In December 2008 Jamie Hooper prepared a detailed summary on the liability to tax, choice of trading entity, employee taxes and value added tax implications for a foreign investor trading in the UK including relevant non tax issues including audit and employment regulations.
We are now able to publish this report.
It is also important to confirm whether there are any regulatory requirements specific to the UK business and whether the regulatory body of your proposed activity requires you to trade from a prescribed vehicle, for example a limited company.
The information is correct at December 2008.
Our report includes the following abbreviations:
|UK||United Kingdom, comprising the territories of England, Wales, Scotland and Northern Ireland|
|US||United States of America|
|HMRC||HM Revenue & Customs|
|GAAP & IAS||‘Generally Accepted Accounting Principals’ & ‘International Accounting Standards’|
Use of the report
Hooper & Co (including its partners, employees, agents subcontractors and employees) accepts no responsibility and shall have no liability in contract, tort or otherwise to any party in relation to the contents of this report. Any use of this report is entirely at their own risk.
2 Taxable presence
A foreign business operating in the UK does not automatically create a taxable presence in the UK.
In order to fall within the charge to UK corporation tax an overseas entity will need to be trading in the UK through a permanent establishment.
There is a distinction between trading ‘with‘ the UK and trading ‘in‘ the UK. A company which is trading ‘with‘ customers in the UK is only likely to create a taxable presence in the UK if it also fulfils the relevant functions detailed below. A company merely purchasing from or selling to UK customers is unlikely to create a taxable presence through these activities but would need to characterised as trading ‘in‘ the UK to become taxable here through the creation of a permanent establishment.
A non-resident has a permanent establishment in the UK if:
- it has a fixed place of business here through which the business of the company is wholly or partly carried on, or
- an agent acting on behalf of the company has and habitually exercises here authority to do business on behalf of the company (as long as that agent is not of independent status acting in the ordinary course of his business). It is therefore important to review contractual capacity in cases where sale are made by UK based agents
Fixed place of business through which the business is carried on
If there is no business being undertaken though a fixed place in the UK then no permanent establishment can exist. It is therefore important to determine where the business is carried on.
Case law establishes that simply seeking orders within the UK (directly or indirectly) is not by itself evidence of trading in the UK. In Grainger v Gough it was held that trading with a country through seeking orders there is not the same as trading in that country:
In the first place, I think there is a broad distinction between trading with a country, and carrying on a trade within a country. Many merchants and manufacturers export their goods to all parts of the world, yet I do not suppose anyone would dream of Saying that they exercise or carry on their trade in every country in which their goods find customers … If all that a merchant does in any particular country is to solicit orders, I do not think he can reasonably be said to exercise or carry on his trade in that country
However, even if contracts are not concluded in the UK, the trade may be carried on in the UK. Whilst the place where contracts are concluded is important, it is not decisive. In the Court of Appeal in F L Smidth & Co v F Greenwood it was held (without subsequent objection from the House of Lords) that
There are indications in the case cited and other cases that it is sufficient to consider only where it is that the sale contracts are made which result in a profit. It is obviously a very important element in the enquiry, and, if it is the only element, the assessments are clearly bad. The contracts in this case were made abroad. But I am not prepared to hold that this test is decisive. I can imagine cases where the contract of re-sale is made abroad, and yet the manufacture of the goods, some negotiation of the terms, and complete execution of the contract take place here under such circumstances that the trade was in truth exercised here.
In conclusion, the business will be carried on through the fixed place in the UK if it is the location where “the operations take place from which the profits in substance arise” (L Smidth & Co v F Greenwood).
There is unlikely to be a business carried on “in” the UK if the activities are restricted to
- taking orders from UK customers
- delivering goods to UK customers
- purchasing goods from UK suppliers
This is also reflected through the definition of “preparatory and auxiliary” activities (see below).
However, there is no requirement that contracts actually be concluded in the UK in order to the business to be carried on “in” the UK.The domestic law definition goes on to give some non-exhaustive examples of places of business that are deemed to be ‘fixed places of business’ such as:
- a place of management,
- a branch,
- an office,
- a factory,
- a workshop,
- an installation or structure for the exploration of natural resources,
- a mine, an oil or gas well, a quarry or any other place of extraction of natural resources,
- a building site or construction or installation project.
The place of business does not have to be rented or owned by the non-resident company itself, but simply has to be available for use by its employees
The personnel carrying on the business through the fixed place can be
(a) employees of the non-resident company or
(b) contractors who are engaged by the non-resident company
Either would have the required capacity to carry on the business of the non-resident
In order that a non-resident company has a “fixed” place of business, it must undertake activities through the same place for a period of time. A non-resident company will not generally have a permanent establishment if it merely undertakes a single transaction from a particular location.
Automatic equipment may be located in another company’s premises, and operated and maintained by their employees. If the non-resident company continues to receive all of the income from the equipment, a permanent establishment may nonetheless exist because the equipment is still operated and maintained “for its own account”
A permanent establishment may also exist in the UK if there is a “dependent agent” in the UK. This is defined as “an agent acting on behalf of the company has and habitually exercises there authority to do business on behalf of the company”.
The authority of the agent to conclude contracts may be written, verbal or implied (ie it is implicit by virtue of the enterprise taking no active involvement in the negotiation or conclusion of contracts).
However, this specifically refers to agents who conclude contracts with customers. Contracts concluded for the purposes of establishing the business in the UK (for instance the rental agreement to obtain premises) will not fall within this definition.
It is necessary that the agent “habitually” concludes contracts on behalf of the non-resident company. If occasional contracts are concluded, then this may not give rise to a permanent establishment, as it would not have the necessary degree of permanence.
An agent will be treated as concluding contracts even if he does not actually sign the contract. The negotiation and agreement of key contractual terms will constitute “conclusion”.
Some of the UK’s older DTAs contain a different definition of dependent agent, which requires that the agent “negotiates and concludes” the contract – conclusion of a contract in this case would not include the negotiation as it is separately identified.
This should be contrasted with the situation where some terms of a contract are negotiated in the UK, but the majority of the contractual terms are negotiated outside the UK. Employees of a non-resident company can attend occasional meetings in the UK to discuss contractual terms without necessarily creating a permanent establishment in the UK.
An independent agent, such as a broker or general commission agent cannot constitute a permanent establishment of a non-resident enterprise provided he is independent of that enterprise, both legally and economically, and acts for the non-resident enterprise in the normal course of business.
Preparatory or auxiliary
There is an exception to the permanent establishment rule if the activities performed in the UK are preparatory or auxiliary in character, commonly referred to as a “representative office”.
Examples of activities which may be preparatory and auxiliary include:
(a) preparing company management profiles
(b) maintaining industry information databases
(c) assisting with financial analysis
(d) monitoring industries/companies
(e) researching market data
(f) providing information and analysis
(g) maintaining client contact database (addresses, profiles etc)
It is important to consider whether the activities undertaken in the UK are preparatory and auxiliary in the context of the company as a whole. Where, for example, the company’s business is to provide market research data to its customers then undertaking market research in the UK would not be preparatory and auxiliary
3 Branch or subsidiary?
Having concluded that a taxable presence has been created in the UK there are a number of trading vehicles in which to choose to operate from including a branch, private/public limited and unlimited companies and the relatively new European public limited company, the Societas Europaea.
Which vehicle is most appropriate for you will depend on a number of factors including the tax regime in the country of residence of the parent company, and the availability of tax treaties between the UK, and the countries of residence of other group companies with which the UK will be transacting.
