Over a number of years the UK has introduced a number of material changes to its corporate tax regime to make it an attractive tax environment to conduct business.
In particular, the United Kingdom has:
- a reduced its corporate tax rates (the standard rate is currently 20 per cent, with a reduction in 2017 to 19 per cent and further reduction to 17 per cent in 2020);
- b exempted UK-resident corporations from tax on the receipt of most dividends and abolished UK domestic withholding tax from dividends paid by UK companies, irrespective of the location and status of the holder, allowing dividends to flow into and out of the UK with no incremental UK tax;
- c completely reformed its controlled foreign company (CFC) regime to make it much more competitive;
- d a participation exemption known as substantial shareholding exemption (SSE) that, subject to meeting criteria about trading status, allows UK-resident companies to dispose of shareholdings of 10 per cent or more held for at least 12 months without being subject to capital gains tax;
- e reformed its taxation of the profits of non-UK branches; and
- f introduced a ‘patent box’ regime offering reduced corporate tax rates for profits derived from qualifying IP.
However, as will be seen from what follows, over the past few years the UK has passed legislation to implement a number of BEPS recommendations and at the same time has strengthened rules to counter what it regards as harmful tax practices. One practical effect of such measures has been to produce a tax system of very considerable complexity and not a little uncertainty. This system requires businesses to invest heavily in tax compliance. Coupled with the impact of Brexit, particularly on businesses from outside the EU that have used the UK as an entry point to European markets, it remains uncertain whether the UK’s stated aim of being an attractive tax location to conduct business will be undermined.
II COMMON FORMS OF BUSINESS ORGANISATION AND THEIR TAX TREATMENT
There are many different entities and business organisations through which business can be conducted in the United Kingdom. Numerous factors influence the final choice, notably market practice in the business sector, regulatory requirements and tax treatment. The most common types are described below.
The most commonly adopted vehicle for doing business in the United Kingdom is a limited liability company. Such companies can be incorporated quickly and cheaply, subject to agreeing the preliminary details such as the names of its officers, its registered address and its name; it is common to buy pre-formed or ‘off-the-shelf’ companies.
Although such companies can be limited by guarantee or unlimited, businesses generally use a ‘limited liability’ company, which is liable for all its debts and obligations without limit but where the investing shareholders’ liability is limited to the share capital they invest. This reflects the fact that, under UK law, a company and its shareholders are separate legal persons.
There are two forms of limited company: the private limited company (designated with the suffix ‘Limited’ or ‘Ltd’) and the public limited company (designated with the suffix ‘plc’).
Limited companies can issue share capital of different classes, if required, with each share class conferring different rights (to dividends, on voting, etc.). Share capital in a UK company can be denominated in a currency other than sterling. There are no minimum capital requirements for private companies, but a public limited company must have a minimum share capital to comply with UK company law, which is derived from the Second Company Law Directive (77/91/EEC). A UK public company has a minimum capital requirement of either £50,000 or €57,100, and this must initially be satisfied entirely in either sterling or euros (although only one-quarter, or £12,500, of this needs to be paid up, and the company may have shares denominated in currencies other than euros or sterling).
Only public companies can offer shares to the public, so it follows that all listed companies will be plcs. Not all plcs, however, are listed on recognised investment exchanges, or for that matter offer their shares to the public.
In return for providing the shareholders with limited liability, the law requires a degree of disclosure, and limited companies must file annual information that is kept on a public register, notably annual audited accounts (with some exceptions for small companies), details of its directors and shareholders, and details of share transfers.
Unless prohibited by the company’s constitution, the directors and the company secretary can conduct the company’s affairs and bind it. The directors are subject to statutory obligations that ensure that when they act they pay proper regard to the interests of shareholders, creditors and employees; thus, for example, if a director allows a company to continue to trade while insolvent, such director may be held personally liable for the company’s debts.
Directors of UK limited companies do not have to hold shares in the companies or reside in the United Kingdom, and no professional qualifications are required.
A detailed description of how companies are taxed is set out below. Broadly, however, a UK-resident company is taxed on its worldwide profits calculated on the basis of the profits shown in its audited accounts as adjusted in accordance with tax principles.
Partnerships are used by many businesses in the United Kingdom, notably by professions such as accountants, lawyers and doctors, and as investment vehicles for private equity. They can take several forms: contractual or general partnerships, limited partnerships and limited liability partnerships (LLPs).
