UK Company Tax Planning

UK Corporation Tax Planning & Compliance Made Simple

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Overseas profits and operations

Overseas tax matters including: double tax relief
2.dividend exemption
3.branch exemption
4.controlled foreign companies legislation
5. taxation of exchange gains and losses
6. the tax treatment of profits accounted for in a foreign currency and functional foreign currency election.
7 worldwide debt cap and thin capitalisation

What an overseas business should consider before setting a business in UK

If an overseas business proposes to set up UK operations, the business will need to consider the following tax issues:

(1) Is there a permanent establishment under UK law? If so, does an applicable double tax treaty override UK domestic law so that there is no permanent establishment?
(2) Should a branch or subsidiary be formed?
(3) Will there be withholding tax on any payments of interest and royalties from the UK? Does an applicable double tax treaty change the position?
(4) Transfer pricing rules may affect the calculation of the profits of a branch or subsidiary for tax purposes. It may be necessary to consider the ownership of intellectual property in particular.
(5) To what extent should a subsidiary be financed with debt or equity? What restrictions are there on the deductibility of interest payments for tax purposes?
(6) The company or branch may need to register for VAT.
(7) The company or branch may need to register for pay as you earn (“PAYE”) income tax deductions and National Insurance (social security) contributions in respect of employees.
(8) There may be a requirement to file accounts with Companies House.
UK Tax Implications: Overseas company operating in UK through a Permanent Establishment (PE)
• Under the DTA, a PE exists if there (a) is a UK fixed place of business OR (b) where an agent concludes contracts.
• Subject to Corporation Tax if it is trading in the UK through a UK PE and then only to the extent of the profits arising from that UK PE.
• Trading means concluding contracts. Note market research considered (auxiliary) and maintaining customer relationship (preparatory) do not result in PE; this is how Apple, Google, Amazon avoids paying tax UK – by only hiring !“marketing pple in the UK and contracts concluded in Ireland
• If overseas company has office premises then a degree of permanence needs to be established.
• If trading, OECD double tax applies and gives the UK primary taxing rights
• If tax is chargeable, taxed on profits attributed to PE and Intercompany transactions should be at arm’s length transfer pricing.
• The Overseas company may be subject to tax in the home country and DTA relief may apply in foreign country
• If tax is chargeable notify HMRC within 12 months after accounting period
• Failure to notify if tax is chargeable results in penalties unless reasonable excuse. Penalty is based on a % of unpaid tax and on the reasons for the error.

UK Tax Implications: UK Subsidiary of an Overseas Company
• UK tax resident and therefore subject to Corporation Tax on its worldwide profits.
• Its possible that the UK company could be dual tax resident in the overseas holdco country
• OECD model convention contains a tie-breaker provision in such cases based on effective management
• If tax is chargeable notify HMRC within 12 months after accounting period
• Failure to notify if tax is chargeable results in penalties unless reasonable excuse. Penalty is based on a % of unpaid tax and on the reasons for the error.

Tax treatment of dividends received by Companies
The general rule is that dividends paid by a UK company to another UK company out of post-tax profits are exempt. From 1 July 2009, this rule was extended to cover UK receiving dividends from overseas company as long as the conditions for the exemption are met.
Generally rules depend on whether the recipient company is a “small company” or a “large company” . Companies can elect for exempt dividends to be taxable on a receipt by receipt basis; and this can sometimes reduce the rate of withholding tax under Double Tax treaties and may be beneficial if the recipient company has tax losses.
Small Company – < 50 employees, < €10 million turnover or < €10 gross assets. Everything else is large companies. Small company exemption applies to dividends received where: 1. The payer is resident in the UK or a qualifying territory; And 2. The dividend is not interest which has been re-categorised as a distribution, And 3. The dividend has not been allowed as a deduction from taxable profits outside the UK, And 4. not part of a scheme of tax avoidance Large Company Exemption The large company exemption applies to dividends which fall in to one of five classes: 1. Where the recipient controls the payer (controlled company exemption) 2. Distributions in respect of non-redeemable ordinary shares 3. Distributions in respect of portfolio holdings (controls < 10% of the payer) 4. Dividends from shares accounted for as liabilities 5. Distributions from transactions not designed to reduce tax (anti-avoidance test)- applies to all the above Advantages of using a foreign branch (PE) vs foreign subsidiary
– Incorporating local subsidiaries that can result in trapped capital and tax leakage through dividend WHT; no WHT on branches; UK exempts overseas income & capital gains subject to CFC anti-diversion rules
– Ideally a separate UK company with a local branch should be set for each project to segregate assets and provide flexibility around future disposals; Dividends between UK companies will be free from WHT and exempt from Corporation Tax; On eventual disposals Substantial Shareholdings Exemption should apply to exempt on the UK sub companies

