CLAUSE 79 AND SCHEDULE 26: DOUBLE TAXATION RELIEF

SUMMARY

1. This Clause and schedule bring into effect a number of changes to the rules concerning claims to relief in respect of foreign tax in Part XVIII ICTA 1988 and amend some provisions in Schedule 30 FA 2000. The revisions affect claims made by multinational companies that receive dividends from overseas companies in which they hold at least 10% of the voting rights.

DETAILS OF THE CLAUSE

2. The clause gives effect to Schedule 26.

Schedule 26 : Double Taxation Relief

3. Paragraph 1 makes two changes to Section 795, which determines how income subject to foreign tax is to be computed

4. It increases the amount to be assessed in respect of an overseas dividend by underlying tax which is not to be taken into account for credit purposes against this dividend either because it has been restricted by the operation of the mixer cap in section 799(1)(b) or because the company has excluded some foreign tax from their claim under section 799(1B), as provided by Paragraph 2 of the Schedule (see 7 below).

5. It does not increase the amount to be assessed in respect of an overseas dividend by either any additional credit to be allowed in respect of a dividend from a company resident in the UK under Section 801(4B) (Paragraph 3 of the Schedule, see 9 below) or any relievable foreign tax arising in respect of another dividend but allowed as underlying tax against this dividend; and

The paragraph applies in relation to dividends paid into the UK on or after 31^st March 2001 .Iregardless, in cases of a chain of companies, of the time when a dividend paid by a lower level company may have been paid.

6. Paragraph 2 amends section 799 by changing the formula that restricts the amount of underlying tax which may be claimed for credit relief (the mixer cap). The amount to be taken into account may not exceed the sum of the dividend (D)and the foreign tax paid in respect of that dividend underlying tax attributable to it(U), multiplied by the maximum relievable rate (M%). The maximum relievable rate is the rate of corporation tax in force when the dividend was paid.

7. Suppose a Case V dividend of 590 is received from an overseas company, A. This is partially in respect of a dividend of 240 it received from a lower level company, B, not resident in the UK. B’s dividend was paid out of before tax profits of 300 on which tax had been paid of 60 and 350 tax was paid by A on its before tax profits of 700 out of which the remainder of the Case V dividend was paid. The mixer cap will not restrict the underlying tax that can be taken into account under section 801 for the dividend from B, so the amount that will be taken into account against the Case V dividend, is 60. However when considering the final dividend from A, the mixer cap will restrict the underlying tax that can be taken into account to (D + U) x M%, i.e. (590 + 60 + 350) x 30% = 300.

8. The paragraph also inserts a new section 799(1B)which allows some underlying tax to be excluded from a claim. Under the Finance Act 2000 rules a company could not make a claim to receive eligible unrelieved foreign tax (EUFT) on a mixed dividend made up of a large dividend with a low rate of foreign underlying tax and a small dividend with a rate only just exceeding the mixer cap limit. By excluding some of the underlying tax from the small dividend and only making a claim for the maximum relievable rate, the mixer cap will not operate. This avoids “tainting” of the dividend paid into the United Kingdom. Any tax excluded from the claim for credit is left out of account for the purposes of this section, so that it cannot be taken into account for credit against tax on this dividend or on any other dividend.

9. The new rules apply to dividends paid to the United Kingdom on or after 31 March 2001 regardless, in cases of a chain of companies, of the time when a dividend paid by a lower level company may have been paid. If the claim includes underlying tax from a lower level company under section 801, this paragraph is taken to have had effect at the time the dividend was paid by that company.

10.Paragraph 3 amends section 801 in respect of dividends paid by a UK company to an overseas company. If the rate of underlying tax paid on a dividend from a United Kingdom company is below the amount given by applying the mixer cap formula, the shortfall is made up so that no further United Kingdom tax is payable in respect of that part of the dividend from the foreign company which represents the dividend from its United Kingdom subsidiary. This situation can arise because the relevant profits of a chargeable period are not necessarily the same as the taxable profits of the same period, and it is the relevant profits that are used to determine the underlying rate of tax. The shortfall is given as an additional credit against UK tax payable.

11.The new rules apply to dividends paid to the United Kingdom on or after 31 March 2001 regardless, in cases of a chain of companies, of the time when a dividend paid by a lower level company may have been paid.The paragraph is treated as applying in respect of lower level dividends which were paid before that date

12.Paragraph 4 amends Section 806A to exclude dividends paid by companies in the United Kingdom from those dividends upon which EUFT can arise. The effect of Paragraphs 3 and 4 is to treat the rate of underlying tax paid on UK dividends as equivalent to the rate of corporation tax no further tax is payable in respect of profits which UK corporation tax has been paid but neither can additional relievable tax arise.

