Companies looking to set up an operation in the UK can do so in a number of ways. The two most common ways are to establish either a subsidiary or a permanent establishment. Alternatively, an individual or overseas entity may (i) look to acquire an established business in the UK, (ii) set up a joint venture company, (iii) enter into a partnership agreement, or (iv) simply appoint an agent or a distributor.
Buying a Company; Tax Considerations
Stamp duty is a transfer tax levied on documents. The purchaser of shares in a company incorporated in the UK will pay stamp duty on the value of the shares transferred at 0.5%.
Where shares are acquired, the purchaser is not able simply to cherry-pick the desired assets, but must also assume the historic liabilities of the business. Typically, a purchaser will require protection for such liabilities and, in general, tax warranties together with a tax indemnity will be provided by the vendor in favour of the purchaser. The warranties are designed to flush out information about the target company. The tax indemnity apportions tax liabilities between the purchaser and the vendor such that, generally speaking, the purchaser will be responsible for post-completion tax liabilities and the vendor will be responsible for pre-completion tax liabilities (together with any specific “post-completion” liabilities suffered by the target company for which the vendor will accept financial responsibility).
Tax Implications of a UK Presence
Companies resident in the UK, and non-UK resident companies carrying on a trade in the UK through a “permanent establishment”, will, in general, be liable to corporation tax on the profits (i.e., “income”) of their business. Capital gains (referred to as chargeable gains for corporation tax purposes) are computed separately from income but are included within the total profits chargeable to corporation tax. A UK subsidiary of an overseas company (like any other UK resident company) will pay corporation tax on its worldwide profits (subject to double tax relief for foreign taxes). The basic rule is that all companies that are incorporated in the UK and all companies whose central management and control is exercised in the UK are resident in the UK for tax purposes.
A non-UK resident company will only be subject to UK corporation tax if it carries on a trade in the UK through a UK permanent establishment. In certain instances and with careful consideration of the facts, it may be possible to create a presence in the UK without creating a permanent establishment. In this manner, there would be no requirement to pay corporation tax on such activities. This is possible when the activities carried out in the UK are of a preparatory and auxiliary nature or if there is no fixed place of business, provided that certain additional criteria are satisfied. UK domestic rules do not provide for permanent establishments to benefit from the lower rate of corporation tax. This, however, is subject to any non-discrimination articles contained in an applicable double tax treaty, and to the concessions afforded by HM Revenue & Customs (“HMRC”) who, in general, accept that a permanent establishment can claim the small companies rate (subject to all other criteria being satisfied).
The main rate of corporation tax is chargeable on income and chargeable gains and is currently charged at 24% when profits exceed £1,500,000 for the current financial year which runs from 1 April 2012 to 31 March 2013. A lower rate of 20% applies when the company's annual profits do not exceed £300,000. Marginal relief is available on profits up to £1,500,000, which provides (in effect) a sliding scale rate of corporation tax. A reduction of 1% per annum in the rate of corporation tax has been proposed for each year until 2014 when it is expected that the rate of corporation tax will be reduced to 22%. If the company has associated companies, the threshold figures are reduced according to the relevant number of associated companies. These threshold rules can sometimes encourage the establishment of a UK branch operation, rather than a separate UK subsidiary company.
Taxation of Dividends
Dividends declared and paid by a UK resident company are not subject to withholding tax. Withholding tax is a tax on a payment that is collected by a payer and that represents the payee’s tax liability on that payment. Withholding taxes are imposed for many reasons, e.g., to save the taxing authorities time and money and to target tax evasion.
Where profits are repatriated by the UK subsidiary, by way of dividend to a company or to an individual resident outside the UK, the applicable tax laws in the jurisdiction of the recipient will determine how the recipient is taxed on receipt of the dividend.
A foreign parent company may benefit from a participation exemption that will exempt dividends received from the UK subsidiary from tax in the foreign jurisdiction. Under the terms of most double tax treaties, where dividends are taxable, the underlying corporation tax will normally be allowed as a foreign tax credit.
The dividend will carry a tax credit of an amount equal to one-ninth of the amount of the dividend. It is possible, depending on the provisions of the relevant double tax treaty, that the recipient may be able to reclaim a very small proportion of the tax credit. If there is no double tax treaty or there is no such provision within the treaty, no tax credit will be available to a nonresident shareholder.