A straightforward contractual partnership has no separate legal personality (although a Scottish partnership is an exception) and the partners are liable for the acts of the partnership. For tax purposes, a contractual partnership is transparent.
A limited partnership must have a ‘general’ partner, which has unlimited liability for the partnership and which generally manages the partnership’s business affairs. The limited partners’ liabilities are limited to their capital contributions, rather like a shareholder in a limited company, and they are not permitted to participate in the general management of the partnership.
The Limited Liability Partnerships Act 2000 introduced LLPs. An LLP has similar disclosure and filing requirements to UK limited companies, including the filing of an annual return and accounts. An LLP has separate legal personality from its members, but for tax purposes is transparent provided it carries on a trade or a business for the purpose of making a profit. Her Majesty’s Revenue & Customs (HMRC) has confirmed that the word ‘business’ may be widely interpreted, so, for example, it would only be in exceptional circumstances that holding and managing a portfolio of investments, or letting a building on a commercial basis, would not be considered a business.
UK general partnerships, limited partnerships and LLPs are all generally transparent for UK tax purposes. The activities of the partnership are treated as being carried on by the individual partners. Partners are individually responsible for reporting and paying the tax due on their share of the partnership’s profit and gain.
Although generally one partner is nominated to complete and file a tax return for the partnership showing the aggregate taxable profits and the partners’ allocated shares, the only purpose of such return is to enable the partners to extract their share of the profit from it to include in their tax returns. The partnership tax return is not used to pay tax for the partnership, as happens when a corporate entity submits its tax return. On 9 August 2016, HMRC started a consultation process on the means by which a partnership may be taxed in future. One proposal (that is unlikely to apply to an investment partnership) would require the nominated partner to provide HMRC with details of all partners and their respective profit shares.
The UK individual partners’ shares are calculated on the same basis as an individual would calculate profit, including UK and worldwide profits. An individual will pay income tax on partnership profit and capital gains tax on their share of partnership gains at their applicable personal tax rates, and a corporate partner will be subject to corporation tax on its allocated profit share at its effective rate of corporation tax. Where the partnership includes a non-UK partner or partners, however, there must be a second partnership return showing only the UK profits, as non-resident partners will not be subject to UK tax on profits derived from activity outside the United Kingdom.
A partner is normally self-employed for tax purposes, so there are more liberal rules about offsetting expenses, and since partners are not employees (although salaried partners may be), no employers’ national insurance contributions (NIC) will be payable and partners will be subject to a different rate of NIC.
In the 2014 Finance Act, rules were introduced to counter some perceived abuse in the use of partnerships in certain areas that cause loss of tax to the UK Treasury. In particular, there was concern that firms were disguising what in reality are employment relationships as self-employed relationships by making employees partners in LLPs (to benefit from the above NIC advantages) and, in addition, that there are abuses through certain arrangements involving allocation of profits and losses among partnerships with mixed memberships.
Where there are partnerships with non-individual members, in certain circumstances profits allocated to such non-individual members may be reallocated to an individual member, for example if an individual member forms a company, makes it a partner in the LLP and then artificially diverts his or her profit share to such company.
As regards disguised employments, in broad terms, if three conditions are met by a member of an LLP incorporated under the Limited Liability Partnerships Act 2000, that person will be treated as an employee, but if any of the conditions are not met then the member can be treated as a self-employed partner.
Broadly, the three conditions are:
- a It is reasonable to expect that at least 80 per cent of the total remuneration received by the member during the relevant period is disguised salary (i.e., not linked to the LLP’s profits).
- b The member does not have significant influence over how the affairs of the LLP are run. The logic is that one would expect the owner of a business to have such influence whereas an employee would not.
- c The member’s capital contribution to the LLP is less than 25 per cent of the total amount of the disguised salary.
Although, for tax purposes, the activities of a general partnership are treated as carried out by the individual partners, registration for value added tax (VAT) purposes can be made in the name of the partnership.
iii UK permanent establishment (PE) (place of business or branch)
An overseas company can set up a UK PE. For example, a French company could rent an office and employ staff, and start to trade in the UK through that office. Such a UK PE is the same legal entity as its non-UK parent, which is therefore liable for the obligations incurred by its UK business.