13. Paragraph 5 amends Subsections 806B(3) to (6) which determine the amount of Case B EUFT. The calculation is made so that no tax advantage is derived from holding subsidiaries indirectly, rather than directly.

14. The amended subsection 806B(3)allows excess relievable tax arising at all level in a chain of companies to count towards the total amount of eligible unrelieved foreign tax arising on a dividend. EUFT is the total of the upper rate amounts found by subsections 806B(4) and (5), less the amount of underlying tax actually brought into account as credit against the dividend.

15. Subsection 806B(4) determines the upper rate amount for the Case V dividend entering the UK. If the underlying tax has not been restricted because of the mixer cap. Otherwise, the mixer cap formula is applied to the dividend, but ignoring any lower level dividend and using the upper percentage in place of M. Any increase under section 801(4B) in respect of UK dividends is ignored.

16.Subsection 806B(5) determines the upper rate amount for lower level dividends. If the underlying tax has not been restricted because of the mixer cap, the appropriate portion (see new subsection 806B(6)) of underlying tax paid will be the upper rate amount. Otherwise, the mixer cap formula is applied to the relevant dividend, but ignoring any other dividend and using the upper rate percentage (45%) in place of M%. If the dividend is paid by a company resident in the UK M% is used.

17.Take the example in paragraph 6 where the Case V dividend is 590. The mixer cap did not restrict the underlying tax that could be taken into account under section 801 for the dividend from B, so the upper rate amount in respect of this dividend is 60 also. But the mixer cap restricted underlying tax in respect of the mixed from A. To find the upper rate amount the formula in section 799(1A) is used again, but with the upper rate percentage in place of M% on the dividend, excluding any lower level dividend. The calculation is (350 + 350) x 45% = 315. The total of the upper rate amounts is 60 + 315 = 375. Taking away the amount allowed under section 799 against the Case V dividend, 300, gives an amount of eligible unrelieved foreign tax of 75 to be used elsewhere. This does not give an advantage over holding A and B as direct subsidiaries of the UK recipient company.

18. The new subsection 806B(6) ensures that the correct proportion (the “appropriate portion”) of underlying tax is taken into account when less than the whole amount of a lower level dividend forms part of the dividend paid to the United Kingdom.

19. There is a consequential amendment to section 806B(9). This ensures that, in determining the EUFT, there is not a continual, reiterated aggregation of tax by determining that the onshore pooling rules and the rules for utilisation of EUFT are, for this purpose, ignored.

20. The new rules apply to dividends paid to the United Kingdom on or after 31 March 2001 regardless, in cases of a chain of companies, of the time when a dividend paid by a lower level company may have been paid.

21. Paragraph 6 amends Section 811 (deduction for foreign tax where no credit allowable) so that any underlying tax that is excluded from the claim to allowance by way of credit (see 7 above), so as not to taint the dividend, is not deductible from income chargeable to tax.

22. Paragraph 7 makes a minor clarification to the amendments introduced by paragraph 4 of Schedule 30 FA 2000. By changing “accounting periods” to “chargeable periods” and treating the amendment as being part of the original legislation, it makes clear that relief is available for all non-residents and not just non-resident companies who trade in the United Kingdom through a branch or agency.

BACKGROUND NOTE

23. Double taxation occurs when income is taxed both by the taxpayer’s country of residence and in another country where the income arises. The purpose of double taxation relief is to remove or reduce the disincentive that double taxation represents to outward investment. A key part in that is played by double taxation conventions that the United Kingdom has entered into with other countries. More than 100 of these are now in force.

24. A company which receives a dividend from an overseas company may claim a credit against the United Kingdom tax payable on the dividend for tax paid on the profits of the overseas company and its subsidiaries. Before FA 2000, if the tax exceeded the United Kingdom tax payable on the dividend, the United Kingdom recipient could not get relief for all the foreign tax. Offshore intermediate companies were therefore set up to mix highly taxed and lowly taxed dividends so that they came into the United Kingdom at an averaged rate. FA 2000 introduced provisions to prevent this.

25. The clause and the schedule modify the FA 2000 provisions so that they work in the way they were intended to work. They have been drawn up in consultation with business and, taken as a whole, the provisions will significantly benefit United Kingdom groups who acquire or already have business structures where tax in excess of 30% is paid at several levels in that structure, or tax at rates both below and above 30% are paid at different levels.