Optimizing withholding taxes with a holding

At Tax Free Today, we have spoken of holdings on several occasions, especially as a way to avoid withholdings on dividends and royalties. Today, we want to provide a clearer picture on the subject.

A holding company is a business that holds majority stakes in other personal and capital companies. Pure holding companies are not engaged in anything other than managing and optimizing these holdings.

An asset management holding company invests the distributed profits with the expectation of obtaining returns.

Finally, an active holding company also takes on work within the group structure, which it then liquidates with its subsidiaries (for example, administrative expenses, etc.).

There are a number of countries, such as Switzerland, the Netherlands and many others, that have a holding system. This model allows a favorable tax treatment of the participation benefits and is applied to companies that exclusively carry out holding activities.

On the other hand, countries with fiscal systems influenced by the Anglo-Saxon world do not have these special systems for holdings. In these countries, a company may have commercial activity and receive profits of shares at the same time. As a general rule, different tax rates apply depending on the type of benefit obtained.

What is essential is to understand that a holding company cannot or can barely help reduce the operating profits of a subsidiary.

The optimization achieved through a holding is made after the subsidiary has been taxed by the corporation tax, since it is up to the holding company to transfer the profits obtained by the subsidiaries to the shareholders free of withholding taxes (as far as possible).

Example of using a holding

Let us take as an example a pure holding company A in Switzerland that holds 100% of its holdings of subsidiary B based in Spain.

Meanwhile, individual C resides in Paraguay, free of taxes on foreign income and without having to worry about if their businesses have enough business substrate or from where they are administered. After discounting operating expenses, their company generates a pre-tax profit of €100,000.

In this example, the subsidiary is taxed first, as is normal, by the corporate tax in Spain. In the case of an average tax burden of 25%, the company would still have €75,000 left, which can be distributed as a benefit to the Swiss parent company A.

Assuming that the full benefits are distributed, the dividends are now sent to holding company A. Thanks to the holding system in Switzerland, these benefits are not taxable.

In Spain the withholding on dividends is 19%, but not in this case, thanks to the European directive on parent companies and affiliates.

Switzerland, although not a member of the EU, fully participates in this directive, with which the benefits of Spain can be transferred without withholding taxes.

Suppose that holding A has the €75,000 that they now want to pay to partner C. In Paraguay, those paid benefits would be tax-free.

But this calculation has been made without considering Switzerland, which in the case of distributions to people without a double taxation agreement, makes a withholding of no less than 35% of withholding taxes. Thus, only (€75,000-€26,250=) €48,750 would arrive to Paraguay.

Unhappy with this situation, person C transfers the shares of his holding to company D in Cyprus (which is also in his possession).

According to the double taxation agreement, the benefits of the sale are taxed at the place of residence, in this case Paraguay, with which they would be tax-free.

This happens supposing that C has established the companies after having begun to reside in Paraguay and that an exit tax has not been made. If the exit tax were applied or if they resided in a country with high taxes, the sale of the holding company would not be so easy to carry out.

Given that 100% of the shares of holding B now belong to company D in Cyprus, the profits can be transferred free of taxes to Cyprus thanks to the European directive on parent companies and subsidiaries. Thus, company B of Switzerland becomes an intermediate holding company. Company D can now transfer the tax-free benefits to person C in Paraguay, since Cyprus does not have withholding taxes. With this, company D gets €70,000 free of taxes.

Cyprus is not only an ideal location for a pure holding company thanks to the absence of withholding taxes, but it can also illustrate very well the concepts of an asset management holding company or an active holding, which are explained in more detail in their respective chapters.

However, the essential thing for the holding company to recognize is that there is a minimum business substrate that gives the right to apply the double taxation agreement or the European directive on parent companies and subsidiaries, even if the country of residence does not necessarily foresee it (for example, Paraguay).

In Cyprus, this requirement is met by having at least one office of your own with a trustee hired for around €350 per month.

Cyprus is ideal as a location for a holding asset manager, first of all because in that country dividends and a large part of the capital gains (excluding Forex operations) of Cypriot capital companies are not subject to the 12.5% tax on companies.

At the same time, the extensive network of double taxation agreements in Cyprus can be used to reduce possible withholding taxes on the different holdings.

For example, when distributing dividends from a Swiss or United States company to a Cypriot company, only 15% of withholdings are applied at source, while in the case of Switzerland the general withholding tax (without agreement) is 35% and in the U.S.A. 30%

On the other hand, the dividends distributed by a Cypriot company are completely tax-free there.

In our example, person C of Paraguay should manage their assets through holding D, since one cannot practically use double taxation agreements in Paraguay.

Finally, person C can also use holding D as an active holding. In the Swiss holding B this is not possible, given that the holding system only applies in the case of pure holding companies.