Where the double tax treaties that the UK has entered into provide credit for the underlying tax paid by a UK company, a corporate recipient of a dividend paid by a UK company will benefit from a foreign tax credit currently at 24%. To the extent that the rate of tax payable in the foreign jurisdiction exceeds 24%, a further amount of tax will be payable. If the rate of tax payable in the foreign jurisdiction is lower than 24%, no further tax is payable.
Dividends received by a UK resident company from both resident and non-UK resident subsidiaries (or indeed from portfolio investments) should generally be exempt from corporation tax, unless they fall within certain anti-avoidance rules.
Tax on Interest
The basic rule is that any company resident in the UK that makes yearly payments of interest to a non-UK resident must withhold tax on interest at a rate of 20%. Where interest is paid to a company resident in a country that has a double tax treaty with the UK, such interest payments may be exempt from withholding tax or the tax may be reduced.
Research and Development (“R&D”) Incentives
In general, companies are able to deduct all expenditures that are not capital in nature andwhich are wholly and exclusively paid for the purposes of the trade.
R&D is defined for tax purposes as occurring when a project is undertaken to achieve an advance in science or technology. For small and medium sized enterprises (“SMEs”), the R&D tax credit is claimed as a deduction (from the company’s taxable income) at a rate of 225% of the qualifying R&D expenditure incurred on or after 1 April 2012. Expenditure incurred prior to 1 April 2012 will benefit from a deduction of 200%. If the company does not make a profit it can surrender the R&D credit in return for a cash payment which is equivalent to 24.75 pence for every £1 spent on qualifying expenditure, for the year ended 31 March 2013. Large companies are entitled to a tax credit of 130%, but cannot claim a cash payment if the company is loss making.
The Patent Box
The UK Government has confirmed its intention to introduce the “Patent Box” and has published draft clauses for the Finance Bill 2012. The new legislation, once enacted, will introduce a 10% rate of corporation tax in respect of income generated from patents. It will apply to patents commercialised after 29 November 2010, but only to income generated from those patents from 2013 onwards.
Incentives to Invest in Small Companies
There are two schemes that are designed to encourage investment in unquoted small and medium-size enterprises in the UK. These are as follows:
- Enterprise Investment Scheme (“EIS”): The EIS provides relief from capital gains tax for qualifying shareholders on a disposal of shares provided that the shares have been held for three years and all other conditions are satisfied. Relief is also available against income tax for funds used to subscribe for new shares. EIS provides for a 30% reduction in the income tax liability on an annual investment limit of £1 million from 6 April 2012.
- Venture Capital Trusts (“VCT”): The VCT scheme allows individuals to invest in a special type of quoted investment vehicle. The VCT invests, in turn, in unquoted trading companies that satisfy certain criteria. The individual investors in the VCT are entitled to income tax relief at a rate of 30% where funds are used to subscribe for new shares. There is an annual investment limit of £200,000. Relief is also provided from income tax on dividends received in respect of the shares held (up to the limit of £200,000) and against capital gains tax on the disposal of shares.
A new form of venture capital scheme, the Seed Enterprise Investment Scheme (“SEIS”) has been introduced with effect from April 2012. The SEIS is designed to help start-up companies attract initial investment. Investors in the new qualifying companies will receive upfront income tax relief at 50% on their investment and capital gains relief on the disposal of shares. This relief is limited to very small businesses and it has low financial limits; the annual investment limit is £100,000.
Tax Implications When Selling a Business
Any gain made by a UK company on the disposal of a business (shares or assets) will be chargeable to corporation tax. Where the selling company is resident outside the UK the tax treatment of the sale will be governed by the rules of the country in which the selling company is resident.
Capital gains tax (“CGT”) on asset disposals is, broadly, payable by individuals who are UK resident in the year of disposal of the relevant asset. The tax on the gain is charged at a rate of 28% for those paying income tax at the higher and additional rates, and 18% for all other tax payers.
Disposals of Substantial Shareholdings
A company's net realised chargeable gains are subject to corporation tax at the relevant corporation tax rate. If a company subject to UK corporation tax makes a disposal of a "substantial shareholding" (i.e., a 10% holding of the ordinary shares) in a trading company or a holding company of a trading group, there is an exemption from the charge to tax on the disposal by a company to qualify for the relief the disposing company must have held the shares in the target company for at least one year and must continue to be a trading company (or the holding company of a trading group) immediately after the disposal.