The following table compares the key aspects of the two most common UK trading mediums, a branch and the private limited company.
It should be noted that a UK limited company can also be treated as a branch for US tax purposes through the ‘check the box’ election.
The follow table illustrates the key tax and legal differences between branches and subsidiaries.
|UK Subsidiary||UK Branch of an Overseas Company|
|Separate legal personality.||No separate legal personality. Legally part of the overseas company.|
|Required to file annual financial statements with the Registrar of Companies for public inspection. Financial statements may require a UK audit.Copies to be filed with HMRC for tax purposes.||Branch financial statements of the local trade are required to be filed for tax purposes. A UK audit is not required.Financial statements of the overseas company of which it is part must be filed with Registrar of Companies for public inspection 1.|
|Subject to UK corporation tax on worldwide profits.||Subject to UK corporation tax on the activities carried on in the UK branch.|
|Profits are not subject to tax in the hands of an overseas parent company until distributed by way of dividend2. Relief should be available to the parent company for UK tax suffered on the profits out of which the dividends are paid.||The worldwide profits of the overseas company (including the UK branch profits) are subject to tax in the hands of the overseas company. Relief should be available to the overseas company for UK tax suffered on the branch profits.|
|Deductions against UK taxable profits should be available for arm’s length interest and royalty payments made by the subsidiary to an overseas parent company.||Interest and royalty payments made by the branch to the overseas company would be not deductible against the UK taxable profits of the branch.|
|Tax losses can be carried forward and set against future profits of the company or be offset against taxable profits of other UK companies within the same group.||Tax losses can be carried forward and set against future profits of the branch or to be offset against taxable profits of other UK companies within the same group. Subject to local tax law, branch losses may be available for offset against the profits of the overseas company but this may effect loss relief available in the UK.|
|Exit can be achieved by overseas company disposing of the shares in the subsidiary. No UK capital gains tax should arise.||As a branch does not have a separate legal personality it cannot be disposed of. Instead, exit would be achieved by disposing of each of the individual branch assets. UK capital gains tax may arise on the disposal of such assets.|
|Closure requires a formal winding up procedure or striking off or the appointment of a liquidator.||Closure is automatic on the cessation of trade. No formal procedure is required.|
|UK stamp duty may arise on the issue or transfer of shares in the UK subsidiary. Stamp duty or stamp duty land tax may arise on the sale of individual company assets.||No UK stamp duty is payable on the contribution of capital to a UK branch. Stamp duty or stamp duty land tax may arise on the sale of individual branch assets.|
|Transfer pricing rules will apply to all transactions between related parties unless the group is small or medium size.||Transfer pricing rules will apply to all transactions between related parties. Profits are attributable to the branch as if it were a separate company.|
|All goods and services supplied may be subject to UK VAT, subject to the registration limit or voluntary registration, including supplies between the subsidiary and parent company.||Goods and services supplied between branch and parent are ignored for UK VAT purposes. UK VAT may apply to external sales subject to the registration limit or voluntary registration.|
1If the overseas company, of which the branch is part of, does not prepare local financial statements, in its territory of incorporation, then financial statements must be prepared for it in accordance with UK GAAP or IAS and will be made available for public inspection in the UK.
2Subject to US ‘check the box’ election.
4 Company residence
In general terms, a company is treated as resident in the UK for tax purposes if:
- it is incorporated in the UK, or
- the central management and control of its business is exercised in the UK.
The definition of central management and control in the UK is determined by case law, it is not defined in statue. HMRC recognises that a company’s central management and control is a question of fact which refers to the highest level of control of a business and the place where the strategic management of the entity is exercised.
It is possible that a company may be regarded as resident in its country of incorporation but also resident in the country in which its management and control is exercised. In this instance you must look at the availability of a “tie-breaker” clause in the Double Taxation Agreement (“DTA”) between the two countries to determine where the company will be deemed to be tax resident.
Tax authorities in many EU countries will deem a company to be tax resident in the place where “effective” management and control is exercised, a definition not recognised in the UK. There is less emphasis specifically on the actions of shareholders and directors and a greater focus on where the management of the company’s business takes place. For practical purposes the key points above apply to both definitions.
You may therefore wish to consider whether you would prefer a company resident outside the UK for legal or regulatory purposes but maintain central management and control in the UK to be UK resident for tax purposes.
You have confirmed that central management and control is likely to take place [in the UK and therefore residence is unlikely to be an issue /outside the UK.][JLH2]
Company A is large manufacturing business based in Germany. The company opens a manufacturing facility in the UK and incorporates a UK company to hold the investment.
The board of the UK company are all UK resident but day to day operation of the manufacturing plant is overseen by the parent company in Germany.
The UK would regard the company as UK resident by virtue of incorporation. Germany may regard the company as German resident buy virtue of effective management from Germany.
The double tax agreement between the UK and Germany assigns taxing rights to the country with effective management and control and therefore even though the company is UK resident and the manufacturing plant is in the UK, profits will be taxable in Germany.
The following sets out a summary of the factors that would be taken into account when seeking to ensure that a company is regarded as a UK resident company under UK domestic tax law.
Management and control of the company
Directors determine the planning and policy decisions and this is evidenced.
Board of Directors
– appointment of officers of the company
– approval of the Financial Statements of the company
– dividend policy of the company
– compliance with relevant overseas statutory requirements
– approval of annual budgets, profit forecasts, cash flow forecasts and similar projections
– tax matters
– changes in capital structure
– funding of the company and arranging financial facilities pricing policy
– marketing policy
– accommodation facilities
– purchasing policy
– capital expenditure
– pension policies
– employee relations
– product service lines
– management changes
– major new capital projects
– annual budgets and all forecasts, profit forecasts, cash flow forecasts
– operating reports of branches and subsidiaries
– significant changes in marketing strategy, pension policies, employee relations, product lines of branches/subsidiaries
– have been resident within the UK for a reasonable length of time
– have a contract of employment detailing their duties and responsibilities
– were engaged in similar work prior to becoming a director of this company
– receive a realistic salary for their duties and responsibilities
Place of board meetings
5 Tax compliance
Tax returns and the payment of tax
UK resident companies and UK branches of foreign companies are required to file a UK corporation tax return, commonly referred to as a form CT600. The return details the companies liability to corporation tax, or losses to carry forward against future profits or surrender for group relief.
Corporation tax returns are required to be filed for each period for which financial statements are prepared. Where financial statements cover a period in excess of 12 months, returns must be completed for each 12 months period or part thereof. For example, an 18 months period of account, (the maximum period for which a company can draw up financial statements) would comprise two tax returns for 12 and 6 months respectively.
Corporation tax returns are due to be filed 12 months from the end of the period of account. In the above example both returns would be due 30 months from the start of the period of account. Automatic penalties are applied for late filling. Branches of an overseas company receive a one month extension to this deadline to allow for the filing of the overseas parent company financial statements.
A Corporation tax return must include a declaration by the person making the return, that the return is to the best of their knowledge complete and correct.
Corporation tax is payable by reference to a corporation tax return and not a period of account. For “small” companies (see below) tax is normally payable 9 months and 1 day from the end of a return period.
In our example, corporation tax would be due 21 months and 27 months after the start of the period of account.
In calculating the tax liability for a multiple return period trading profits are prorated between tax returns for long periods of account, i.e. 12/18ths and 6/18ths, however, each return is treated as independent for the purposes of tax allowances and the recognition of capital gains. This means that the payment of tax may not be a simply prorata between each return. In our example, a large capital gain arising in month 14 would be reported in the tax return for the 6 month period and any tax on the gain would be due in full 27 months after the start of the period of account, the due date for that return.
