Tax issues for UK holding companies

Generally, a UK tax resident company is subject to UK corporation tax on its worldwide profits and gains. The main rate of UK corporation tax is currently 25%. There are a variety of tax exemptions potentially available to a UK holding company, which can make having a UK holding company an attractive prospect in certain circumstances.

Some of the general considerations which may apply to UK holding companies are outlined below. Whether a UK holding company is the appropriate solution for a company or investors depends on the particular circumstances and the other jurisdictions involved, so this guide only gives a brief indication of the issues that may be relevant.

Tax treatment of payments made by a UK holding company to investors

Broadly, investors can invest in a UK holding company through a combination of two methods:

• by way of debt - lending the company money; or
• by way of equity - subscribing for shares in the company.

The nature of the returns that investors receive from the UK holding company will vary depending on how their investment is structured. Interest is likely to be received where an investment takes the form of debt, whereas dividends will be distributed where an investment is structured as equity funding.

Debt and interest

A corporation tax deduction may be available to the UK holding company on the payment of interest to investors, although these payments may be subject to anti-avoidance provisions - for example, transfer pricing which is discussed below. These anti-avoidance rules are very complicated and may apply to deny any tax deductions for the UK holding company.

There is a general rule restricting the ability of a UK company to deduct interest expenses from its taxable profits. This general restriction operates to restrict tax deductions for interest by reference to a fixed ratio of 30% of a company's earnings before interest, taxes, depreciation and amortisation (EBITDA). The rule only applies where a group’s interest expenses exceed £2 million per annum – known as the de minimis threshold. There is also a narrowly drawn exemption for third party interest expenses on certain public benefit infrastructure projects.

The UK’s interest limitation rule was introduced in 2017 following the Organisation for Economic Cooperation and Development's (OECD) project to prevent "base erosion and profit shifting" (BEPS). The BEPS project aimed to combat the artificial shifting of profits of multinational groups from high to low tax jurisdictions and the exploitation of mismatches between different tax systems, so that little or no tax is paid.

Withholding tax on interest

Generally, a UK holding company has a duty to withhold tax (currently at a rate of 20%) on UK source payments of interest to investors.  Where tax is withheld, it will have to be paid to HM Revenue & Customs (HMRC) to account for the investor's liability for UK tax. In certain circumstances investors can then claim a repayment from HMRC of the tax withheld.

There are several exemptions to this general rule regarding withholding tax. For example, there is currently no withholding tax on payments of interest to UK banks and UK corporation taxpayers.

Quoted Eurobonds also benefit from an exemption from UK withholding tax. A quoted Eurobond is a debt security issued by a company that carries a right to interest and is listed on a recognised Stock Exchange. 

An exemption is also available for certain qualifying private placements. A private placement is a type of unlisted debt instrument that is sold by way of a private offering to a small number of investors. 

For non-UK resident investors, there may be no requirement to withhold tax if the investor is based in a country which has a double tax treaty with the UK which provides that no UK tax is payable on interest paid to a resident of that country. A double tax treaty may also provide for a lower rate of withholding tax. Even if a double tax treaty does apply, the holding company cannot make the payments without deducting tax or with tax withheld at less than 20% unless it has received clearance from HMRC to pay investors without withholding tax.

Shares and dividends

No tax deduction is available for the holding company for dividends paid to investors.

There is no withholding tax on dividends paid by a UK company.

Tax treatment of payments received by the UK holding company from its subsidiaries

Dividends received by the UK holding company from other UK companies or from overseas companies should benefit from an exemption from corporation tax, called the dividend exemption. If the exemption is available, the UK holding company does not have to pay corporation tax on the dividends it receives.

Whether the UK holding company is eligible to benefit from the dividend exemption will depend on whether it is a 'small' company. Generally, a company will be a small company if it has fewer than 50 employees and its annual turnover or annual balance sheet is less than €10 million. When determining whether a company is “small” the number of employees, turnover and balance sheet values of any linked enterprises (such as subsidiaries) are aggregated.

If the holding company is a small company, the dividend exemption should prevent UK tax being payable in respect of dividends paid to it by UK companies or companies resident in most places where the UK has a double tax treaty, provided a few additional conditions are satisfied.