UK law (the Overseas Companies Regulations 2009) governs foreign companies operating in the UK. It provides that foreign companies (but not partnerships or unincorporated bodies) must, within one month of opening a UK establishment, register prescribed particulars of the foreign company and the UK establishment with the Registrar of Companies (the authority charged with the administration of UK companies), including:
- a the non-UK company’s corporate name, legal form, register in which it is registered and its registration number;
- b a certified copy of the foreign company’s constitutional documents, together with a certified translation if they are not in English;
- c details of the directors and secretary of the foreign company; and
- d particulars of the UK establishment including its name (if different from the name of the overseas company), address, the date it was opened, the business carried on by it, and the name and address of every person resident in the UK who is authorised to accept service of documents on behalf of the foreign company with respect to the establishment.
From 1 October 2011, overseas companies no longer need to register charges they create over their UK assets with Companies House. In general, foreign companies must file with the Registrar of Companies any accounting documents that they are required to prepare and disclose under the law of the country in which they are incorporated. The specific filing requirements vary depending on whether a foreign company is incorporated within or outside the EEA, it is a credit or financial institution, or it is a company whose constitution does not limit the liability of its members.
Every foreign company that has registered a UK establishment must, with some exceptions, display at its places of business its name and the country in which it is incorporated. Its name and other prescribed information must also appear on all business letters, websites and other specified correspondence used in its UK activities. There are also restrictions on the name the overseas company can register in the United Kingdom.
A non-UK-resident company that carries on a trade in the United Kingdom through a UK PE is subject to UK corporation tax on its profits, broadly calculated and charged as if the PE were a UK company. Like a UK-incorporated company, a UK PE is taxed on profits, but only to the extent that they are properly attributable to such PE. Agreeing how profits should be allocated can sometimes be an area of dispute. Unlike a UK company, which needs to pay a dividend to extract profits, the net profit of a UK PE can simply be paid to the non-UK owner.
A PE is sometimes used where the non-UK company anticipates that in the early period of UK trading, losses will be made that can be used to offset profits of the non-UK owner if the business is run through a PE.
III DIRECT TAXATION OF BUSINESSES
i Corporation tax
UK companies are subject to corporation tax on all worldwide profits, whether such profits are income or capital in nature. Profits for corporation tax purposes must be calculated in accordance with generally accepted accounting principles (GAAP), subject only to any adjustments required or authorised by law. The key adjustments are for losses, allowances and expenditure that, while reflected in the accounting profits, are not allowed for tax purposes so are added back when calculating profits for tax purposes.
Calculation of taxable profits
UK-resident companies (see Section IV, infra) are subject to UK corporation tax on their profits, wherever they arise. A non-UK company that trades in the United Kingdom through a PE (branch or agency) is subject to corporation tax on the profits of the branch or agency, which are broadly calculated as if the PE were a stand-alone company in its own right.
Corporation tax is charged on the profits of each financial year, which runs from 1 April (so, for example, the 2014 financial year is the year from 1 April 2014 to 31 March 2015). The tax charged for such financial year is based on the accounts of the company prepared for the accounting period that falls in that financial year (an accounting period is generally 12 months, but while it cannot exceed 12 months, it can be less). Where the company’s accounting period and accounts for such period do not coincide with the financial year, the profit shown in the relevant set of accounts is, when required, apportioned, on a time basis, between the financial years that overlap the accounting period.
Calculation of income profit
The most common adjustments to accounting (income) profits before they are taxed are as follows.
Although all expenses incurred by the company will depress accounting profit, not all such expenses will be allowed for tax purposes. To be deductible, an expense must be ‘wholly and exclusively’ incurred for the purposes of the company’s trade. Whether an expense is so incurred is a question of the company’s intent in incurring a cost and is thus a question of fact. It is often clear and obvious that an item of expenditure was incurred to promote the interests of the trade, such as paying staff salaries or suppliers of raw material used to make products produced by the trade. The position is not always clear, however, and there is a great deal of case law that considers when an item of expenditure, deducted in the accounts, is also deductible for tax purposes; for example, expenditure may be incurred on fees connected with changes to share capital, which would generally be regarded as non-deductible, as such an expense is incurred in connection with the company’s capital structure, not its trading activity. In addition, expenditure incurred with a dual purpose, such as the cost of an airfare of an employee who goes on holiday but visits a customer while on the holiday, would generally be disallowed.