Corporation tax payable by advance instalments
‘Large’ companies are required to pay their corporation tax liabilities by instalment. Instalment payments normally result in an acceleration of tax payments on average ten months earlier than for “small” companies.
Instalment payment are quantified based on the anticipated liability for the year in question, not the liability of the previous year.
Instalment Payments (IPs) only apply to companies which are “large”. Where a company is not large, it will continue to be liable to pay corporation tax nine months and one day after the end of the relevant accounting period.
A company will be “large” for the purposes of IPs if it has taxable profits over £1,500,000 (reduced pro rata for periods shorter than 12 months). This limit is also reduced if there are worldwide associated trading companies at any time during the accounting period. Thus, for example, a member of a group of ten trading companies will have to pay in instalments if its taxable profits exceed £150,000 in a 12 accounting period.
In some circumstances, individual members of bigger groups could be required to pay tax by instalment even though their tax liabilities are expected to be small. To assist with administration, instalment payments do not apply where a company’s tax liability does not exceed £10,000. Again, this amount is proportionately reduced where the accounting period is less than 12 months.
A company is not required to make instalment payments for an accounting period if the taxable profits for the period do not exceed £10 million and it was not large in the previous 12 months (unless by virtue of the £10 million let out).
Where there are associated companies, the £10 million threshold is reduced, using the total number of associates at the end of the previous accounting period.
The four instalments are payable at the following times after the commencement of the accounting period:
|Your year end||[31 December 2007]|
|Your payment dates|
|Six months and 13 days||[14 July 2007]|
|Nine months and 13 days||[14 October 2007]|
|12 months and 13 days (14 days after the year end)||[14 January 2008]|
|15 months and 13 days (three months and 14 days after the year end)||[14 April 2008]|
There are special rules for periods shorter than a year.
A company is required to estimate its tax liability for the current accounting period and make instalment payments based on that estimate. If the estimate changes, the company will need to recalculate its instalment payments based on the revised figures to ensure interest and penalties do not arise for underpayment of tax.
For a 12-month accounting period each payment should be one quarter of the anticipated corporation tax liability for the year.
Companies need to calculate payments quickly, as interest and possibly penalties are charged on late paid tax. Any underpayments should be corrected at the earliest opportunity and this can be achieved at any time by making a “top-up” payment.
If it is discovered that too much tax has been paid by instalments, a claim for repayment can be made.
Groups of companies can surrender overpayments between group members (ie offsetting amounts overpaid by one company against amounts underpaid by another company in the same group). There are also Group Payments Arrangements that allow groups to make instalment payments on a group-wide basis, rather than company by company. Such arrangements can be utilised to minimise exposure to interest charges on late paid tax and record keeping requirements.
The rates are summaries as follows:
|Full rate of corporation tax(before 31 March 2008)||30%|
|Full rate of corporation tax(after 31 March 2008)||28%|
|Small companies’ rate(before 31 March 2008)||20%|
|Small companies’ rate(after 31 March 2008)||21%|
|Small companies’ rate(after 31 March 2009)||22%|
|Lower limit for marginal small companies’ rate||£300,000|
|Upper limit for marginal small companies’ rate||£1,500,000|
Companies should keep adequate records regarding their calculations of the instalments due (including estimated profits) in case of enquiries being instigated.
Interest is charged on late payments at a rate higher than that received on credit interest on overpayments. Interest paid is deductible for tax purposes in the year of payment and interest earnt is chargeable to corporation tax in the year of receipt. Where a company “deliberately or recklessly” fails to pay an instalment payment as required, a penalty can be levied of up to twice the amount of interest due on the late payment.
UK corporate tax rates
The UK corporate tax system is based on a single rate applied to all chargeable profits. The rate is determined by the level of total profits.
The full rate of corporation tax is applied to all profits where the chargeable amount exceeds the upper limit.
The small companies rate is applied to all profits where the chargeable amount is below the lower limit.
Profits falling within the upper and lower limits are subject to the full rate of corporation tax less a calculated deduction, the effect of which is to taper the effective tax rate from the lower rate to the full rate as profits approach the upper limit.
The limits are pro-rated for tax return periods of less than 12 months and apportioned between associated companies, reducing any advantage of the small company rate for large groups.
Company A has chargeable profits of £130,000 for the 6 month period to 31 March 2009. Company A has 5 associated companies.
The upper rate of £1,500,000 is reduced by 6/12 for the short accounting period = £750,000.
The reduced upper limit is apportioned between the 6 companies (5 + self) = £125,000.
As the profits chargeable are greater than the restricted upper limit tax is chargeable at the full rate of 30% = £39,000.
If the company was not required to pay by instalment the tax would be due in full on 1 October 2007.
If the company was required to pay by instalment the tax would be due:
- 14th January 2007 £19,500
- 14th April 2007 £19,500.
You will note that there are only two instalments. This is because, even though instalments are due 3, 9, 12 and 15 after the start of the period, all tax must be paid within 3 months from the end of the period. The total liability is divided between the number of instalments between these two dates, in this case two being 6 and 9 months after the start of the period.
Calculation of profits chargeable to corporation tax
Profits per the financial statements, provided they are prepared in accordance with UK GAAP or IAS form the basis of UK tax computations. These profits are adjusted for expenses and allowances either not allowed as a deduction for tax purposes or not reported in the financial statements. Non deductible expenses include specific items such as entertainment of customers and general expenses not directly applied for the generation of trading profits including the costs of incorporation of a company and associated legal fees.
Depreciation is not an allowable deduction for tax purposes. Instead an annual writing down allowance is given for the purchase of qualifying items, such as plant and machinery, at a rate determined by the HMRC each year. The annual rate of allowances range from 6% to 100% subject to the type of asset acquired and the date of purchase.
Research and Development allowances
Expenditure on R&D that meets strict criteria is entitled o additional allowances, this time dependant on the size of the company incurring the expenditure.
Claims are made by reference to a company’s accounting period and must be for qualifying expenditure in excess of £10,000. There is no upper limit on the amount of the claim.
Small companies may deduct an additional 50% of R&D expenditure from chargeable profits or elect for a cash credit from HMRC where they have losses in the accounting period. The cash credit is equal to £24 for every £100 of expenditure.
Large companies may deduct an additional 25% of R&D expenditure from chargeable profits but can not elect for a cash credit.
6 Transfer pricing
Transfer pricing refers to the pricing of goods, services, funds and tangible and intangible assets transferred within an organisation, between internal divisions or to cross border associates. Since the prices are set within the organisation, they are deemed to be “controlled” i.e. the typical market mechanisms that establish prices for similar transactions between third parties may not apply.
The transfer prices selected will affect the allocation of the organisation’s total profit among the different parts of the group. This has provided scope in the past for multi-national entities to manipulate internal pricing mechanisms setting transfer prices on cross-border transactions in a way to reduce their taxable profits in high tax jurisdictions and to increase their taxable profits in lower tax jurisdictions. These practices created major concerns for tax authorities, leading to a rise in transfer pricing regulations and enforcement, and making transfer pricing a major tax compliance issue for multi-national companies.
There is general common consent between tax and other fiscal authorities that to achieve a fair apportionment of taxable profits across international borders, transactions between connected parties should be treated for tax purposes by applying the amount of profit that would have arisen, if the same transaction had been carried out by unconnected parties. This pricing strategy, which is expected to be observed between independent trading partners, is referred to as the “arm’s length principle”.
