Many businesses which are subject to the UK corporate tax regime have their origins abroad. Most will have deliberately arranged their affairs to bring part of their business or a particular transaction within the UK tax net whilst a few will have inadvertently become subject to UK tax. This article considers the application of the UK direct taxation system to non-UK origin businesses from those two very different perspectives. In broad terms, it explains why some foreign businesses may choose to be subject to UK tax rules and warns others about the risks of doing business with the UK whilst expecting to remain 'off shore'.
A New Hope
Businesses looking to expand into, or within, Europe have always been attracted to the UK for non-tax reasons but, until recently, may have been daunted by the tax consequences. However, as a result of recent legislative changes the UK's business tax regime is arguably as competitive as that of jurisdictions such as the Netherlands, Ireland and Luxembourg.
The current corporation tax rate is 28%, which is significantly lower that the average rate over the last 20 years, and the new UK Government recently announced that the rate is to reduce by 1% in each of the next 4 fiscal years so that from 1 April 2014 it will be just 24%.
Perhaps more importantly, the UK can now boast an attractive tax regime both for inward investment and for the establishment of European holding companies.
In building international groups and structuring cross border transactions the management of withholding tax risk is often a significant problem. Many taxing regimes require that income such as interest, dividends and rents owed to a foreign counterparty be paid subject to deduction of tax. Tax is withheld from such payments on account of the foreign recipient's liability to tax on income sourced from the payer's jurisdiction. This inevitably results in additional funding costs and often times double taxation. The recipient will usually be taxed on the same income in its jurisdiction of residence so if the withheld amount is not fully creditable against that tax, nor otherwise recoverable, there will be an element of double-taxation.
A significant benefit of having group subsidiaries held under a UK holding company is that the receipt of dividends on shares held as an investment will not usually be subject to UK tax even when received from a non-UK subsidiary. And, when the intermediate UK holding company distributes its profits to the ultimate parent that payment is also free from withheld tax because the UK does not generally impose a withholding tax on dividend payments even if the recipient shareholder is overseas.
Rental income from UK real estate can also usually be paid gross to an offshore landlord without the deduction of UK tax. True, a UK borrower may be required to withhold tax at 20% on cross-border interest payments but, in practice, the borrower's obligation is often relieved under a Double Tax Treaty, the EU Parent/Subsidiary Directive or national law or the funding may be structured in a way that avoids the withholding requirement.
Access to its network of over 100 Double Tax Treaties is a further benefit of doing business in the UK. The UK procedures for claiming tax relief are already more efficient than in many other jurisdictions and became more so with the introduction of a "Treaty Passport" scheme from 1 September 2010. Under the new scheme a corporate lender established outside the UK may apply to Her Majesty's Revenue & Customs ("HMRC") for a "Treaty Passport" which effectively recognises the lender as a person entitled to Treaty relief and accelerates the processing of subsequent claims.
If a UK borrower is notified by its overseas corporate lender that it holds a “Treaty Passport” and the borrower passes this notification together with the lender's identifying number to HMRC, HMRC will issue a direction to pay interest at the relevant Treaty rate on the basis of that information.
It is not only in relation to income streams that the tax rules encourage investment. A non resident company which holds UK capital assets, for example land or shares, otherwise than for the purposes of a UK branch or permanent establishment is not subject to UK tax on any capital gain realised on the eventual disposal of the assets. Furthermore, even if shares are held by a UK permanent establishment or UK resident company any gain on disposal may still be retained tax free if the shares have been held for 12 months and constitute at least a 10% stake in a trading enterprise.
The announced reductions in corporation tax rates and other policy statements have created a new hope that the Coalition Government will continue with business-friendly reforms to the UK tax system. For example, the Government has already indicated its intention to introduce greater stability by slowing down the pace of change in relation to tax legislation and extending the timetable for pre-legislative consultation. It seems that even HMRC may adopt a less zealous approach to tax litigation. The Financial Times reported on 19 August that Dave Hartnett, permanent secretary for tax, had said that some officials had been too “tough” in tax disputes and that HMRC had sometimes been "too black and white about the law". However, a final word of caution, the tax rules mentioned above are intended to benefit commercial business arrangements and as such may not apply to arrangements entered into with the main purpose of enjoying the tax benefits.