In addition to the general rule that expenditure must be wholly and exclusively incurred for the purpose of a trade to be deductible, there are a few important cases provided for in legislation that make specific items of expenditure deductible or non-deductible for corporation tax purposes, irrespective of whether such cost was incurred in the course of trade. The most important example of this is probably expenditure on business entertainment. Irrespective of the purpose of incurring expenditure on business entertainment or gifts, the general rule is that it is not deductible. Conversely, incidental costs of obtaining loan finance, such as bank fees and commissions, which under the general rule may be regarded as linked to capital rather than trading, are specifically allowed as a deduction.
Depreciation (capital allowances)
Accounting depreciation is generally not the basis upon which tax depreciation is based, and tax depreciation is based on a system of capital allowances. There a number of exceptions where tax broadly follows accounting amortisation, most notably in the case of intangible fixed assets and loan relationships.
‘Intangible fixed assets’ defined by GAAP include patents, trademarks, copyright and goodwill. Such assets, provided acquired or created after 1 April 2002 (internally created goodwill for accounting periods starting after 22 April 2009), will be amortised in accordance with the amortisation in the accounts prepared in accordance with GAAP.
Although not all capital expenditure qualifies for capital allowances, allowances are normally given for expenditure on things such as plant and machinery, and R&D.
Expenditure on plant and machinery is pooled for capital allowance purposes and generally depreciated for tax purposes at 18 per cent per annum on a reducing balance basis. In the case of long-life assets (assets with an anticipated working life of 25 years or more), the rate is reduced to 8 per cent per annum. Small companies may have enhanced allowances. If assets are sold at a price above their tax-depreciated value there may be a claw back of allowances, or if assets have been under-depreciated there may be a balancing allowance.
Trading and income losses
If there is a trading loss in any year, the loss can be offset against total profits (income or capital) for the current accounting period of the company. The trading loss can be set against all profits (including chargeable gains) and not just the profits arising from the same trade as that in which the loss was incurred.
Excess trading losses can also be surrendered to another UK company in the same group or consortium (see below for a description of the taxation of groups), or carried back to set off against the company’s total profits (income or capital) of the preceding year.
Income and trading losses can also be carried forward indefinitely, but only against income profits and only against income profits arising from the same trade.
R&D tax credit
Relief is available for expenditure on revenue on R&D. The nature and rate of relief depends on whether the company is a large company or a small or medium-sized enterprise (SME).
The relief for SMEs provides a greater than 100 per cent deduction for all qualifying R&D expenditure in computing profits for corporation tax purposes. Relief is given at 230 per cent for SMEs in relation to expenditure incurred on or after 1 April 2015. The enhanced tax benefits used to apply only to small companies but now extend to medium-sized companies (companies with fewer than 500 employees, with an annual turnover not exceeding €100 million or a balance sheet not exceeding €86 million, or both, that meet certain independence and going concern tests). If an SME is loss making after deducting the R&D relief, it can elect to surrender the loss relating to the R&D expenditure and SME R&D relief and take credit in cash from the HMRC. A separate relief, similar to that available to an SME with some modification, exists for large companies but is being phased out and replaced by an R&D expenditure credit (also known as the ‘above the line’ tax credit) for R&D expenditure incurred on or after 1 April 2016. Large companies may make an irrevocable election to use the R&D expenditure credit for expenditure incurred on or after 1 April 2013.
Under this new regime, large companies will be able to claim a nominal 100 per cent deduction for R&D expenditure plus an extra 30 per cent deduction. Large companies, unlike SMEs, cannot surrender a loss to HMRC in return for a payment. Under the old regime (pre-April 2016), large companies could claim an ‘R&D expenditure credit’ equivalent to 9.1 per cent of the qualifying R&D expenditure incurred that they could offset against tax or surrender to other group companies.
An added attraction of the new regime is the way in which it appears in the company’s accounts. The credit is recognised as part of the company’s profit before tax (hence the reason it is called an ‘above the line credit’) and so will have a favourable impact on a company’s accounting profits.
Conditions are attached to ensure that the credits meet EU state aid requirements; in particular, an SME’s expenditure is capped at €5.7 million per project.