Transfer pricing rules and guidelines, in the UK and elsewhere, therefore require that this principle is recognised when calculating taxable profits.
Exemption for small and medium sized enterprises
Small enterprises are those with fewer than 50 employees and either turnover or gross assets not exceeding €10m. Medium-sized enterprises are ones that are not small but have fewer than 250 employees and either turnover not exceeding €50m or gross assets of less than €43m. It is important to note that for these purposes the employees, turnover and assets of all the connected parties, UK and otherwise, will be taken into account. The definition of connected parties is widely defined for the purposes of applying the small and medium sized thresholds.
The transfer pricing rules will not generally apply to small enterprises, although they will apply where the transaction takes place with an entity in a jurisdiction that does not have a suitable tax treaty with the UK.
The rules also give HM Revenue & Customs (HMRC) the power to enquire and make transfer pricing adjustments on medium-sized enterprises in “exceptional circumstances”.
Please note that the small and medium-sized exemption applies only within the UK rules, and an overseas counterparty to a transaction may well not benefit from a similar exemption in their own country.
Exemption for dormant companies
This is not a blanket exemption, rather it applies to transactions where the dormant company is “potentially advantaged”. So for instance a loan balance where the debtor is an active company and the creditor a dormant company would not be exempt because the active company is the party that is potentially advantaged.
Also the exemption only applies to dormant companies that were dormant throughout the pre-qualifying period, being (in general) the period ending 31 March 2004. Companies that become dormant after this date would not fall within the exemption.
The obligation to maintain appropriate documentation arises from the requirement under self assessment to keep and preserve “all such records as may be requisite for the purposes of enabling” the taxpayer “to make and deliver a correct and complete return”.
HMRC has made it clear that the documentation they will expect taxpayers to maintain to support their transfer pricing policies will be that which any “prudent businessman” would keep for transactions of a similar level of importance and complexity.
Guidance on how HMRC interpret the record-keeping requirements of the self assessment provisions for the purposes of the transfer pricing legislation is available. In the event of a transfer pricing adjustment, HMRC identifies the following classes of records as being relevant in considering whether a penalty should be applied:
- primary accounting records
- tax adjustment records
- records of transactions with associated businesses.
A key feature of the rules is that evidence to demonstrate an arm’s length result need only be produced upon HMRC request. Thus it is likely that taxpayers will not need to find suitable third party comparables when filing their tax return provided that they have good grounds for considering that the tax returns are being prepared on an arm’s length basis.
Once again, the rules differ in other jurisdictions, and it is worth commenting that many jurisdictions do have a requirement to prepare third party comparables when filing their tax returns or even at an earlier point in time, for instance contemporaneous with the intra-group transactions.
A tax return will be incorrect unless transactions reflected within it reflect arm’s length prices. It is necessary to determine the correct arm’s length price for each inter-company transaction prior to the filing date, for each separate tax return.
As noted above, evidence to demonstrate an arm’s length result need only be produced upon HMRC request (although best practice is that it should be available at the time the return is submitted as it gives the taxpayer the evidence needed to know that its tax return is prepared on the arm’s length basis). Such requests are however, frequently accompanied by deadlines such as within thirty days of the enquiry letter.
In practice, therefore, it is advisable to maintain documentation that is contemporaneous with the transaction concerned.
HMRC enquiry into a company’s transfer pricing
HMRC have given some pointers towards the factors that will be considered when deciding whether to make an enquiry into a company’s transfer pricing arrangements. These include:
- where the amount of tax at stake is large
- where there is a significant difference in the marginal tax rates borne by the related parties that are transacting, e.g. where one of the companies is loss making or where one of the transacting parties is located in a low tax jurisdiction.
- In general, the more that a taxpayer’s revenue or costs derive from related party transactions, the more likely it is to be selected for an enquiry
The general self assessment rules relating to the imposition of penalties for incorrect returns applies to errors in a return that relate to transfer pricing. Where a return is incorrect due to “fraud or neglect”, this can mean a penalty of up to 100% of any further tax payment (which may be nil if the taxpayers can relieve the additional tax with brought forward or group issues).
HMRC issued guidance on the circumstances in which they will apply the penalty provisions in December 1998. The guidance specifies that penalties will not be imposed where the taxpayer has made an “honest and reasonable” attempt to comply with the arm’s length standard. The examples that HMRC use in the guidance indicates that this would involve finding third party comparables and “seeking professional help where they know they need it”.
In addition to the tax-geared penalty, HMRC may impose a fixed penalty of £3,000 a year for each taxpayer, for failure to maintain adequate transfer pricing documentation. Although the exemption for small and medium sized enterprises avoids the imposition of a tax-geared penalty, the fixed penalty for inadequate documentation may still apply. As the UK structure of limitations is six years, taxpayers may suffer penalties and interest on a multiple year basis.
Advance Pricing Agreement (APA)
This arrangement will enable UK companies to agree in advance with HMRC (and potentially other tax authorities as well) that their transfer prices are acceptable for a pre-determined period of time. HMRC guidance, however, makes it clear that APAs are designed to assist taxpayers with “complex” issues – generally only where there is significant doubt as to the manner in which the arm’s length principle should be applied or where there is difficulty in establishing a market comparable. APAs are therefore unlikely to be of everyday practical use to the average inbound or outbound investor.
Similar options for the taxpayer include an Advance Thin Capitalisation Agreement and a “Code of Practise 10” post transaction ruling, typically needed for simple costs plus service arrangements and interest deduction claims.
Pricing Methods Recognised by HMRC
HMRC recognises the five transfer pricing methods outlined in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, namely:
- comparable uncontrolled price
- cost plus method
- resale price method
- transactional net margin method
- profit split
It is also prepared to recognise other methods where these reflect the typical commercial arrangements within an industry.
The Pricing of Typical Inter-Company Transactions
A Inter-Company Transfers of Product
In order to determine which of the five transfer pricing methods recognised by HMRC apply to the pricing of inter-company transactions of products it is necessary to undertake a functional analysis of the parties involved. A functional analysis involves identifying:
- the functions performed by each party to the transaction
- the assets owned and brought to bear by each of the parties – these may not necessarily be tangible assets but can include intangible asserts such as brands, customer lists, patented and un-patented technical know how etc
- the risks borne by each party e.g. credit risk, market risk and stock obsolescence risk to name but a few.
On the back of the functional analysis an appropriate transfer pricing policy can be designed by applying one of the five recognised OECD methods.
It is important to note that whilst two businesses may nominally appear similar e.g. both businesses may be, say, manufacturers, the pricing method applied to them may be very different if they have different function, risk and assets profiles. For example, a manufacturing company operating on a contract, low risk basis, without any intellectual property (IP), may be remunerated on a cost plus basis whilst a high risk bearing, function rich, IP owning manufacturer may use the profit split approach. A similar range of pricing mechanisms may apply to distribution businesses. For example, a business that does not contract with customers, does not own any warehouse facilities and only provides information to potential customers may be remunerated on a cost plus basis, whereas a distributor with a warehouse, bearing all the associated risks of contracting with customers with responsibility to develop the local market may be remunerated on the basis of a gross margin.
The key part of defending the selected policy is to set out the evidence of why the policy meets the arm’s length standard. Depending on the methods applied this could be in the form of evidence of transactions undertaken by the group with third parties or could be evidence gathered as part of a benchmarking study. Facts and circumstances of each case will determine the exact information needed.