Why an overseas company may want to set up a UK Holding Company

1. Participation exemption on income & gains from investments

Dividends will be exempt from Corporation Tax, if it falls within one or more of the classes below, unless an anti-avoidance rule applies:
1) Distributions from controlled companies;
2) Distributions in respect of non-redeemable ordinary shares;
3) Distributions in respect of portfolio holdings;
4) Distributions derived from transactions not designed to reduce tax;
5) Dividends in respect of shares accounted for as liabilities.

Capital Gains for Corporates are exempt from tax through the Substantial Shareholding Exemption (SSE) providing the relevant conditions are met:
1) The company making the disposal must meet certain ‘trading’ conditions.
2) The company whose shares are being disposed of must meet similar ‘trading’ conditions.
3) The ‘investing company’ must have held at least 10% of the shares in the ‘investee company’ for a continuous period of at least 12 months ending not more than one year before the disposal.
2. Treaty network and withholding taxes
• The United Kingdom has one of the largest networks of tax treaties, with more than 100 countries. Treaties help minimise withholding taxes deducted from dividend, royalty and interest payments made to the UK HoldCo
• Though the Brexit deal is still be done, UK is a member of the European Union, the EU Parent/Subsidiary Directive and EU Interest and Royalties Directive have been implemented into UK law, which result in a withholding tax rate of nil on income received from European subsidiaries.
• There is no withholding tax applied to dividends paid by UK companies.

3. Controlled Foreign Companies (CFC)
Ideally, a holding company should not need to bring into tax the profits of its subsidiaries arising in other territories.
The UK’s CFC regime seeks to charge UK tax on foreign profits only when these are artificially diverted from the UK. But the rules are complex.
In order to determine whether a CFC is subject to Corporation Tax, it is necessary to consider:
1) The nature of the income of the company.
2) Whether any of the statutory exemptions apply, such as the temporary period of exemption, the excluded territories exemption, the low profits exemption, the low profit margin exemption and the tax exemption.
3) If none of the exemptions apply, then a CFC will be subject to Corporation Tax if any of its profits pass through one of the statutory gateways:
(a) Profits attributable to UK activities
(b) Non-trading finance profits
(c) Trading finance profits
(d) Captive Insurance business
(e) Solo consolidation

4. Financing
It would be advantageous for a holding company to be able to obtain tax relief for the financing costs of acquiring subsidiaries.
In the UK, financing costs for making acquisitions are tax deductible. For related party loans, the UK has thin capitalisation rules which limit the amount of deductible interest to the amount of interest which would have been payable on arm’s length terms. Companies are able to enter into Advance Thin Capitalisation Agreements with HM Revenue & Customs.
“Worldwide debt cap” rules limit tax deductions for financing expenses to no more than the gross finance expense suffered for the relevant period by the worldwide group.

5. Losses
Obtaining tax deductions for financing costs is more beneficial if any losses can be offset against profits arising in other companies within the group.
The UK has group relief provisions which enable losses arising in a company to be offset against profits arising in the same accounting period in other UK companies within the group.

6. Other properties
A territory which offers a stable tax regime and has a low corporate tax rate is attractive.
The UK has a long-standing and stable tax regime. There is also a statutory clearance and non-statutory clearance service.
A UK Holdco can claim VAT if it meets certain conditions eg part of a VAT group, has a management agreement with subsidiaries or provides loans at commercial terms to the subsidiaries.
The UK has a competitive Corporation Tax rate of 20%.
The UK has no capital taxes/duties except for stamp duty which is payable on transfers of UK shares at 0.5% (group relief available).
The UK tax regime also includes incentives such as research and development tax credits and patent box, which whilst not necessarily relevant for holding companies nevertheless make the UK an attractive place to invest.

Central Management Vs Effective management
Central management & control – case De Beers Consolidated Mines v Hove where SA company with UK directors meant the SA company was UK resident. HMRC looks at the highest level of control vs place of business operations. Factors such as directors’ residence, director meetings etc are considered. Used in UK to determine tax residence of foreign companies or Pes.
Place of effective management – where key management and commercial decisions are made. Used by OECD to determine tie breaker & less strigent than central management tests above. Not many cases, one being Wood vs Holden= for holding companies, place of effective management is the same as central management & control is excercised. However these could be different.

