Multinational entreprises (MNEs) may decide to establish a Holding Company (HoldCo) as an efficient way of managing a group of subsidiaries in a particular region. This allows financing, licensing and management activities to be centralised, preferably in a politically and legally stable environment.
The HoldCo model also serves to protect the other assets of a HoldCo from risks or liabilities stemming from one subsidiary. If one subsidiary goes bankrupt or becomes subject to litigation, your HoldCo’s other subsidiaries, stocks and bank balances are unaffected. A HoldCo structure may also offer tax advantages in relation to capital gains and withholding taxes on dividends.
For all of these objectives, the location of the underlying business activities, any HoldCo and the ultimate shareholders will be key. The location of the underlying business activities and the ultimate shareholders will usually be fixed or subject to commercial requirements, but there is often flexibility regarding the location of HoldCos. Here are six considerations that MNEs should address before selecting a HoldCo jurisdiction:
1. Double Taxation Agreements (DTAs)
It is important to consider the tax treaties between the HoldCo jurisdiction and the locations of its subsidiaries or operating entities. A tax treaty is made by two countries to resolve double taxation issues related to passive and active income. Therefore, the treaty can have an effect on the taxation of income, capital gains, dividends and royalty payments.
It is essential that incoming dividends that a subsidiary remits to the HoldCo must either be exempted from or subject to low withholding tax rates in the subsidiary’s jurisdiction, while dividend income received by the HoldCo from a subsidiary, profits realised by the HoldCo on the sale of shares in a subsidiary and outgoing dividends paid by the holding company to its ultimate shareholders must all either be exempted from or subject to low corporate income, capital gains or withholding tax rates in the HoldCo’s jurisdiction.
2. Economic substance in jurisdiction
The OECD Base Erosion and Profit Shifting (BEPS) project has created the need to ensure that a company must have both economic and commercial substance in a jurisdiction in order to avoid negative tax and regulatory consequences. You should be transparent with tax authorities and be able to provide applicable documentation and information. HoldCos will generally only be required to meet a reduced test for economic substance (except for intellectual property companies which face more onerous requirements) but, as a minimum, should be able to provide evidence in the HoldCo jurisdiction of:
- Local office where accounts and corporate documents are stored and maintained;
- Locally qualified directors and key personnel to hold Annual General Meeting/Board meetings to demonstrate that decisions are being made in holding company jurisdiction.
Optimised HoldCo tax structures may only be effective if there is sufficient economic and commercial substance that is transparent to tax authorities.
3. Nature and location of underlying assets
The nature of the underlying assets and their location are some of the most important aspects to consider when designing the holding structure and choosing the most appropriate jurisdiction.
Equity holdings – If a HoldCo is to hold minor equity stakes in underlying companies or wholly-own subsidiaries will have an impact. Certain jurisdictions provide for participation exemptions on dividends and/or capital gains provided that the HoldCo holds a certain percentage of ownership from a subsidiary.
Active business – If HoldCo is to engage in business activities other than pure holding, it is important to look at how payments and transactions between affiliates are treated between jurisdictions and whether withholding taxes are applicable or are exempted or reduced under tax treaties.
Intellectual Property – If HoldCo is to hold intellectual property, it is important to examine how local laws protect and enforce legal rights to inventions, patents and copyrights, and whether IP income qualifies for exemptions and has access to treaty benefits.
Leasing – If HoldCo is to lease assets to subsidiaries, it is important to examine how payments would be taxed and ensure that transactions are carried out at a fair market value.
Financing – If HoldCo is to be used for financing, it is important to examine how interest payments are taxed at source and in the hands of the recipient, as well as the extent to which interest payments are deductible.
4. Types of legal structure for a HoldCo
The type of assets and purpose of the holding entity will generally determine the choice of legal structure. Possible legal structures include:
- a) Limited Company or International Business Company (IBC) – If your HoldCo’s purpose is segregating different business assets, activities or units, fundraising, providing financing or leveraging tax planning strategies, it would make sense to use a corporation, which is a company limited by shares and a taxable entity that can leverage corporate tax benefits from international tax treaties. It can also provide for stricter governance and management structures.
- b) Limited Liability Company (LLC) – LLCs are more simple, flexible and have less operational requirements and formalities than corporations. The capital of an LLC is divided into membership interests, which may not be freely transferable and they do not constitute securities. LLCs may also elect to be tax-transparent, meaning that income can be taxed at the personal level of its owners rather than the corporate level.
- c) Special Purpose Vehicle (SPV) – The operations of an SPV are limited to the acquisition and financing of specific assets, and the separate company structure serves as a method of isolating the risks of these activities.
- d) Trusts / Foundations – If the holding entity’s purpose is estate and succession planning then a Trust or Foundation can be a useful holding vehicle for avoiding probate and forced heirship or to hold specific assets such as land or an interest in a family business where it might not be appropriate or practical to divide the assets between individuals but profits can still be distributed to these individuals.
5. Access to professional and financial services.
When selecting the location for your HoldCo it is essential to assess whether the geographical location is accessible for shareholders and directors, that the legal system is suitably stable and robust, and the cost and governance requirements involved.
Amongst other things, your HoldCo may require assistance with financing for operations and cash management, trading arrangements and profit positioning, and tax, accounting and legal issues.
6. Planning for expansion
Taking care to determine the most appropriate corporate structure should form part of the early stage decision making when planning for international expansion. It is only once the structure has been agreed that it will be possible to resolve some of the other fundamental structuring issues that relate to the cross-border finance and trading arrangements.
Sovereign works on an execution-only basis to incorporate structures around the world for our clients. We highly recommend getting third party tax/legal advice before incorporation. Please contact me for further details and assistance.