B Management Services
The typical way to remunerate the provision of inter-company management services is to use the cost plus methodology. In the absence of any comparable transaction with a third party, UK groups usually charge the actual cost of providing the service (including a fair apportionment of the relevant overheads), plus an arm’s length profit mark-up, to the recipient of the service. Where there is no direct way of calculating how much of a particular service was provided to each related party then the group has to apportion the central costs across the recipients, e.g. central human resources costs are often apportioned on the basis of headcount etc.
Certain centrally incurred costs should not be recharged to group companies and these are discussed in more detail below.
Shareholder Activities – If a group member performs an activity solely because of its ownership (direct or indirect) in one or more of its group members, then this type of activity does not necessarily justify a charge to the recipient company. Where the recipient would not need or require the service if it were not a member of a group, it would not pay for it at arm’s length and therefore no fee should be charged
Incidental Benefits – In some cases an intra-group service performed by a group member relates only to some group members but incidentally provides benefits to other group members. Examples of this include analysing whether to reorganise the group, to acquire new members, or to terminate a division. These activities may constitute intra-group services to the particular group members involved, but they may also produce economic benefits for other group members not involved in the object of the decision by increasing efficiencies, economies of scale or other synergies. The incidental benefits ordinarily would not cause these other group members to be treated as receiving an intra-group service because the activities producing the benefits would not be ones for which an independent enterprise ordinarily would be willing to pay.
Other Activities – Where intra group services are provided and the activities provide a clear benefit to group members, then a fee should be charged for these services.
In short, the test is whether an independent enterprise in comparable circumstances would have been willing to pay for the activity if performed for it by an independent enterprise, or whether the recipient would have undertaken the activity itself.
Development of intangible assets – where a taxpayer recovers the cost of developing intangible assets through a royalty or uplift in product price to related parties, then it should not make an additional charge to related parties for developing those intangible assets.
C Inter-Company Loans
There is potential for the UK transfer pricing rules to apply whenever one company has lent money to another group company even if the amounts are not in the form of a formal loan. For example, long term trading balances can be characterised as loans and interest imputed thereon.
In pricing inter-company loan facilities and determining how much interest payable will be deductible in the UK, there are three elements to consider – they are of course not separable, but it is helpful to look at each aspect distinctly:
- The quantum of the borrowing – when assessing the arm’s length amount of the inter-company borrowing, HMRC would look at the amount of lending that would have been agreed between third parties in the same circumstances.
- The interest rate – HMRC will look at the rate charged and the deductibility of interest will be considered in the light of the arm’s length range of interest rates applied between third parties for loans made under comparable circumstances (e.g. purpose of loan, credit rating of borrowing, amounts etc).
- The guarantee rate – whether a guarantee fee is required to be charged and if so whether the fees paid fall within the arm’s length range.
7 Value added tax
VAT is a tax on consumer expenditure and is collected on business transactions. In the UK, the standard rate of VAT is 17.5%. Depending on the goods, different rates may apply i.e. reduced rate (5%), zero rate (0%), or the item could be exempt from VAT.
The basic principle is that VAT is charged at each and every stage of the supply of goods and/or services. This charge of tax is known as output tax. If the client is registered for VAT, all VAT incurred on supplies (VAT incurred is known as input tax) used for business purposes can be recovered from HMRC. Thus the broad effect is that the business should not be affected and that the VAT charges are actually borne by the final consumer.
In the UK, if you have a taxable presence for corporation tax you are also likely to be within the charge to VAT. You would be required to register for VAT if the turnover of the UK entity exceeds the VAT registration threshold, currently £64,000.
If your turnover exceeds £64,000 (subject to change every year) in either the past 12 months or in the next 30 days, you will be compulsorily required to register for VAT.
However, if this is not the case, you may still be able to voluntarily register for UK VAT. The advantage of registering for VAT is that input tax incurred on expenses can be recovered.
If you are not currently trading but intend to do so in the future, we could apply for you to register for VAT as an intending trader. The advantage of this would be to recover input tax incurred on initial setting up costs. However, we would need to demonstrate to the UK tax authorities that client intends to trade in the future by way of contracts with potential clients, etc.
Consequences of registration
Once registered for VAT in the UK, there are a number duties required to be performed as follows:
- Issue valid VAT invoices;
- Submit quarterly/monthly VAT returns to HMRC;
- Make payments to HMRC on a timely basis if their output tax exceeds input tax;
- Keep key accounting records for a minimum of 6 years such as invoices, documentation relation to import/export, etc;
- Submit EC Sales Lists, Intrastat Declarations, Supplementary Declarations, if applicable.
VAT registered companies in the UK are required to file UK VAT returns either quarterly or monthly using a VAT 100 sent by HMRC. VAT returns reflect all the sales and purchases and VAT incurred/charged in the VAT return period. Monthly returns canbe submitted if the business is likely to receive repayments of VAT.
VAT returns are normally due on the last day of the month following the end of the VAT return period. If the company is in a payment situation i.e. its output tax exceeds its input tax, the client will also be required to make the payment to HMRC by the last day of the month following the end of the VAT return period.
For example, if the VAT return covers the three months ending September, the VAT return and payment to HMRC must be submitted and paid by 31 October at the latest.
Failure to submit VAT returns and/or make payments to HMRC on time can give rise to penalties being imposed by HMRC.
Online submission of VAT returns
VAT returns can also be submitted online. If the client submits VAT returns online, they will also be required to make electronic payments to HMRC. The advantage of online filing is that it quick and easy to use and that HMRC also give you a seven day grace period for the submission of the return and payment of tax. Thus, if the client were to file their VAT return online, following from the above example, they will be required to submit their online return and make the payment by 7 November at the latest. Submission on online VAT returns in the UK will become compulsory from 2010.
In the UK, for VAT purposes, income is split between taxable and exempt income. Since you are making both i.e. taxable and exempt supplies, you will not be able to reclaim VAT incurred on making the exempt supplies. As a result, you will be deemed to be partly exempt.
A partly exempt business will normally have to apply a particular partial exemption method to determine the recoverable proportion of the VAT incurred. Determining and where appropriate agreeing a method, should be done prior to the first VAT return being submitted.
Connected companies can be eligible to be treated as members of a VAT group provided that:
- they are corporate bodies;
- established in the UK; and
- are under common control (Companies Act 1985 s 736).
There are several consequences to being part of a VAT group, namely:
Any business carried on by a member of the group is treated as though carried on by the representative member. A VAT group must have a “representative member” which must account for the group’s output tax and input tax. However, all members of the group are jointly and severally liable for any tax due from the representative member
- A VAT group also eases administration since only one VAT return needs to be completed.
- Any supply of goods or services by a member of the group to another member of the group is disregarded for VAT purposes which makes it administratively easier and also provides cash flow savings.
The broad effect of VAT grouping, therefore, is to merge the separate legal identities of companies into one entity for VAT purposes. As a result intra-group supplies are ignored altogether for VAT. This treatment eliminates VAT costs where taxable supplies are made by one client to another client which is either partly exempt or non-registered.
Land and Property
Capital Goods Scheme
If the property’s value is in excess of £250,000 or if you has carried out refurbishments on the property exceeding £250,000 over the last 10 years, the property could be subject to the Capital Goods Scheme (CGS) adjustment.
The CGS is a mechanism for apportioning VAT recovery on certain capital expenditure over a period of 10 intervals (broadly, of periods of one year each), based on use to which the building is put.
Under the scheme, businesses are required to make adjustments to VAT recovered in acquiring capital items where the use of the items changes between taxable and exempt use.
