When an overseas company decides to trade in the UK, one of the first decisions to make is whether to trade through a UK permanent establishment (a branch) or a UK subsidiary company. Tax should be an important driver in making that decision and this briefing highlights some of the tax issues that arise. By way of summary:
- A UK permanent establishment (PE) is part of the overseas company. A UK subsidiary of an overseas company is a legal entity in itself.
- If trading losses are likely, a UK PE is normally preferable to a UK subsidiary as the losses of the PE are usually available for offset against the overseas company's profits.
- UK corporation tax, VAT, transfer pricing and non tax-related issues should all be considered.
UK Corporation Tax
A UK tax-resident subsidiary will pay UK corporation tax on its worldwide profits (trading income and gains from the sale of capital assets), subject to credit for tax paid elsewhere.
A UK PE will not itself pay UK corporation tax. The overseas company (of which the PE forms part) will pay UK corporation tax if it carries on a trade in the UK through the PE. The overseas company will remain subject to local tax in the overseas jurisdiction, although that jurisdiction may provide for a credit in respect of the UK tax paid. The overseas company will pay UK corporation tax on profits 'attributable to' the PE. These profits include trading income arising through or from the PE and gains from the sale of capital assets that are used for the trade or for the purposes of the PE.
When calculating the profits attributable to the PE, the PE is deemed to be an entity distinct from the overseas company, operating at arms length with the overseas company. Therefore, the amount of UK corporation tax paid by an overseas company on profits attributable to its UK PE should be broadly similar to the amount of UK corporation tax paid by a UK subsidiary of an overseas company.
Because a UK subsidiary is a legal entity distinct from its overseas parent, trading losses made by the subsidiary will only be available to offset against the taxable profits of the overseas parent if the tax regime of the overseas parent allows this. Where the overseas parent is resident in the EU, EU law has provided some scope for the subsidiary to surrender its losses to its overseas parent.
A subsidiary that cannot offset its losses against the profits of its parent will carry forward those losses and use them against its own taxable profits in the future.
With a UK PE, trading losses made in the UK will usually be available for offset against the taxable profits of the overseas company. An overseas company in a high tax-rate jurisdiction could consider setting up a PE initially (when the possibility of trading losses is relatively high, so that the losses can be offset more easily overseas) and incorporate the PE further down the line (when the trade is profitable, so that the profits are taxed only at the lower rate).
Extraction of Profits
A UK subsidiary can pay dividends to its overseas parent without tax being withheld in the UK. Those dividends will be paid out of profits that have already borne tax in the UK (the 'underlying tax'). Usually the overseas parent will itself be taxed on receipt of the dividends and there will therefore be an element of double taxation. However, the tax regime of the overseas parent will usually allow some tax relief in respect of the UK underlying tax.
Because a PE is part of the overseas company, profits made by the PE are automatically treated as part of the overseas company's profits.
Value Added Tax (VAT)
A business operating in the UK should usually register for VAT in order to recover the VAT it incurs. A UK subsidiary will usually register for VAT in its own name. With a UK PE, the overseas company will usually register.