Controlled Foreign Companies
What is the issue?
The CFC rules are anti-avoidance provisions designed to prevent diversion of UK profits to low tax territories. If UK profits are diverted to a CFC, those profits are apportioned and charged on a UK corporate interest-holder that holds at least a 25% interest in the CFC.

Definition of a CFC
A foreign company is a CFC if it’s a non-resident UK company that is controlled by a UK resident person or persons.

Where control is determined by reference to:
o legal control
o economic control
o a joint venture test
o accounting standards
Application of the rules and exemptions
Entity level exemptions (targeted at entities that pose a low risk to UK tax base) – if CFC qualifies for one of these exemptions then the entire income of the CFC will be outside the scope of the CFC rules.

(i) have profits below the de minimis limit; < £50,000, or < £500,000, then provided non-trading income is < £50,000.
(ii) Low profit margin: This exemption applies where accounting profits are less than 10% of operating expenditure. This exemption will typically apply to low-risk overseas subsidiaries, such as those providing services to other group companies which are charged on a cost-plus basis.
(iii) Excluded territories: This exemption applies where the CFC is resident in one of the excluded territories, which are specified in regulations. In addition, specified income must not be more than the higher of 10% of profits or £50,000.
(iv) y High tax: The exemption applies if the local tax paid is at least 75% of the UK corporation tax which would have been paid on the same profits.
(v) Exempt period. A CFC is exempt for the 12 months after it first becomes a CFC, for example if it is acquired by a UK company from a third party do not have a tax avoidance motive.

[The gain arising on sale of the investment property is outside the scope of the CFC rules and will not be apportioned to the UK].

Applying the excluded territories exemption
Exempt from CFC tax charge if resident on excluded territories list, and meets certain tests in respect of its income.
(a) company’s ‘bad’ income is no higher than the greater of: £50,000; and 10% of its annual accounting profits
(b) Intellectual Property (“IP”) must not have been transferred to the CFC from the UK in the past 6 years and as a result of which the CFC’s income from that IP or the value of that IP is significantly higher than it would have been if the transfer had not taken place.
(c) CFC not involved in tax avoidance arrangements.
There are two lists of excluded territories, the second of which applies to six countries with a tax system similar to that of the UK (no need for the conditions above to be met). CFCs resident in countries on this second list have fewer conditions to be satisfied before the excluded territories exemption applies.
Applying the low profits exemption
Where the CFC’s ‘accounting profits’ or ‘assumed taxable total profits’ in an accounting period are no more than £50,000 or the CFC’s ‘accounting profits’ or ‘assumed taxable total profits’ in an accounting period are no more than £500,000 of which non-trading income is no more than £50,000, then the CFC provisions will not apply.
‘Accounting profits’ in this context are pre-tax profits computed using acceptable accounting principles (which would include IFRS and UK GAAP) excluding dividend income which would be exempt from tax under the UK’s dividend rules, property business profits or losses and capital losses or profits.
‘Assumed taxable total profits’ are broadly the amount of profits that would be subject to Corporation Tax under UK tax rules.
Applying the tax exemption
The tax exemption applies where a CFC’s profits are subject to a charge to tax in their country of residence equal to at least 75% of the UK corporation tax that would be payable on such profits.
The exemption only applies where it is possible to determine the CFCs territory of residence and the tax rates in that country are not designer rate.
The CFC rules only apply if profits pass through a ‘gateway’. Before applying the Gateway tests, the following pre-gateway tests results in excempt charge:
• No assets or risks are managed by connected parties in the UK;
• Any assets or risks which are managed by connected parties in the UK could be replaced by unconnected parties; or
• The subsidiary holds assets or risks for bona fide commercial purposes, and not for the purpose of avoiding tax.
There is no attribution required of non-trading finance profits if they fall below a de minimis level.