Option to Tax – if the property has been opted, please insert below.
Property is generally exempt from VAT. However, commercial land or property can be elected to opt to tax or “waive the exemption”. An effective option to tax enables VAT recovery on costs incurred, (including purchases) but means VAT must be charged on rental or sale of the property.
Before deciding on whether the land or building should be opted, it is important to consider the whether the tenants would be able to recover the VAT that may be charged on rent if the building was opted.
If the tenants are registered for VAT, this may not be an issue. However, if the tenants are not registered for VAT, the VAT charged on the rental will be an additional cost to the tenants since they will not be able to recover the VAT incurred.
EC VAT Registrations
If you buy or sell goods to/from other EU member states, there may be a requirement for you to register for VAT in those countries. However, there are various conditions and scenarios we will have to consider before we can fully advise you on this matter.
EC Sales Lists (ESL)
If you make supplies of goods to VAT registered traders in other EC countries; transfers its own goods from the UK to other EC country; or is the intermediary in a triangular transaction between VAT registered traders in other EC countries, you will be required by HMRC to submit EC Sales Lists (ESLs). ESLs are statements containing details of individual transactions.
Supplementary Declarations (SDs)
If the client’s annual value of intra EC trade exceed a certain threshold, you will be required to prepare and submit Supplementary Declarations (SDs). It is important to note that the threshold applies separately to:
- Dispatches of goods to other EC countries; and
- Arrivals of goods from other EC countries.
The current threshold, beyond which SDs need to be made is £225,000 for both dispatches and acquisitions.
If you supply goods to other EC VAT registered traders, there may be scope to reverse charge the supplies and avoid the need for you to register in those EC countries. However, we would need to consider individual transactions to advise fully on this matter.
Another matter to consider is Customs Duty and ensuring all necessary records are kept.
In the UK, the client will be required to pay duty upon importation of goods. In order to avoid paying duty every time a shipment comes in, we have an arrangement known as Duty Deferment. The client will need to apply for such an arrangement. Once approved, duty can be paid monthly to Customs and Excise, normally on the 15th of the month following.
If you supply and deliver goods to a non-taxable person in another EC Member State this is referred to as distance selling. Depending on the level of turnover, you may or may not be required to register for distance sales in various EC member states.
It is important to note that distance selling can only occur between Member States, so that mail order sales to the UK from outside the VAT territory, for instance from the Channel Islands, are not distance sales.
Since the client’s distance selling turnover in [insert member state] exceeds [insert registration threshold], they are required to register for distance sales.
8 Employment taxes
Individuals that are working in the UK for a period that exceeds 30 days are strictly subject to UK withholding on all their earnings. However, HMRC has issued guidelines as to when they expect PAYE to be operated. It should be noted that without prior agreement from the UK Tax Authorities it is necessary to operate PAYE on 100% of earnings.
It is generally the case that the UK withholding requirements are applicable regardless of whether the individual is actually paid by a UK or non-UK resident employer. If the non-UK resident employer has a presence in the UK, such as a branch, this withholding responsibility falls on the employer. If the employer does not have a presence the withholding responsibility falls on the UK company obtaining the benefit of the individual’s services. There are also strict employer filing requirements for the year-end forms, P35, P14, P60 and P11D.
If coming for less than 6 months, and the costs are borne by home country and remuneration paid by home country.
Regardless of duration of assignment to the UK, if costs or remuneration borne by the UK and the relocated staff are not tax equalised.
Regardless of duration of assignment to the UK, if costs or remuneration borne by the UK and the relocated staff are tax equalised.
Short Term Business Visitors Agreement
It may be possible to relax strict PAYE requirements for relocated employees on short term business visits to the UK. If you have staff who are considered resident in a country with which the UK has a Double Taxation Agreement, it is likely that they will qualify for Treaty Relief under the Dependent Personal Services/Income from Employment Article (usually Article 15).
Provided that the relocated staff are:
- coming to work in the UK for a UK company or the UK branch of an overseas company
- expected to stay in the UK for 183 days or less in any twelve month period
- it can be shown that for specifically named employees the UK company or branch will not in fact ultimately bear the remuneration specified.
It is possible to apply for a Short Term Business Visitors (STBV) Agreement with HMRC and therefore not have a UK PAYE withholding requirement. Therefore, there is no requirement to operate a UK payroll or file self-assessment tax returns with HMRC.
An agreement must be applied for and authorised with HMRC before a company can operate under this Agreement, and the company must fulfil certain reporting requirements as specified in the agreement.
These arrangements will not apply where the expense of the remuneration is passed on to another UK company or branch and not recharged overseas. It is possible to apply for a dispensation from HMRC in certain circumstances where remuneration is either delivered or borne by the UK company or branch.
Regular PAYE Withholding and UK payroll
A regular UK payroll is operated on a typically on either a weekly or monthly basis. UK tax withholding (PAYE) and National Insurance Contributions (NICs – if relevant) are withheld against 100% of earnings.
Modified PAYE Scheme
An alternative to the strict withholding system in the UK is a plan known as a “Modified PAYE Scheme”. The UK authorities have issued guidelines as to when it can be used, it is designed specifically for employers seconding tax equalised employees in to the UK that stay on their home country payroll.
What is tax equalisation?
Tax equalisation is a process whereby an expatriate assigned from their home country to a foreign country (in this case the UK) and is placed in the same position as he, or she, would have been had they remained in their home country i.e. the employee is neither better off nor worse off as a result of the assignment.
How does the scheme work
A best estimate of salary, bonuses and benefits in kind is made at the beginning of the year in respect of your expatriate staff. Relief can be taken for any days worked outside the UK where the expatriate has the appropriate residence status. In addition, relief can also be taken throughout the year for employee contributions into a correspondingly approved foreign pension scheme. During the year, adjustments need to be made where there are new arrivals and departures.
PAYE is calculated on the basis of these estimates and paid over in the usual manner each month, although quarterly payment schemes are available in repeat of smaller (5 or fewer) expatriate populations.
Before the end of the tax year, usually between December and March, a review will be carried out to take account of any material changes and in particular, to ensure that any calendar year end bonuses are accounted for. After the end of the tax year, any additional tax found due is calculated on the Self Assessment tax return and paid by 31 January following the end of the tax year.
The main advantages of the scheme are that:
- it offers PAYE failure protection and relaxation of the submission date for forms P11D (return of expenses and benefits).
instead of providing accurate information to your payroll agent or payroll department on a monthly basis, it will only be necessary to provide estimated information twice a year.
- Additional information would of course be required to cover new arrivals and departures.
- the estimate for the year will include all remuneration (e.g. salary and bonuses paid in the UK and elsewhere) as well as benefits (e.g. company car benefit, company loan benefit, house rental paid by the company on employer/landlord leases etc.). Accordingly, there should be fewer large underpayments or overpayments on Self Assessment returns. This may help your company account for tax liabilities with more accuracy and certainty and avoid large accruals of income tax.
- provisional relief is available for resident but not ordinarily resident employees for non UK workdays without a formal claim on each individual’s behalf, offering significant cash flow advantages for your business. In addition, relief can be taken for employee pension contributions into a correspondingly approved foreign pension scheme.
Other Specialised Payroll Options
By concession in agreement with HMRC it is possible to operate PAYE on a reduced portion of earnings. For example, it should be possible to obtain agreement from the UK authorities to only operate PAYE on 75% of the earnings for an individual who will only be subject to UK tax on 75% of their income.
