU country and is covered by Article 2 of the EU Parent Subsidiary Directive.
 

Withholding tax:

Dividend:

Dividends distributed by a Luxembourg company are in principle subject to withholding tax at a rate of 15%, unless the relevant tax treaty provides for a lesser rate.

The aforesaid rate could be reduced to 0% under the EU Parent Subsidiary Directive, subject to fulfilment of prescribed conditions.

Interest:

There is no withholding tax on ordinary interest paid to non-resident companies. The feature of the loan instrument needs to be evaluated to ensure that it is in the nature of debt and is not an equity or quasi-equity instrument. In that event, there could be withholding tax implications in Luxembourg.

Accessibility to EU Directives:

Luxembourg is a member of EU and is therefore eligible for the benefit of the EU Parent Subsidiary Directive and EU Interest & Royalties Directive on incoming dividend and interest income, respectively. However, the Luxembourg resident company must fulfil the conditions prescribed under the respective directive so as to avail the benefit.

Thin capitalisation rules:

There are no specific thin capitalisation rules in Luxembourg.

Controlled  Foreign Company  (CFC):

There are no CFC rules in Luxembourg.

Capital  duty:

Contribution of cash to the capital of a company in exchange for shares is subject to capital duty at the rate of 0.5%. The taxable base is the amount of cash contributed.

Summary  :

The summary of analysis of aforesaid holding company jurisdictions is given in Table 1 on the next page:

Conclusion:

The selection of European holding company jurisdiction is a function of multiple variables. Although all the countries discussed above provide for exemption from dividend and capital gain taxation, the conditions to be fulfilled under each jurisdiction differ.

For example, there is a minimum holding period requirement of one year and a higher threshold of participation for availing the capital gains tax participation exemption in case of Switzerland. In case of
 
Luxembourg and Cyprus there could be a possible capital duty incidence.