UK Company Tax Planning

UK Corporation Tax Planning & Compliance Made Simple

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Overseas profits and operations

Overseas tax matters including:
1.company 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 capitalization

WHAT AN OVERSEAS BUSINESS SHOULD CONSIDER BEFORE SETTING A BUSINESS IN UK

Options available to trade in UK: Branch, Subsidiary Or operate from home country & local agent, distributor or franchisee
Charge to corporation – UK incorporated (worldwide income) or PE or agent/franchise (no UK tax)
Residence rules – Incorporated in UK or central management & control in UK (case law: Debeers); where company is resident in more than1 country; OECD tie breaker clause based on place of effective management

Other factors to consider:

1.Both require Companies House registration, and similar registration with HMRC for direct tax, VAT and PAYE/NIC as appropriate.
2.A branch is easier to set up or wind down. Its automatically closed when the trade of the branch ceases. In contrast, closing a subsidiary requires a formal procedure (winding-up, striking off, or the appointment of a liquidator).
3.Anonymity – branch required to file overseas parent accounts at Companies House (which may not in public domain in home country). UK subsidiary is only required to file its own financial statements.
4.Regulatory requirements may dictate that a branch is used instead of having to adequately capitalise a subsidiary.
5.Branch subject to UK tax on parent company’s profits which are attributable to that branch. A UK subsidiary is subject to UK corporation tax on its worldwide profits.
6.Start-up losses of the branch should be available to the overseas parent to set against home profits, where the start-up losses will need to be carried forwards against future profits in the UK. Treatment trading losses for a company vs PE – if there is UK company then EU losses may be relieved (Marks & Spencer case).
7.A branch can be incorporated, when the UK venture has been established, without any UK tax costs using the reliefs for transfer of a trade.
8.Will there be withholding tax on any payments of interest and royalties from the UK? Does an applicable double tax treaty change the position?
9.Transfer pricing rules may if transactions between interco and this may affect the calculation of the profits of a branch or subsidiary for tax purposes. If large enough, may be required to prepare country-by-country report.
10.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?
11.CFC rules – may apply if overseas profits should be apportioned to UK that pass through the gateway.
12.DPT may apply if large multinational trading in UK but (i) avoiding UK PE or (ii) with no economic substance tax avoidance transactions.
13.Dividends treatment – Incorporating local subsidiaries that can result in trapped capital and tax leakage through dividend WHT; no WHT on branches; subject to CFC anti-diversion rules.
14.If large enough to come under the rules, required to publish its tax strategy on the internet.
15.If option to incorporate PE into a UK co then it’s a transfer of trade and can result in chargeable gains. However, provided that the relevant conditions are satisfied, reliefs are available to result in nil tax implications.

In conclusion, it’s easier to set or wind down a branch than subsidiary and for an overseas company testing the waters, a branch is better. However, business may become more profitable, and there may longer be losses to set against the UK profits and the business may want protection from liability for the parent company, and is a separate legal entity, a subsidiary, which can contract in its own name may be required.It is usually possible to incorporate the branch without any adverse UK tax consequences, provided the right steps are followed, and the relevant conditions are satisfied.

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.

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 stringent 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 exercised. However these could be different.

Controlled Foreign Companies Rules
1.What is a CFC? – A foreign company controlled by a UK person(s)
2.What is control – Economic or legal control through voting powers, shares, company articles or other documents.
3.What the purpose of the CFC legislation? Its an anti-avoidance legislation to prevent profits from being diverted from UK to low tax jurisdictions.
4.What is the tax implications for a CFC?- If a company is a CFC, and no exemptions applies, the profits pass through the gateways then a 20% charge on the profits apportioned to the UK source if the UK shareholder has at least 25 interest in the CFC.
5.What are the exemptions for a CFC? – Before CFC rules apply, one has to check the following exemptions apply: Period exemption – new CFC 12 month exemption period; Excluded territories; Low profit exemptions; Low profit margin exemption; Tax exemption
6.What are gateways? – Gateway acts as filters, only profits that pass through the gateways are charged UK tax. There are two steps to take: (i) – Does the profits pass through the gateway (ii). How much of the profits are subject to UK tests
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
7.What does “Profits attributable to UK activities” encompass? The default position is that gateways tests are applied to all CFCs. However this gateway is not applied if these PRE-GATEWAY tests are met (chapter 3 of TIOPA S371): Motive test; UK assets test; Can the CFC stand of its own two feet, are CFC made up of non-trading profits or property profits ONLY?

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

Diverted Profits Tax (DPT)
What is DPT – New tax for profits diverted from UK tax system
When is it effective – from April 2015
Why was it introduced – Multinationals used legal means based on existing legislation at that time to divert tax eg Amazon, Google, Starbucks etc
What circumstance may result in DPT being applied – Avoided PE or Insufficient economic substance (applies to both UK or non-resident companies through tax mismatch.
What is the interaction with other taxes: DPT takes priority over other taxes?
What is the rate? – 25% of taxable profits compared to 20% the current corp tax rate
What entities may be subject DPT – large multinationals with UK activities
Penalties – see FA 2015
Appeals – appeal must be normally be made within 30 days of the amendment and must state the grounds for appeal
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Advance Pricing Agreements (APA)
1.What is APA? Transfer agreement pricing agreed with the tax office (s) in one or more countries
2.What situations require APA? – Complex transfer pricing where no comparable market prices are not available.
3.Why a taxpayer may choose APA? Avoid surprises – enquiries, reviews from HRMC, interest and penalties; certainty on pricing.
4.How does the procedure work? Initial proposal to HMRC with details of transfer pricing; HMRC reviews and responds; Formal APA proposal with details workings provided to HRMC; results binding to all parties -usually lasts 3- 5 yrs

Transfer pricing rules
1.What are they? To determine arm’s length prices between connected parties
2.What is a connected part? – where one party participates in the control, mgt or capital of the other OR one party participates in the control, mgt or capital of both parties.
Controlled Foreign Company Rules

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