The UK government continues to encourage investment in innovation. Regardless of government interventions, UK businesses will continue to undertake research and development in order to grow their business. The IP created by some businesses, as a result of research and development, can be exploited in overseas territories resulting in the receipt of royalty income.
Current position – pre Brexit
If the receipt is coming from an EU resident company, then the EU interest and royalties directive (the directive) may apply to reduce the withholding tax obligation to 0%. Withholding tax (WHT) is an income tax which the payer of the royalty may be obligated to deduct from its gross payment to the UK supplier.
If the UK and EU companies are associated (one holds directly at least 25% of the voting power or capital of the other, or a third company holds at least 25% in both companies), then the WHT on royalty payments can be reduced to 0% as a result of the directive. The directive most commonly applies in group structures where IP is licenced from a UK company to EU based subsidiaries.
Likely position – post Brexit
As it stands, it appears likely that the UK will no longer be a party to the EU interest and royalties directive. This means that the benefit of the directive would no longer apply and the benefit of 0% WHT could be lost.
In such cases, the UK company will need to consider the domestic legislation of the payer’s home jurisdiction, along with the relevant UK tax treaty, in order to determine the impact on WHT rates.
Take Italy as an example jurisdiction. A successful UK company has expanded into Italy and has done so through the incorporation of an Italian subsidiary. As part of the arrangement the Italian company has been granted a licence by the UK parent to exploit valuable IP in the Italian market. The domestic rate of WHT in Italy is 22.5%. Currently this is reduced to 0% by the Directive. Post Brexit (without the Directive), the UK-Italy tax treaty reduces the WHT to 8% leading to a requirement to withhold income tax.
UK companies in receipt of royalty income from EU located businesses need to consider the potential impact on their tax position. WHT may suddenly be deductible impacting cashflow and the overall tax cost if it cannot be recovered against the UK corporation tax liability. Where a reduced treaty rate can be claimed, the UK company will need to understand the process it is required to undertake to access the benefit of that lower rate.