Corporate inversions are in the headlines at the current time. Pfizer’s recent bid for AstraZeneca follows in the footsteps of a number of similar high profile deals which have seen US domiciled groups (Aon, Eaton Corporation and Liberty Global being three recent examples) relocate to the UK.
Why is a US/UK tax inversion so attractive at the current time?
The UK is the destination of choice for US corporations looking to “invert”.
The US tax regime - which has a headline corporation tax rate of 35 per cent - subjects US domiciled groups to a worldwide basis of taxation and imposes withholding tax on outgoing dividends. By comparison, the UK looks very much like a tax haven.
A UK holding company:
- is subject to a very competitive headline rate of corporation tax (20 per cent from 2015) and can benefit from an even more attractive rate (10 per cent) if it receives patent income under the UK’s “Patent Box” regime;
- is not subject to tax on worldwide earnings as:
- dividends received by a UK holding company (whether from a UK or foreign subsidiary) are generally exempt; and
- the ambit of the UK’s controlled foreign companies legislation has been radically cut back so that:
- in most cases it only applies where there is an artificial division of profit which would otherwise have been taxable in the UK; and
- the regime positively encourages the establishment of offshore finance vehicles in low tax jurisdictions;
- is exempt from tax on profits realised through sales of qualifying subsidiaries (under the UK’s substantial shareholdings exemption);
- can receive dividends gross from subsidiaries wherever located in the European Union;
- is never required to impose withholding tax on outgoing dividends; and
- can elect to opt in to the overseas branch profit exemption regime.
Moreover, whilst sales of shares in a UK company remain subject to stamp duty (at ½ per cent of the consideration given), in practice this can be avoided by US shareholders who will typically trade their shares in a UK company through a depositary system such as The Depository Trust Company, which does not give rise to a transfer tax liability. Recent case law has made it clear that the 1.5 per cent entry charge (which the UK tax authorities used to collect when shares were transferred to a depositary or clearance system) no longer applies.
How is a US/UK tax inversion achieved?
The easiest way for a US domiciled group to escape the US tax net is through merger.
If the former shareholders of the US company hold less than 80% of the enlarged group, the US will respect the residence of the new holding company. (If this test is not met, the company may be treated as a “surrogate foreign corporation”.)
Further US tax advantages can be obtained if the former shareholders of the US company hold less than 60 per cent of the enlarged group. (This will prevent gains on certain assets held by the former US company being taxable on sales over the next 10 years.)
One way for a US corporation to achieve this is by inviting a UK company of comparable size to make an offer to its shareholders (a reverse merger).
Another – often a more attractive route - is for the US corporation to find a UK company of comparable size and to bring both companies under a new UK holding company which can become the parent of the enlarged worldwide group.
Typically, a new UK company will be inserted as the new parent of the group through a court approved scheme of arrangement in the UK and a reverse triangular merger in the US.
Under a UK court approved scheme of arrangement a new UK company is formed (NewCo PLC); the ordinary shares of UK PLC held by the public are cancelled and reissued to NewCo PLC.
The advantages of a UK court approved scheme of arrangement are that:
- only 75 per cent of shareholder acceptance by value and a majority by number of those who vote is required to force a “squeeze out” of non-accepting shareholders (in a market offer a 90 per cent level of acceptances is required); while
- no stamp duty is due on the acquisition of the shares of the UK company because in mechanical terms the acquisition is effected by way of a cancellation and issue of new shares.
Moreover, UK resident shareholders will normally be able to “rollover” any gain on their shares in UK PLC into the new shares in NewCo PLC although care will need to be taken if there is a cash alternative (but often this will not be the case as the US corporation will want to ensure that its former shareholder basis is swamped to the maximum extent possible to satisfy the 80 per cent or 60 per cent threshold).
In a US reverse triangular merger the shares of the US corporation are cancelled; former shareholders receive merger consideration which may be cash and/or shares in the new UK holding company designed to qualify as a tax free reorganisation for US tax purposes.
Whether the US tax benefits of redomiciliation will be allowed to remain in place for long remains to be seen. But for the moment UK/US inversions look set to achieve significant tax savings. It would be surprising therefore if there are not major UK/US mergers over the coming months.