Disposals of a limited category of assets may qualify for “Entrepreneurs’ Relief”, which can reduce the CGT rate to an effective 10% on £10 million of qualifying gains (this is a lifetime limit). This relief applies to various qualifying disposals (for example, shares or securities in a trading company, or the whole or part of a business) provided that certain other criteria are satisfied.
Individuals who are resident in the UK are generally liable to UK taxation on their worldwide income and gains. “Residence” is a question of fact and there is detailed guidance published by HMRC, describing the basis on which they will regard an individual as being resident in the UK for a tax year or for a part of a tax year. Special rules apply to resident but non-UK domiciled individuals – (see below).
Non-resident individuals will generally only incur UK taxation on income and gains relating to a trade carried on in the UK, or, in the case of income from employment, to the extent such income is attributable to duties of the employment performed in the UK. As regards income from investments, tax will normally only be charged (if at all) to the extent that tax is collected via deductions or withholdings made from payments of such income.
Income tax is charged on bands of income, principally at 20% and then at 40%, on taxable income for the tax year in excess of £34,370 (for the tax year 2012-2013). The top rate of income tax of 50% is payable on taxable income in a tax year in excess of £150,000.
Employees and employers also pay social security charges, known as “national insurance contributions”. The employee’s contributions are deducted from salary along with the income tax due. The employer’s contributions are currently charged at the rate of 13.8% on, broadly, the employee’s gross pay.
The UK also has an Inheritance Tax regime, whereby most gifts of assets during lifetime (unless the donor survives 7 years from the date of gift) or on death are subject to inheritance tax at rates up to 40%. Where chargeable gifts (or cumulative chargeable gifts if more than one, including those made on death) do not exceed a threshold figure, currently £325,000, tax is charged at a nil rate, only the excess above £325,000 is charged at 40%. Gifts of assets between spouses or civil partners are, in most cases, exempt from inheritance tax. In addition, certain business assets, including shares in many trading companies, can enjoy 100% relief from inheritance tax in certain circumstances.
For individuals who are not “domiciled” in the UK (domicile being a different concept from residence, concerned with where one’s true or ultimate home is or will be), the UK offers an attractive tax regime. Non-UK domiciled individuals are, generally, only liable to income tax and capital gains tax on their income and gains from overseas investments and assets to the extent such income or gains are “remitted” to (i.e., brought back into, or otherwise enjoyed in) the UK. However, for non-UK domiciled individuals who are long-term residents of the UK (resident for at least seven out of the nine previous tax years) this remittance basis of taxation, in the case of overseas assets, is now only available for any tax year if the individual elects to pay, for that year, a £30,000 additional tax charge.
With effect from April 2012, the remittance basis charge is £50,000 for individuals who have been UK resident for 12 years or more. Initially there was doubt as to whether US taxpayers resident in the UK could claim a credit for the remittance basis charge; fortunately, the IRS ruled in August 2011, that US citizens resident in the UK would be able to claim such a credit. Non-UK domiciled individuals are only liable to UK inheritance tax on gifts of assets which are situated in the UK. However, for inheritance tax purposes only, a non-UK domiciled individual who has been resident for at least 17 out of the last 20 tax years will thereafter be deemed to be UK domiciled (and hence subject to inheritance tax on his worldwide assets).
Partnerships (whether a general partnership, a limited partnership or a limited liability partnership) are generally treated as transparent for UK tax purposes. Accordingly, where the member of a partnership is the member company or an individual, the member will be taxed on its share of the profits as if they accrued to the member directly. In the event that a non-resident company is a partner or a member in a partnership that carries on a trade in the UK, the nonresident company will be considered to have a permanent establishment in the UK such that that partner/member’s profits will be subject to UK corporation tax at 24%, unless an alternative arrangement has been agreed with HMRC.
Double Tax Treaties
It is important to consider the impact of any applicable Double Tax Treaty. Such a treaty may cut across the basic rules above, for example, to enable a resident of another country coming to the UK on a short term work assignment (not exceeding six months) to be exempt from UK employment taxes.