The Non-Trading Finance Profit Gateway
Broadly speaking profits are relevant in calculating a CFC charge under the Non-Trading Finance Profit Gateway if they can be traced to capital investment from the UK.
However there are a number of exemptions that could fullly or partially exempt the interest income and these include:
1. The 5% rule de minimis rule and applies where the non-trading finance profits of a CFC, that carries on a trading / property business, do not exceed 5% of the CFC’s total trading profits and property business profits.
2. Qualifying loan relationships – finance company exemptions
i- Non-trading finance profits arise that would pass through the gateway;
ii – Overseas sub is not resident in the UK and amounts otherwise chargeable are not reduced;
iii- There will not be a qualifying loan relationship if certain avoidance has taken place.
iv – a CFC should have business premises available to it throughout the accounting period in its territory of residence, which it occupies for the purposes of its business.

a) The 100% interest income exemption
Funding from CFC to subco should have been funded either “qualifying resources” i from profit from loans, dividends, profits from the sales of subsidiaries etc; and not directly from the UK capital investment.
[worthwhile keeping records of the profits that arise from the respective loans]

b) The 75% interest income exemption
If 100% exemption does not apply, then 75% exemption ELECTION HAS TO BE MADE. If the 75% charge applies it leaves 25% interest chargeable to the CFC at main rate – effective rate of 5%.

c) Matched interest
If the 100% or 75% exemption does not apply or if there is any remaining interest income, this can be exempt through the matched interest rules. Where under the worldwide debt cap rules (rules which seek to limit the amount of finance deductions in the UK) there is a surplus of net finance income over net finance expenses in the UK.

[Note any WHT may be credited against UK Corporation Tax payable on chargeable profits of overseas sub]
UK Holdco with an overseas subsidiary tax implications

(i) Large company – Another related 51% group company, affects large company – quarterly payments etc
(ii) Exempt dividends – Dividends from subsidiary not taxed in UK if they meet the exemptions (which is usually the case). Dividends will not affect franked profits – large company ..
(iii) Dividends withholding tax – if withholding tax is charged, it may not be recovered as foreign tax is usually exempt
(iv) Transfer pricing – Interco transactions should be at arm’s length. If large company then an adjustment to the UK holdco to increase profits (if need be)
(v) SSE – On eventual disposals Substantial Shareholdings Exemption should apply to exempt on the UK sub companies
(vi) No UK tax for foreign sub – Holdco is tax resident in UK, overseas subsidiary is tax resident in overseas territory. Overseas subsidiary is not taxed in UK unless if subject to CFCs rules
(vii) CFC Rules – see above

UK Holdco with an overseas PE
(i) UK tax resident and therefore subject to Corporation Tax on its worldwide profits, including PE profits. PE profits are likely to be taxed in the overseas country, resulting in double tax.
(ii) If DDT agreement follows OECD model convention contains a tie-breaker provision in such cases based on effective management.
(iii) DDT relief or unilateral relief if treaty relief does not apply
(iv) UK holdco – may elect to have PE profits exempt from UK tax – election at start of the accounting period. Applies to all PE and losses wont be deducted.

There are four main OECD methods for transfer pricing: CUP, Cost Plus, Resale Price, Profit based methods:
1.Comparable Uncontrolled price (CUP) – compare controlled price to uncontrolled similar transactions between independent parties. Pros – commonly used method; Cons – stringent rules to meet “uncontrolled transaction”; difficult to find comparables.
2.Cost Plus – costs incurred in a controlled transaction and then adding an arm’s-length mark-up to that cost base. Pros -Simple and easy to understand; Cons – difficult to find comparable mark-ups
3.Resale price – selling price less uncontrolled gross margin. Pros – commonly used by wholesellers/manufacturing businesses. Cons- not enough data for comparables.
4.Profit based methods – unlike the traditonals methods above, taxpayers tend to use profit based methods due to lack of comparables and these include:
(a)Transactional net margin method (TNMM) – compare net profit margin earned in a controlled transaction with the net profit margin in a comparable uncontrolled transaction.Net margin base could be sales, assets etc. Pros – Commonly used and easy to understand; Cons – not enough data for comparables.
(b)Profit split method – divides the profit based upon the relative contribution of each related party business to the transactions. Pros- used by multinational business; Cons- difficult practical application.

Non-resident company tax implications
1.Only chargeable to UK corporation if trading through a PE
2.Chargeable to other UK taxes to the extend the activities fall within UK ambit eg VAT if sales to UK > threshold
3.If dealing or developing land in UK, then UK tax resident
4.With regards to PE corporation tax is charged according to UK Acts & OECD Model Convention. OECD model has precedence over UK acts.
5.PE rules are found in s1141 CTA 2010 –
6.S19-32 explains how profits of a PE are determined

Rules for Companies using non-sterling currency ss 5-17 CTA 2010