The Cyprus holding company D can, for example, invoice certain expenses to subsidiary A of Spain. For example, you could issue an invoice for administrative tasks to reduce the taxable benefits in Spain by €20,000. This lower benefit for the Spanish company would mean a greater profit for the Cypriot society, but would only cost the usual corporate tax of 12.5%, considerably less than the 25% tax of Spain.

Of course, when billing one’s own company there are many things to pay attention to: the rules in linked operations must be taken into account and everything has to happen at market prices.

What more can a holding company be used for?

A holding company does not only serve to collect business benefits in a fiscally optimal manner, but also to avoid taxes on the benefits derived from the sale of companies.

In our example, person C can sell his Spanish company A completely free of taxes. For example, the sales value of 1 million euros is transferred free of taxes to Swiss company B, and is distributed through company D of Cyprus duty-free to person C in Paraguay.

In practice, a pure holding can be used for both the reduction of withholding taxes in the distribution of dividends and for the tax-free collection of capital gains on the sale of companies.

In addition, holding companies that manage assets can optimize their holdings and securities fiscally, reducing the profits of the subsidiaries.

This can be achieved by charging management fees for administrative tasks, through loans from the holding company to the subsidiary with the corresponding interest payment (thus reducing benefits) or through the collection of intellectual property licenses.

However, the new fiscal regulations, mainly the OECD BEPS Project, establish a clear catalog of rules for these practices in order to hinder the aggressive avoidance of taxes.

So, with a holding, effectively two things are avoided:

1. In their country of residence, the partner does not directly pay taxes for capital income on dividend distribution.
2. In the absence of a double taxation agreement with the country of residence, the member is not subject to withholding taxes on dividend distribution.

A holding company is thus a kind of buffer between the individual and the operating company.

This buffer can often invest and treasure the money in a fiscally optimal way before proceeding with the distribution. In addition, the accumulated benefits can be reinvested or flow to projects of newly constituted subsidiaries through distribution or loans.

Many times a holding company alone is not enough to achieve the desired objectives. That’s when an intermediate holding is created, which can achieve the desired goal, for example, through a better double taxation agreement.

In the aforementioned example, person C could completely do without the intermediate holding B of Switzerland, given that the holding company D of Cyprus is already capable of collecting the dividends and capital gains derived from sales, without paying company taxes or making withholdings.

In that particular example, selling Spanish subsidiary A to the new holding company D would mean, however, that the surplus value of the sale would have fallen to holding company B in Switzerland. This would be free of taxes, but the benefit could only be distributed from the company with a high withholding tax of 35%.

If there are no reasonable possibilities to grant loans or to buy properties in Switzerland with the Swiss holding company, it is advisable to resort to the variant presented above of selling the company.

After all, the objective is always to reduce withholding taxes. These should be as low as possible in the final holding company or they would have to recover or at least compute through a double taxation agreement with the country of residence of the individual.

If the country of residence is a country of strong fiscal pressure, the most advisable in general is a national holding company due to the lower complexity. In this case, there are no withholding taxes on the distribution of dividends, but instead country taxes in regards to the income from capital. In the case of dividend distributions from a Swiss limited company with residence in Switzerland, these are much lower than the 35% withholding taxes for dividends flowing abroad.

In the case of residing in a country with a high tax burden, such as Germany, France or Spain, a foreign holding company offers practically no advantages beyond a possible reduction of withholding taxes for subsidiaries.

The network of double taxation agreements in these countries is already quite good and it is rarely necessary to optimize it.

Whoever plans to emigrate will not earn much by establishing a holding company abroad if they keep their address. This is because the exit tax also applies to foreign companies.

In any case, to avoid the exit tax the holdings must be maintained by an entity that belongs to itself, such as a trust or association.

To understand this better, let’s see another example.

Person C wants to expand a new business and in three years emigrate from Spain. The operational SL must continue in Spain after emigrating. After three years, the estimated value of the SL is 1 million euros.

Five possible scenarios:

1. Person C keeps the shares completely private and migrates to a country not belonging to the European Union, such as Paraguay. Upon emigrating, the exit tax is applied to the value of the company. Person C pays about €230,000 in taxes. Once in Paraguay, C must pay the withholding taxes at the full 19% on the collection of dividends from the Spanish SL because there are no double taxation agreements.
2. Person C keeps the shares completely private and migrates to a country not belonging to the European Union, such as Paraguay. The amount of the exit tax is calculated, but the payment is exonerated. Through a merger within the EU, the limited company can be merged, for example, with a Cypriot limited company in a fiscally neutral manner. After that, you can think about emigrating without having to worry about the tax for changing your address to a non-EU country. In the case of distribution of dividends of the Spanish SL, the person must pay taxes at source. But being a non-dom from Cyprus, dividends are not taxed.
3. Person C keeps the holdings with a Spanish holding company and emigrates to a country outside of the EU, such as Paraguay. The exit tax falls on the value of the holding company. If the subsidiary is sold to a fiscally optimized holding company, the benefit remains in the holding company.
4. Person C keeps the holdings with a Spanish holding company and emigrates to a country outside of the EU, such as Cyprus. The amount of the exit tax is calculated, but the payment is exonerated. The subsidiary can be sold to a new holding company in Cyprus practically free of taxes. Thanks to the European directive on parent companies and their subsidiaries, benefits can flow to Cyprus almost tax-free.
5. Person C represents an association or a trust that holds the shares in the operating subsidiary. Given that these belong to themselves, instead of to C, in the case of emigrating no tax is applied for a change of address, regardless of whether the person moves inside or outside the EU. Associations and trusts are generally treated as resident capital companies in relation to their taxation. If the subsidiary is transferred to a fiscally optimized holding company, the possible surplus value generated by the sale will have minimum taxation. Of course, what cannot be done with this association or trust is distribute dividends since these structures do not have partners; remember that they belong to themselves. Be that as it may, once abroad C may collect their tax-free money as a beneficiary of the trust.

Partnerships even allow small businesses to access very powerful but low-cost structures. If one maintains their residence in their country of origin, a non-profit or family trust may also be convenient, but these require more wealth and income due to the need for capital for their creation, and also due to operating expenses.

Austrian or Swiss associations can be founded with only two members and without the need to provide seed capital. Since Swiss associations are not registered, it is difficult to present the necessary documents to set up a subsidiary. That is why it is preferable to opt for doing it through the Austrian association, for which there is the possibility of online registration.

It is advisable to use an association as a holding company, especially when we simply want to hold shares, for example, to avoid the exit tax or to avoid problems during insolvency proceedings.

In this case, the associations would not receive dividends, they would simply keep the shares to sell them to the physical person as soon as possible (when they have moved to their chosen country).

The benefits that remain in the association can be paid to the directors of the association as salary or be invested in the objective of the association, which of course can coincide with the interests of the directors.

This does not require any type of bureaucracy for the association until the moment of the sale (which can often be processed for a symbolic value, since the profit of the sale is not taxed).

A trust is much more complicated in comparison and almost always requires the contribution of a high initial capital. A trust is worth more as a long-term solution in countries with strong fiscal pressure to achieve fiscally advantageous asset management and to pass on corporate shareholdings to the following generations.

The trust collects the profits of the intermediate holding companies or directly from the affiliated subsidiaries, thus increasing its own assets. Distributions can be made to the designated beneficiaries of the trust.

In countries with strong fiscal pressure, one must pay close attention when managing family trusts. In the first place, substantial control must be given in order to obtain advantages in taxation and in the protection of heritage.

After this, it is not so easy to sell business shares on your own account or dissolve the trust to have direct access to the company.

Those who live in Germany, Austria or Switzerland should resort as a rule to the local trusts of each country.

Anyone who lives abroad but intends to return to those countries may think of establishing a family trust in Liechtenstein. If they are properly constituted and structured, they are recognized and can offer enormous tax advantages, such as being subject to only 1% of the capital income tax.

With residence in the correct foreign country, assets can be transferred tax-free to the trust, which will then be irrevocably deposited there.

With this, control is transferred substantially – in general to a board consisting of family, good friends and an experienced trustee – but in return we obtain great fiscal advantages.

Tax Free Today is happy to help you in the establishment through partners with extensive experience.

The parent company and subsidiaries directive

We have already mentioned on several occasions the European Directive on parent and subsidiary companies. This provides that an EU subsidiary can distribute dividends to its parent company in the EU without withholding tax at source.

Here we do not have to take into account the possible double taxation agreements. Since its entry into force in 1990, it was amended several times and extended to all the new EU Member States plus Switzerland.

After the last modification of 2009, the minimum participation fee to apply this directive amounts to only 10%.

The subsidiary that distributes benefits must be a capital company subject to an unlimited tax obligation. The foreign owner of the holdings (parent company) must also present this legal form, have residence in an EU country and be subject there to a comparable corporation tax (no minimum amount).

The minimum share must amount to 10%. It is also a requirement that the share be direct; this also includes the holdings held through an actual establishment abroad.

The share must be kept for twelve months without interruption before the distribution of dividends without withholdings can proceed. Otherwise, the lower amounts of the double taxation agreement will apply.

The parent company must submit the application for tax exemption at source. In any case, it should be taken into consideration that when the exemption is resolved later, the amount paid is reimbursed. The power to decide and control is in the hands of the Federal Office of Finance as a creditor of reimbursements, which controls the parent company, the debtor of reimbursements.