Expenditure that qualifies for R&D credit is defined by reference to expenditure that qualifies under GAAP, subject to certain exclusions. Most notably, to qualify, the R&D must seek to achieve a general advance in knowledge or capability in a field of science or technology, not just a company’s own knowledge or capability; furthermore, the research does not have to be successful for the revenue expenditure to qualify for R&D credit.
Calculation of capital (chargeable gains)
A company is potentially liable for corporation tax on any chargeable gains arising from the disposal of a capital asset. The gain is taxed at the same rate as an income trading profit, and is the difference between the original acquisition cost and the disposal value minus designated allowable expenses (e.g., the costs of improvements and an allowance for inflation).
If a capital asset qualifies for capital allowances, these are deducted from the acquisition cost, but only to eliminate or reduce a loss so that if, for example, the asset is sold at a gain, capital allowances are ignored.
Unlike trading losses, capital losses can only be set off against chargeable gains in the same or future accounting periods. Capital losses can be carried forward indefinitely, but not back.
Anti-avoidance rules exist that restrict the ability to buy loss-making companies to use their capital losses, and the use of capital losses made on transactions with related parties.
Rollover relief is available to companies that reinvest the proceeds from disposals of certain types of capital assets into new capital assets. This allows any gains on such assets to be deferred until the new asset is sold, unless the proceeds of that sale are also reinvested.
Subject to the selling company and company being sold meeting certain trading company criteria, broadly a company that holds at least 10 per cent of the share capital of another, and has held such interest for 12 months, may qualify for SSE on a disposal of those shares so that any gain arising on disposal is completely exempt from tax on the capital gain.
Rates of corporation tax
The rates of corporation tax are set for each financial year, and if the rate changes during a company’s accounting period, the profits are generally split between the two financial years on a time-apportioned basis and the different rates applied to the relevant part. The corporation tax rate for the financial year commencing on 1 April 2016 is 20 per cent, to be reduced to 19 per cent from 1 April 2017 and to 17 per cent by 2020.
Unlike the position in some other jurisdictions, a group is not taxed as a single entity in the United Kingdom, and members of a group are taxed on an entity-by-entity basis but with rules to allow sharing of tax relief and movements of assets between group members on a tax-neutral basis.
The definition of a group for UK tax purposes differs according to the context, but as a broad rule a company will be grouped with another if 75 per cent of a company’s ordinary share capital (which gives proportionate economic rights, broadly 75 per cent of the right to any dividend paid and assets distributed on a winding-up) is owned by that other company.
Subject to certain exclusions, UK companies within a capital gains tax group may transfer assets between them without triggering a capital gain or UK stamp duty.
Current year trading losses (not carried-forward losses or capital losses) and certain other deductions such as debits on loans can be surrendered between group members.
Administration and payment
UK companies self-assess by submitting a tax return within 12 months of the end of their accounting period (nine months for small companies with profits of £1.5 million or less). If the return is filed late there is a small fixed penalty, which increases to 10 per cent of the unpaid tax if the return is submitted more than 18 months after the end of the accounting period, and then to 20 per cent if the return is more than two years late. Companies (other than small companies) pay their corporation tax by quarterly instalments: two in the current year and two after it has finished. The first payment is due six months and four days after the start of the accounting period; the second nine months and four days after the start of the accounting period; the third four days after the end of the accounting period; and the final payment three months and 14 days after the end of the accounting period. However, for accounting periods starting on or after 1 April 2017, this will change to quarterly payments in the third, sixth, ninth and 12th months of the accounting period.
ii Other relevant taxes
The United Kingdom has no capital duties but does levy stamp duties. Stamp duty land tax (SDLT) is charged on the execution of some documents that transfer UK land generally at rates of up to 5 per cent on commercial property and 12 per cent on residential property, unless the purchaser is a non-natural person (see below). SDLT does not apply in Scotland, where Land and Buildings Transaction Tax applies. Stamp duty is charged on instruments that transfer UK company shares or securities (usually at 0.5 per cent). Securities generally exclude ordinary commercial loan capital, provided such loan capital has no equity-type characteristics, such as a yield linked to profit. Agreements to transfer UK company shares or securities, or shares of a non-UK company that maintains a UK register of such shares or securities, may attract stamp duty reserve tax (SDRT) (usually at 0.5 per cent). If stamp duty is paid on the instrument of transfer within prescribed time limits, the SDRT charge on the contract pre-dating the formal transfer document need not be paid.
