Participation exemption
Encyclopedia
Participation exemption is a general term relating to an exemption from taxation for a shareholder
in a company
on dividend
s received, and potential capital gains arising on the sale of shares.
of shareholders.
In any accounting period
, a company may pay a form of corporate income tax on its taxable profit which reduces the amount of post-tax profit available for distribution by dividend to shareholders.
In the absence of a participation exemption, or other form of tax relief, shareholders may pay tax on the amount of dividend income received. This results in double taxation
as the dividend is paid out of taxed profits of the company.
A participation exemption will typically provide that certain types of dividends are not taxed in the hands of shareholders. In addition, many participation exemption regimes provide that capital gains on shares are not taxed as long as a specified proportion of the company's share capital
is held for a specified period.
A participation exemption may apply to qualifying shareholdings in overseas companies, domestic companies, or both.
location, although other factors such as the presence of a network of double taxation treaties are relevant.
Countries with a participation exemption include:
Some systems (e.g., The Netherlands) provide that dividends from a subsidiary meeting the minimum ownership requirements is wholly exempt from taxation. Some systems provide a partial exemption. A few extend this treatment to interest or other forms of participation.
Most systems require that the parent company must own some significant portion (e.g., 25 percent) of the equity of the subsidiary in order to qualify for participation exemption. In addition, most systems require that this ownership either have already continued for a minimum period at the time the income is received or continue beyond the date of such receipt until the minimum period is reached. The minimum ownership period is often one year.
A few systems require an advance ruling by tax authorities in order to benefit from participation exemption. This requirement, however, is becoming less prevalent.
The United Kingdom
has a substantial shareholding exemption in relation to capital gains on qualifying shares. However, dividends received from overseas companies are taxed, although credit may be available for any withholding tax
or underlying tax suffered on a dividend.
Shareholder
A shareholder or stockholder is an individual or institution that legally owns one or more shares of stock in a public or private corporation. Shareholders own the stock, but not the corporation itself ....
in a company
Company
A company is a form of business organization. It is an association or collection of individual real persons and/or other companies, who each provide some form of capital. This group has a common purpose or focus and an aim of gaining profits. This collection, group or association of persons can be...
on dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
s received, and potential capital gains arising on the sale of shares.
Background
The justification for a participation exemption is to eliminate double taxationDouble taxation
Double taxation is the systematic imposition of two or more taxes on the same income , asset , or financial transaction . It refers to taxation by two or more countries of the same income, asset or transaction, for example income paid by an entity of one country to a resident of a different country...
of shareholders.
In any accounting period
Accounting period
An accounting period is a period with reference to which United Kingdom corporation tax is charged. It helps dictate when tax is paid on income and gains...
, a company may pay a form of corporate income tax on its taxable profit which reduces the amount of post-tax profit available for distribution by dividend to shareholders.
In the absence of a participation exemption, or other form of tax relief, shareholders may pay tax on the amount of dividend income received. This results in double taxation
Double taxation
Double taxation is the systematic imposition of two or more taxes on the same income , asset , or financial transaction . It refers to taxation by two or more countries of the same income, asset or transaction, for example income paid by an entity of one country to a resident of a different country...
as the dividend is paid out of taxed profits of the company.
A participation exemption will typically provide that certain types of dividends are not taxed in the hands of shareholders. In addition, many participation exemption regimes provide that capital gains on shares are not taxed as long as a specified proportion of the company's share capital
Share capital
Share capital or issued capital or capital stock refers to the portion of a company's equity that has been obtained by trading stock to a shareholder for cash or an equivalent item of capital value...
is held for a specified period.
A participation exemption may apply to qualifying shareholdings in overseas companies, domestic companies, or both.
Participation exemption regimes
The existence of a participation exemption under a local tax regime enhances a jurisdiction's attractiveness as a holding companyHolding company
A holding company is a company or firm that owns other companies' outstanding stock. It usually refers to a company which does not produce goods or services itself; rather, its purpose is to own shares of other companies. Holding companies allow the reduction of risk for the owners and can allow...
location, although other factors such as the presence of a network of double taxation treaties are relevant.
Countries with a participation exemption include:
- AustriaAustriaAustria , officially the Republic of Austria , is a landlocked country of roughly 8.4 million people in Central Europe. It is bordered by the Czech Republic and Germany to the north, Slovakia and Hungary to the east, Slovenia and Italy to the south, and Switzerland and Liechtenstein to the...
- BelgiumBelgiumBelgium , officially the Kingdom of Belgium, is a federal state in Western Europe. It is a founding member of the European Union and hosts the EU's headquarters, and those of several other major international organisations such as NATO.Belgium is also a member of, or affiliated to, many...
- LuxembourgLuxembourgLuxembourg , officially the Grand Duchy of Luxembourg , is a landlocked country in western Europe, bordered by Belgium, France, and Germany. It has two principal regions: the Oesling in the North as part of the Ardennes massif, and the Gutland in the south...
- NetherlandsNetherlandsThe Netherlands is a constituent country of the Kingdom of the Netherlands, located mainly in North-West Europe and with several islands in the Caribbean. Mainland Netherlands borders the North Sea to the north and west, Belgium to the south, and Germany to the east, and shares maritime borders...
- NorwayNorwayNorway , officially the Kingdom of Norway, is a Nordic unitary constitutional monarchy whose territory comprises the western portion of the Scandinavian Peninsula, Jan Mayen, and the Arctic archipelago of Svalbard and Bouvet Island. Norway has a total area of and a population of about 4.9 million...
- ItalyItalyItaly , officially the Italian Republic languages]] under the European Charter for Regional or Minority Languages. In each of these, Italy's official name is as follows:;;;;;;;;), is a unitary parliamentary republic in South-Central Europe. To the north it borders France, Switzerland, Austria and...
- SwedenSwedenSweden , officially the Kingdom of Sweden , is a Nordic country on the Scandinavian Peninsula in Northern Europe. Sweden borders with Norway and Finland and is connected to Denmark by a bridge-tunnel across the Öresund....
Mechanism
Participation exemptions generally limit taxation of a parent company (corporation) in its country of organization on income from subsidiaries. This reduction of taxation generally has some limitations as to the nature of income on which is tax is reduced and the minimum level and period of ownership of the subsidiary. Participation exemptions are only relevant in countries which tax companies on their income from sources outside the country.Some systems (e.g., The Netherlands) provide that dividends from a subsidiary meeting the minimum ownership requirements is wholly exempt from taxation. Some systems provide a partial exemption. A few extend this treatment to interest or other forms of participation.
Most systems require that the parent company must own some significant portion (e.g., 25 percent) of the equity of the subsidiary in order to qualify for participation exemption. In addition, most systems require that this ownership either have already continued for a minimum period at the time the income is received or continue beyond the date of such receipt until the minimum period is reached. The minimum ownership period is often one year.
A few systems require an advance ruling by tax authorities in order to benefit from participation exemption. This requirement, however, is becoming less prevalent.
Alternatives to participation exemption
Some jurisdictions offer alternative forms of tax relief which are designed to achieve similar results to a participation exemption.The United Kingdom
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
has a substantial shareholding exemption in relation to capital gains on qualifying shares. However, dividends received from overseas companies are taxed, although credit may be available for any withholding tax
Withholding tax
Withholding tax, also called retention tax, is a government requirement for the payer of an item of income to withhold or deduct tax from the payment, and pay that tax to the government. In most jurisdictions, withholding tax applies to employment income. Many jurisdictions also require...
or underlying tax suffered on a dividend.