HMRC Strikes Back
So far we have looked at reasons why a foreign business might voluntarily become subject to UK taxation. The remainder of this article considers how a foreign company may inadvertently become liable to pay UK tax and some of the risks attached to having business links with the UK.
Although the UK's business tax climate is now generally benign it may not look like that when viewed from a tax haven and a business new to the UK should never assume that a structure which 'works' for tax at home will have a similar effect in the UK. Anyone who has an interest in an offshore company which has any links to the UK needs to be aware of the risks attached to such links.
A company which is incorporated outside the UK may nevertheless become resident in the UK, and therefore subject to UK tax on its worldwide income, if its central management and control is exercised from within the UK. The risk is particularly acute for single or special purpose companies which are established in low/no tax jurisdictions but are effectively controlled by UK entrepreneurs.
HMRC has shown a marked willingness to challenge the residence of such companies on the basis that their central management and control is actually being exercised from the UK either because the Board Of Directors in fact makes strategic decisions from the UK or because some other committee or person located in the UK has usurped the strategic decision making powers of the Board.
Where transfer of residence to the UK is a potential problem it is important that the documented procedures of the company should address in detail the precautions which are necessary to limit the risk. UK tax counsel can assist on this procedural framework but it will only be effective to the extent that the company's managers follow the procedures in practice and accurately record the exercise of central management control in detailed and contemporaneous documentation.
The rules on the taxation of non-UK individuals who come to work in the UK have also changed significantly in recent years, from the 'day counting' counting rules in relation to the 183 days residence test through to the meaning of 'remittance' for resident but non-domiciled individuals. Consequently, employers who are seconding employees to the UK and, of course, individuals moving to the UK, even for only a few weeks, should always take advice on the UK tax consequences.
A second area of concern is the UK use of financial and business products which have been structured for an overseas tax regime. For example, successful foreign companies which are looking to expand in the UK may seek to attract staff with the offer of remuneration packages, including equity grants and options, on the same terms as those offered in their home jurisdiction. The UK has extensive legislation on the taxation of management incentives and a foreign incentive plan should never be used for UK staff or consultants without having been reviewed by tax counsel to ensure that it does not result in unexpected fiscal costs both for the employee and the employing company or give rise to reporting obligations which might otherwise have been overlooked.
Other common commercial documents which need to be reviewed by tax counsel before being used for UK parties included loan documents (to ensure both that the lender receives gross payments and that the UK borrower is entitled to tax relief on interest); all transaction between connected parties (the UK has extensive transfer pricing legislation based on the OECD model); and, all agency relationships.
Foreign businesses often choose to 'test the market' for their products and services in the UK by appointing a selling agent expecting that by doing so they can avoid any UK tax on their profits. Businesses familiar with civil law jurisdictions, in particular, may look to transact with UK customers through a "commissionaire" structure like that employed in continental europe. However, UK law does not recognise the "commissionaire" concept and is likely to interpret it as a simple agency. In that case, the offshore company may be subject to UK tax on the profits from the agent's activity and the agent may be liable to HMRC to account for that tax.
Fortunately, this charge to tax may often be avoided under an applicable Double Tax Treaty or UK legislation, for example the statutory investment manager exemption. But for these exemptions to apply, the agent should be both demonstrably independent of its principal and acting in the ordinary course of its business. HMRC has published extensive guidance on its approach to UK agents and any non-UK business should seek advice from tax counsel before appointing a UK based agent or "commissionaire".
So, in conclusion, although the UK tax systems offers many benefits it also has significant traps for the unwary. In particular, foreign businesses which have UK connections but intend to remain 'offshore' should consider having the consequences of their UK links reviewed by tax counsel.