From an practical and operational point of view, it may be possible to operate a home country payroll alongside a regular UK payroll, in other words operate a ‘shadow’ or ‘dummy’ payroll in the UK.
If an individual or his/her employer has overseas connections, the national insurance (NI) position can be quite complicated. Liability to UK national insurance contributions (NICs) generally depends on the individual being present, resident or ordinarily resident in the UK.
The normal rule is that work carried out in the UK is liable to UK NICs. The contract of employment may be made under foreign law and the employer may be located abroad, but these factors on their own do not override the basic rule. The nationality of the worker is only relevant under certain EC regulations or reciprocal agreements.
If an individual comes to the UK to start a new job, he/she is subject to UK NIC rules immediately. If, however, the job relates to a secondment, the individual may be allowed to contribute to the home country’s social security system for 52 weeks, or longer if the appropriate agreement allows. These periods can be extended in certain circumstances. There are exceptions where a worker is replacing another secondee or has employments in two or more countries.
It should also be noted that the worker’s home country may not have the same rules as the UK. Whilst a worker may only start to pay UK NICs after 52 weeks, there may be a liability under their home country’s social security system for a different length of time.
Secondary (employer’s) NICs generally follow the primary (worker’s) NICs, ie if the worker is liable to pay UK contributions so is the employer, provided the employer is resident, present, or has a place of business (see below) in the UK. The secondary contributor is also responsible for collection and payment of the primary contributions. In the very rare case where there is no liability to secondary contributions, the worker may be required to make direct payment of the primary contributions.
For the situations when cross-border issues arise, the rest of the world is divided into three groups:
- the European Economic Area (EEA) – the EU member states
- plus Iceland, Norway and Liechtenstein.
EC regulations prevail over both UK law and existing reciprocal agreements between EEA States, unless stipulated otherwise. The EC regulations provide that a person should not be liable to the contribution regulations of more than one State at a time. Broadly, workers coming to the UK for 12 months or less may remain subject to the other State’s social security system if they are not replacing another worker. A form E101 is needed to certify the position. If the UK employment is unexpectedly extended, the form E101 can be extended for a further 12 months, or beyond in very limited cases.
non-EEA countries with whom the UK has a reciprocal agreement or double contributions convention
For this category of worker, liability for a temporary posting generally stays with the “home” country if the UK stay is expected to last less than a certain period, often two years but in some cases five years. Note that this test is based on the expectation at the outset, whereas the change of jurisdiction at 52 weeks mentioned earlier is not linked to how long the posting is likely to last.
countries not in the first two groups.
If such workers come from countries not in categories 1 and 2 above, it is the UK rules which determine their liability. Usually, they will not be liable to UK NICs for the first 52 weeks if:
- they are not normally employed in the UK and
- the employer’s place of business is outside the UK
- (regardless of whether they also have a UK place of business) and
- they are not normally resident in the UK – this term is slightly
different for NI purposes from the usual direct tax meaning.
Otherwise, there is a liability to UK NICs from the first day.
There are detailed rules for returning home for holidays, paid or unpaid, sick leave and other temporary presence in the UK or absences abroad.
UK Tax Registration and Compliance
Individual Arrival and Departure Formalities
Upon arrival in the United Kingdom, individuals are required to register with HMRC. This registration involves completing and submitting Form P86, an Arrival in the United Kingdom questionnaire. The responses on this questionnaire are important, as they determine the individual’s tax status while in the UK and their liability to UK tax.
Upon departure from the United Kingdom, individuals are required to deregister with HMRC. This registration involves completing and submitting Form P85 or P85(s), a Departure from the United Kingdom questionnaire.
The United Kingdom does not use the calendar year for tax purposes. The UK tax year, for income tax purposes, runs from April 6th to the following April 5th. The UK operates a system of self-assessment and personal tax returns for the current tax year must be submitted by January 31, the following year, for example for 2007/08 the tax return must be filed by January 31, 2009.
Any remaining balance due should be paid by 31 January following the year of assessment. The self-assessment tax regime also includes automatic penalty provisions for late payment and filing of tax returns.
Assignment Planning Opportunities
Provision Of Housing
Lease Premium Arrangements
Where employers provide housing for employees a taxable benefit accrues to the employee calculated as the higher of:
- the rent paid by the employer and
- the deemed “rateable value”. However when the cost to the employer (at time of occupation by that employee generally) of the accommodation exceeds £75,000 there is an additional deemed taxable benefit to the employee consisting of the excess cost over £75,000 multiplied by the official interest rate. Where the property is owned outright by the employer, the cost can be significantly in excess of the £75,000 threshold and the resultant benefit can be very large.
Ordinarily where rent is simply paid on behalf of the employee, by the employer, then the taxable benefit is the rent paid by the employer, assuming the property is being let commercially. This planning opportunity considers the possibility of reducing the employee’s taxable benefit by the employer purchasing a lease by paying an up front premium.
The employer could, instead of paying a market rent for the accommodation, purchase a short-term lease by paying a premium (ideally less than £75,000) at the commencement of the lease and then paying a minimal ground rent under the lease. In these circumstances the employee’s taxable benefit would be limited to the higher of the minimal ground rent and the deemed rateable value.
Provision of accommodation and per diems free of UK tax
The UK has a rule for tax free reimbursement of “away from home” expenses for employees that are away from there normal place of work for a temporary period of time for business purposes. Such expenses can only be claimed if the assignment length is not expected to exceed 24 months. Hence, for assignments that are expected to last no more than 24 months, it may be possible to provide accommodation and per diems free of tax in the UK.
Corresponding approval for Foreign Pension Plans
While on assignment to the UK, individuals typically remain in their home country benefit programs. To ensure that individual’s contributions made to their foreign pension plan are tax deductible and any employer contributions are not considered taxable income it is necessary to seek approval for the plan from the from HMRC.
Establishing Favourable Residency Status
There are three levels of tax residence in the UK, which will influence how an individual is taxed while working in the UK (although it is important to remember that, subject to the mitigating effects of a double taxation agreement, an individual who is not resident will be liable to UK tax on income relating to UK duties). These three levels are resident, ordinarily resident and domicile. We are detailing briefly each of these below.
An individual will be considered resident in the UK for each tax year that he or she spends more than 182 days in the UK. If the individual expects to be here for 2 years or more on arrival, he or she will be resident from date of arrival until the date following the day of departure.
Once resident in the UK then an individual’s earnings fall within the scope of UK tax. The extent to which they are taxable in the UK will also depend on their ordinary residence status.
Not Ordinary Residence
An individual that comes to the UK and intends to be here less than 3 years will generally be considered not ordinarily resident. It is important to note that if a person buys a house in the UK he/she will be ordinarily resident in the UK.
The benefit of being not ordinarily resident is that earnings relating to non-UK workdays will not be subject to UK tax provided they are paid outside the UK and are not remitted to this country. For example, an individual working in the UK with total earnings of £100,000 who is working outside the UK 25% of the time will only be subject to UK tax on £75,000 of their earnings provided at least £25,000 is paid outside the UK and is not remitted. If a person is ordinarily resident this simple income splitting plan it not available.
An individual’s domicile status in the UK currently depends upon their long-term intentions. Generally, individuals who are coming to the UK to work for a limited period of time and who have no previous ties with the UK will not be considered domiciled in the UK.
The benefit of being not domiciled in the UK is that investment income is not subject to UK tax unless it is either remitted to the UK or is sourced in the UK. It is also essential that, among other things, a person is not domiciled in the UK if there is to be available in the UK a deduction in respect of a non-UK company pension plan.
