Avoiding tax traps when relocating
Relocation is a factor that can drive M&A transactions and many jurisdictions use various strategies to attract or retain businesses, whether that be on tax, regulation, creation of critical business mass, or other reasons. There may be many non-tax reasons for enterprises to relocate, but there will always be tax consequences to consider. In this article, we outline the possible tax traps and opportunities for this type of activity.
Main tax traps
The main tax issues in business relocations, which can amount to traps if not fully taken into account in the planning, include the tax deductibility of finance costs, the application of controlled foreign company regime and the ability to use accumulated tax losses against future profits. In addition, there may be new transfer pricing regulations to consider. The operation of different tax treaties could also impact overall tax costs.
The EU ATAD Directives require EU member states to introduce a range of rules aimed at reducing tax avoidance. While there is an overarching framework as a result of the Directives, there is a range of methods by which member states can apply the rules. Consequently, there are differences between EU member states in how the rules apply, presenting potential traps and opportunities.
Relocation can lead to a simplification of the group structure, and will require a re-examination of transfer pricing strategies and documentation. However, there may be other considerations depending on business activity. For example if the business is digitally or platform based consideration will need to be given to the impact of new digital economy taxes.
Where relocating entities take advantage of tax exemptions and tax holidays particular care will need to be given to the application of controlled foreign company rules. In managing this risk, one will need to take account of the commercial requirements of the group when considering the different relocation options.
Business location decisions should not be driven by tax, but consideration of tax matters can present opportunities in addition to risks.
Main tax opportunities
The main tax structuring opportunities are commonly centered around favourable treatments for amortisation of assets/goodwill, carry-back/carry-forward of losses, group tax regime, incentives for certain knowledge intensive or IP rich businesses. These are often designed to attract certain business activities and jobs.
The trend to consider relocation created by these incentives has been accelerated as a result of Brexit and COVID-19.
Many European jurisdictions have focussed on incentives to attract high earning jobs and the relocation to their jurisdiction of intellectual property through patent box regimes, numerous enhanced R&D deductions or tax credit, schemes for employee relocation, etc. Asian and American jurisdictions have focussed their incentives on attracting headquarter businesses through, for example, relocation tax credits.
Another tax consideration that will impact the choice of relocation jurisdiction concerns will be the tax issues relevant to the repatriation of profits. Tax treaties can impact the tax costs associated with the chosen method for repatriating profits: for example, dividends, related party loans, royalties, management fees. The potential application of the OECD’s multilateral instrument (MLI) on the operation of a tax treaty will also need to be considered. The MLI’s potential application of the principal purpose test (PPT) to prevent abuse of the use of a tax treaty, may need to be considered in addition to the application of beneficial ownership test. Treaty shopping is under scrutiny and even though the PPT has more limited impact in Europe than for other jurisdictions (due to EU law anti-abuse provisions), it should counteract location choices driven by tax considerations.
Conclusion
In addition to considering the business aspects of relocation options, it is important to consider the tax risks and opportunities. The changing tax landscape, coupled with other factors such as Brexit, covid-19 and new more digitalised ways of working are encouraging companies to reconsider their existing business location and tax strategies and adapt them to optimise their commercial and tax position.
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