If the holding company is not a small company, then the dividend exemption may still be available if the dividend is paid by a company which the holding company controls, provided certain other conditions are satisfied.

Controlled foreign company rules

Anti-avoidance rules, called the controlled foreign company (CFC) rules, prevent the artificial diversion of a UK company's profits to subsidiaries or other corporate entities in low tax jurisdictions to avoid UK corporation tax.

A CFC is a company that is tax resident outside the UK and controlled by one or more UK resident persons. In certain circumstances, the rules will impose a corporation tax charge on a UK resident company in relation to certain profits of the CFC.

There are certain exemptions that prevent a CFC charge applying. For example, subject to certain conditions there is an exemption for CFCs resident in a jurisdiction with a headline rate of corporation tax that is more than 75% of the UK corporation tax rate (currently 25%). The UK's CFC rules are complex and tax advice should always be sought where they may be relevant.

Transfer pricing

The transfer pricing anti-avoidance rules apply where services or transactions take place between connected parties for a price calculated to provide a UK tax advantage. The rules also apply to the terms of loans between connected parties. The effect of the rules is to treat goods or services as supplied to or by UK companies for their "arm's length price", rather than the price charged.

A UK holding company may need to consider the impact of these rules when it enters into transactions with other companies in its group. Depending on the circumstances, the rules may also prevent a tax deduction being available or restrict the tax deduction in respect of interest paid by the holding company to its investors.

The rules only apply to large companies – small and medium-sized companies are exempt. They apply to transactions which are cross-border, and to transactions which are between UK residents.

Diverted profits tax

Diverted profits tax (DPT) is a UK tax aimed at multinational organisations operating in the UK that are considered to be diverting profits from the UK to avoid UK corporation tax. DPT was introduced in April 2015. It does not apply to small and medium sized companies.

The current rate of DPT is 31% of the diverted profit. In January 2024, the previous government announced its intention to reform DPT and remove its status as a separate tax by bringing it within the charge to UK corporation tax. Draft legislation was expected to be published later in 2024. However, following the UK's general election and change of government in July, it is unclear if this timeline will be maintained.

For further details of this regime, see our Out-Law guide to the UK’s diverted profits tax regime.

Calculating a DPT charge is complex and there are various rules that need to be considered.  Specialist tax advice should always be obtained if a UK holding company considers that DPT might be relevant to its operations.

Patent box

The UK has an optional patent box regime, which applies to the taxation of intellectual property.

Broadly, the regime allows certain companies liable to UK tax to elect to apply a lower rate of corporation tax on profits earned from their patented inventions (and certain other innovations).  Where the regime applies, a UK company may be able to benefit from an effective corporation tax rate of 10% on its worldwide profits attributable to qualifying patents and similar IP rights. 

For further details of this regime see our Out-Law guide to the UK’s patent box regime.

Exit strategy

Sale of subsidiaries by the UK holding company

The UK holding company may wish to sell its shares in its subsidiaries and distribute the money to its investors by way of a dividend. The disposal of the shares is likely to trigger a capital gain on which corporation tax may be payable. The UK holding company may benefit from a relief called the substantial shareholding exemption (SSE), which would have the effect of making the entire gain exempt from capital gains tax. Where the SSE applies, it is automatic and does not depend on the company making an election.

Various conditions need to be satisfied for a company to benefit from the SSE. These conditions are complex and are focused on the seller company’s shareholding in the subsidiary and the trading status of the subsidiary being sold. Broadly, the selling company must have held at least 10% of the shares continuously for at least one year. The subsidiary must also satisfy conditions relating to its trading activities, such as its activities cannot to a substantial extent include activities other than trading activities. There are a variety of other requirements which must be satisfied, meaning that each transaction needs to be carefully checked to see whether the SSE is available.

Where the SSE is available the gains will not be taxed in the hands of the holding company and consequently, there should be more funds available to return to investors.

For further details on the SSE see our Out-Law guide to the substantial shareholding exemption.

Sale of UK holding company by investors

If the investors decide to sell their shares in the UK holding company, any chargeable gain may be subject to UK capital gains tax depending on the tax residence status of the person disposing of the shares.