Employment of foreign nationals in the UK
European Community law gives European Economic Area (EEA) nationals a right to live and work in the United Kingdom without work or residence permits subject to certain limitations for residents of the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, and Slovenia.
Non EEA nationals usually require a work permit issued by the Home Office and which must be applied for by the UK employer on behalf of the foreign national.
Work permits are issued for a specific period up to a maximum of five years.
Financing creates a number of tax issues. Setting up a business centre in the UK is likely to require external funding either from independent institutions or parent companies.
Key areas are highlight below
As outlined earlier in this report, intra-group interest payments must be arms length in order to secure a tax deduction for those payments.
Thin capitalisation in relation to branch and subsidiary company funding
A company is said to be thinly capitalised when it has excessive debt in relation to its arm’s length borrowing capacity leading to the possibility of excessive interest deductions.
The arm’s length borrowing capacity of a company is the amount of debt which it could and would have taken on from an independent lender as a stand alone entity rather than part of a group of companies. In establishing the arm’s length borrowing capacity it is therefore necessary to view the borrower as a separate entity from the larger group of which it is part.
Funding a company with excessive intra-group or parentally- guaranteed debt is likely to lead to excessive interest deductions by the borrower. UK legislation on thin capitalisation seeks to counteract any tax advantage achieved by these excessive deductions. In this scenario, tax relief is limited to the interest that would have been paid on an arm’s length loan at market rates of interest.
It is understood that start up businesses need additional funding and this is normally factored into a thin capitalisation assessment. It will however be necessary to review subsidiary funding after this initial start up period.
A similar provision is also applied to branches where loans made to the branch are greater and those that would have been obtainable had the branch been a UK company managing only the UK permanent establishment.
The UK requires that interest payments made to an overseas entity are made with deduction of basis rate tax.
This requirement is overruled where the UK has ended into a double taxation agreement with the receipt country and that agreement contains an interest article which reduces or eliminates the UK’s taxing right. The reduced rates may be given by way of relief at source or by repayment of tax deducted but, the recipient must apply for this relief. It is not automatic.
Where the relief is given at source, authorisation will be issued to the payer, the UK entity, once the recipient’s application has been agreed.
Until clearance is given, it must be assumed that the treaty will not apply. If interest is paid gross without clearance, then an assessment may be made on payer that failed to withhold tax to recover lost tax, interest and penalties.
There are also exemptions for withholding tax on interest on short term debts of less than one year.
Loan relationships for unallowable purposes
Regardless of whether a non-resident recipient of UK interest suffers UK withholding tax, it does not guarantee deductibility for the payer if the loan is for an unallowable purpose .
An unallowable purpose is a purpose which is not amongst the business or other commercial purposes of the business and includes, for instance, where the UK branch of a company resident outside the UK was paying interest on a loan which was being used to fund activities of the company unconnected with the UK branch or where the loan has been put in place, the sole or main purpose of which is the avoidance of UK tax.
Inter-company loan accounts
Inter-company loan accounts are subject to the same restrictions as third party loans with regard to transfer pricing and the deductibility of interest.
Additional issues arise where inter-company debts are written off by the lender. A debt provided to provide finding to a branch, subsidiary, or indeed a parent, is generally tax natural for tax purposes in that neither the lender nor recipient is subject to tax or entitled to a deduction where the fund debt is written off.
Where an inter-company debt has arisen through trading transactions, the write off of the debt is not an allowance deduction in computing the profits of the lender but may be a taxable receipt in the hands of the recipient of the loan. This is likely to be relevant for foreign direct investment in the United Kingdom as it will be the UK entity that will be in receipt of goods and services from the parent and likely to have outstanding trading balances.
It is important to the note that this provision should only apply if the debt is formally waived by the lender and the provision of a bad debt in the lender accounts should not trigger a charge.
Interest and Royalties directive (IRD)
Businesses trading within the EU are subject to the IRD which became effective in 2004. Under the IRD no withholding tax is generally not applied to interest and royalty payments between residents of the EU and will apply to most companies under common control. The regulations include Switzerland.
10 Audit and accounting
A UK subsidiary must prepare annual financial statements prepared in accordance with UK GAAP or IFRS and file with Companies House. Filed accounts are available for public inspection.
The deadline for filing the financial statements is ten months after the year-end for an unlisted and eight months for a listed company.
A statutory audit may be required if the worldwide group has 2 of the following:
- revenues exceeding £5.6m per annum; and
- gross assets exceeding £2.8m
- >50 employees
A basic small company audit would cost from £7,000 to £10,000.
The branch is not required to prepare financial statements other than for the purposes of drafting a company tax return, however, the non resident parent company must file a copy of its audited accounts in the UK.
If the parent company does not prepare published accounts, it must instead prepare and deliver financial statements to Companies House as if it were a company registered in the UK. These must relate to the parent company and not solely of the place to business or branch
Filed accounts are available for public inspection in the UK.
Both subsidiaries and branches are required to file with Companies House an annual return confirming changes to members, share capital and similar statutory information. Like financial statements, annual returns are available for public inspection.
Theses returns are independent from the filing of financial statements and tax returns and are required every 12 months form the date of incorporation or registration.
The UK activates is also likely to require ongoing bookkeeping services which may comprise the completion of VAT returns and management financial statements.
In 2001 the UK introduced legislation that employers must offer their employees access to a stakeholder pension scheme.
The rules will generally apply to any business with 5 or more employees.
As an employer you would be required to:
- designate (formally choose) a stakeholder scheme.
- provide employees with information about the scheme.
- make deductions from an employee’s salary for their pension contributions to the designated scheme if they want it.
Employers are not required to comply from the first day of employment but the requirement becomes mandatory after an employee has been working for an employer for three months.
Employers are not compelled to contribute into stakeholder schemes on behalf of their employees.
Exemptions are available to employers with occupational pension schemes which meet certain conditions.
The Pensions Regulator is not likely to enforce penalties on employers who have not given their employees access to a stakeholder pension scheme, as long as the employer can show that they are currently putting a scheme in place. The Pensions Regulator will consider fining
employers who deliberately ignore their responsibility or avoid sorting out the problem. The Pensions
Regulator can fine employers up to £50,000.
|1 January 2009||Commencement of trading in the UK|
|31 March 2009||Last date to notify HMRC trading has commenced|
|31 March 2009||Last date to set up stakeholder pension scheme and notify employees|
|19 May 2009||Last date to submitted employee payroll records for the 2008/2009 tax year|
|14 July 2009||First instalment of corporation tax (where applicable)|
|6 July 2009||Last date to return record of employees taxable benefits for the previous tax year (2008/2009)|
|14 October 2009||Second instalment of corporation tax (where applicable)|
|31 December 2009||First accounting date|
|14 January 2010||Third payment on account for instalment of corporation tax (where applicable)|
|14 April 2010||Fourth and final instalment of corporation tax (where applicable)|
|19 May 2010||Last date to submitted employee payroll records for the 2009/2010 tax year|
|6 July 2010||Last date to return record of employees taxable benefits for the previous tax year (2009/2010)|
|31 July 2010||Last date to file financial statements for a PLC|
|1 October 2010||Full and final payment of corporation tax (if not paying instalment)|
|31 October 2010||Last date to file financial statements for a LTD|
|31 November 2010||Last date to file financial statements of a Foreign parent of a UK branch|
|31 December 2010||Last date to file corporation tax return for the period 1 January 2009 to 31 December 2009.|