Where a person (whether a company or an individual) is resident in the UK (under UK rules) and in his home country (under local rules), and there is a Double Tax Treaty between the two countries, that treaty will normally have a residence “tie-breaker” provision. This will determine in which country the person is to be treated as resident for the purposes of allocating taxing rights between the two countries under the treaty.
Whilst, as mentioned above, the UK regards an LLC as opaque, in certain circumstances the UK/US Double Tax Treaty does contain provision to allow US resident members of an LLC to access treaty benefits with respect to UK source income of the LLC.
Some Specific Matters
In certain circumstances, individuals who come to live and work in the UK for a period of time, but not to settle permanently:
- may be able, notwithstanding being technically “resident” in the UK, to avoid UK income tax on that part of their earnings from employment (if any) which are attributable to duties of the employment performed outside the UK; and
- may be able to avoid being drawn into the UK’s social security regime (under which theemployee contributes, by deduction out of salary, national insurance contributions and the employer pays separate employer’s national insurance contributions).
Companies Subject to Corporation Tax
There is a degree of competition between corporate tax regimes in Europe, and one of the pressures on Governments is to enhance their own country’s competitive position. Historically, tax factors which have been regarded as “positive”, so far as the UK is concerned, include:
- a relatively competitive top rate of corporation tax, currently 24%;
- generous rules as to deductibility of interest expenses (although some restrictions have been introduced - see below);
- no withholding tax on dividends paid out to shareholders;
- an exemption from tax on capital gains on the disposal of trading subsidiaries and certain minority interests in trading companies (known as the “Substantial Shareholdings Exemption”);
- an extensive network of double tax treaties and a comprehensive tax exemption regime to avoid double taxation of profits earned overseas and brought back to the UK; and
- an attractive tax regime for non-UK individuals (i.e., not UK domiciled) coming to base themselves in the UK.
The UK’s interest deduction rules have been amended to introduce a “worldwide debt cap” for international groups of companies. This is designed to restrict the tax relief available to UK members of a worldwide group on their finance expense by reference to the external consolidated finance costs incurred by the group as a whole. There is, however, an important exemption for the financial services sector. This new regime for corporations sits alongside both the UK’s existing transfer pricing/thin capitalisation regime and the Controlled Foreign Companies (“CFC”) legislation which itself is currently under further review.
Value Added Tax
The UK, as a member of the EU, operates the Value Added Tax system (“VAT”). In broad terms, a sale of goods or a supply of services by a business for a consideration may be – and; where vendor and purchaser are UK businesses, normally will be – subject to VAT. In certain industries, including financial services, insurance, gaming and healthcare, such sales or supplies are normally “exempt” from VAT. Some goods and services, including certain categories of foods, books and clothing, are “zero-rated”.
The current “standard rate” of VAT is 20%. It is the responsibility of the vendor or of the person supplying the services (at least where he or she is UK-based) to account to the tax authority for VAT which arises on a transaction. Accordingly, a vendor or supplier must ensure his sale price reflects this (or is expressed to be “exclusive of VAT”).
A business is obliged to register for VAT, and then charge VAT on its sales, if the value of its taxable turnover in the last 12 months has exceeded the registration threshold, currently £77,000, or if the expected value of its VAT taxable turnover (this only includes the goods and services that are sold on which VAT is charged) in the subsequent 30 days will exceed such threshold. If their turnover is below the threshold, businesses may register for VAT on a voluntary basis and it may often be advantageous to do so.
VAT is essentially a consumer tax. The idea behind the imposition of VAT is that it should be borne economically by the ultimate consumer of any goods and services supplied. A business that is trading in the UK will account to HMRC for the VAT that it charges on supplies (less an amount in respect of the VAT on supplies made to it). However, in those industries (see above) where sales to customers are “exempt” from VAT, the right to recover VAT incurred on purchases is restricted or prohibited.
In a cross-border context, UK VAT:
- is charged on most imports of goods into the UK (and for imports of goods from outside the EU, VAT, together with other Customs or Excise duties or tariffs, is generally paid at the point of import);
- is charged on the purchase of certain services by a UK business from businesses either in other EU countries or outside the EU – it is the UK business which has to account for such VAT under a special “reverse charge” rule;
- is normally “zero rated” on the export of goods to business (but not private) customers in the EU, or to any customer in a destination outside the EU; and
- is not charged on the supply of certain services by UK businesses to business customers in other EU countries or to customers generally who are outside the EU.