We will not go into technical details here. One would only need to pay attention to the rules on treaty-shopping if the 10% minimum participation fee is met with a one-year holding period.

Treaty-shopping means that an intermediate holding is only created to take advantage of the double taxation agreements or the directive on parent companies and subsidiaries. Thus, dummy corporations are not enough to take advantage of this directive. As in double taxation agreements, there must be a real establishment and a trustee chairman in situ.

The best location for holding companies

Anyone who wants to set up a holding company has to be clear in the first place why they want it. Depending on that, there are different locations that are more or less convenient.

To choose the jurisdiction of the holding company, the following aspects should be taken into account:

A good holding location stands out for the following characteristics:

• Many and good, or at least convenient, double taxation agreements.
• Member of the EU in order to take advantage of the directive on parent companies and subsidiaries.
• Minimum participation share as small as possible.
• Tenure periods as short as possible.
• No taxation or reduced taxation of the typical earnings of a holding company.
• No withholding on the payment of dividends.
• Not subject to any regulations on controlled foreign companies (CFC-rules)

In the case of a final holding company the issue of withholding taxes is especially important if the partners live in low-tax countries. On the other hand, this is not as important in an intermediate holding company thanks to the existing double taxation agreements and the directive on parent companies and subsidiaries.

The countries that do not have a withholding tax within the EU are Cyprus, Malta, Estonia, England and, with restrictions, Ireland.

All the other countries in the EU could be interesting as intermediate holdings. The essential thing is that they have an advantageous double taxation agreement.

In the case of companies from non-EU countries, it is worth taking a look at the United Arab Emirates, Singapore and Mauritius.

Cyprus: Cyprus continues to be the best recommendation for a holding company, since it combines exemption from withholding taxes with fiscal freedom for added value from capital gains and dividends. With this, it is also ideal for asset management. The other benefits are taxed at less than 12.5% or, until the IP-Box expires in 2021, only 2.5%, provided that they have to do with intellectual property. Cyprus has many very good double taxation agreements and clear regulations on the business substrate. The requirements are to have a permanent establishment and a manager hired with a minimum salary of €350.

Malta: Given the complications of its tax refund system, Malta is no longer recommended for active companies. However, with no withholding taxes the country remains attractive as a pure holding site. All profits are taxed at 35%, of which, however, 30% is reimbursed. However, these are transferred to an individual or to an additional holding, which can have unpleasant tax consequences. In addition, the reimbursement takes several months. The regulations on business substrate are similar to those in Cyprus.

United Kingdom: Due to the imminent Brexit, it maybe advisable to wait. England does not retain withholding taxes, but with the possible departure from the EU, it would lose an important advantage by canceling the directive of parent companies and subsidiaries. Corporate taxes are relatively high (18%) if the holding company is to be actively used. It has a very attractive network of double taxation agreements, especially with its former colonies.

Ireland: Ireland is a classic holding site for many large companies. However, the exemption from withholding taxes only applies if the member is in a member country of the EU. Thus, the Irish holding is only recommended as a final holding company. But, with its many double taxation agreements and its corporate tax of 12.5%, Ireland scores high.

Estonia: The idea that Estonia has no withholding taxes is often misunderstood. Estonia has a deferred corporate tax with a tax of 20% on the distribution of dividends. This falls on all the operating profits of the company, including asset management. But if the Estonian company receives dividends from a subsidiary, there would not be operating profits. These dividends can be collected tax-free and transferred to members without withholding taxes. Whoever only wants to reinvest can do so tax-free within the Estonian company. Thanks to the simple management as e-resident since there is no requirement on the substance, this country is a real recommendation.  However, it should be taken into consideration that anti-treaty-shopping and similar rules are already really demanding for people to have an office in the country.

United Arab Emirates: Companies in the free zone have the possibility of taking advantage of a network of double taxation agreements very well negotiated by the UAE, which generally implies only 5% withholding taxes with most countries of the world. The profits of the holding company are also completely tax-free. Likewise, having a partnership enables members to have a residence visa. Apart from a standard physical establishment, it is not necessary to have much more business substrate.

Singapore: Companies in Singapore are required to have an administrator present with residence in Singapore. Although it is a rather premium variant, Singapore stands out for its many good double taxation agreements, its absence of withholding taxes and its reduced corporate tax of 12.5%.

Mauritius: Mauritius is on this list especially because of one country: India. Mauritius has by far the best double taxation agreement with India, making it a very popular investment vehicle in the subcontinent. But the other double taxation agreements and low corporate taxes of 15% (with possible reductions for income from abroad) can also be interesting.