To discourage the practice of buying residential property in an offshore company then transferring shares in such company without paying SDLT, SDLT is charged at 15 per cent on interests in residential dwellings costing more than £500,000 purchased by certain non-natural persons such as companies, collective investment schemes, and partnerships with one or more members who are either a body corporate or a collective investment scheme. Additionally, from 1 April 2013, any such non-natural person that owns a residential dwelling will be subject to an annual tax on enveloped dwellings (ATED). The amount of ATED is worked out using a banding system based on the value of the residential property. Currently, there are six valuation bands and six corresponding levels of charge from £3,500 per annum for properties worth between £5000,000 and £1 million up to an annual charge of £218,200 for a residential property worth more than £20 million. Capital gains tax applies on a sale of properties in this regime from April 2013, even for non-UK-resident entities. In respect of both the SDLT charge and ATED, there are exclusions notably for companies acting in their capacity as trustees for a settlement and property developers or property rental businesses that meet certain conditions.
VAT is a tax on non-business consumers, and for most business is an administrative burden rather than a tax cost. VAT is charged on goods and services supplied in the course of business. If the customer is itself a business, is registered for VAT and uses the supplies it receives for business purposes, the business will receive credit for the VAT it pays (input tax), which it can offset against the VAT it charges (output tax). If a business is charged more VAT than it charges its own customers it can reclaim the difference, but if it charges more than it is charged it pays the difference to HMRC. Thus, generally the burden is passed down the supply chain until it reaches the ultimate non-business consumer who bears the cost.
Certain supplies are exempt from VAT, notably supplies of shares and securities (including loans), and certain supplies of land and buildings. Other supplies are zero-rated, such as books, food, transport, children’s clothing and supplies of goods and services outside the United Kingdom. In cash terms, a zero-rated supply (where VAT is charged at zero per cent) is the same as an exempt supply (where no VAT is chargeable), but the difference is that a business can generally recover VAT incurred on costs incurred in connection with a zero-rated supply but may not recover VAT on costs incurred in respect of exempt supplies.
Currently, UK businesses with a taxable turnover greater than £83,000 in the preceding 12 months (the £83,000 limit applies from 1 April 2016 but is subject to regular increase), or where there are reasonable grounds for expecting that turnover in the next 30 days will exceed this limit, must register for VAT. Businesses may also choose to register if they anticipate being able to reclaim material amounts on VAT charged by their suppliers.
VAT has been generally charged at 20 per cent, with some exceptions such as a rate of 5 per cent on home energy. Taxpayers are required to maintain detailed records of output and input tax. Large taxpayers pay tax monthly, as do those who regularly reclaim; others may pay quarterly.
Income tax and social security contributions
Unlike corporate tax rates, the United Kingdom’s income tax rates are relatively high; this is a factor that a business thinking of moving into the United Kingdom and relocating staff will need to take into account. In the current tax year (to 5 April 2017), individuals pay tax on total chargeable income at 20 per cent (the basic rate) on the first £32,000 of their income, then at 40 per cent (the higher rate) on income above that figure up to £150,000, then at 45 per cent (the additional rate) on income above £150,000.
There are personal (tax-free) allowances on the first slice of income (generally £11,000 in the current tax year). Dividend and savings income is taxed at slightly lower rates.
Employers are required to deduct income tax from their employees at source and account to HMRC under a system known as pay-as-you-earn.
In addition to income taxes, UK employees (other than the very low-paid) and their UK employer are subject to NIC. In the current tax year (to 5 April 2016), a UK employer must pay NIC at 13.8 per cent of their employees’ gross earnings. The self-employed also pay NIC, but at lower rates.
Employees must also pay NIC on their earnings and the employer is responsible for collecting it from their earnings. It is charged at a fixed rate (currently 12 per cent) between a threshold and an upper earnings limit (currently £43,000), and thereafter at 2 per cent.
The government has been involved in a review of this area of the law with a view to simplifying the taxation of employment income. To this end, the Treasury has announced plans to consider the integration of income tax and NIC; the government’s plans, however, acknowledge that closer alignment will not be easy and, realistically, envisages that if it is to be achieved a generous time frame will be needed for its implementation.
IV TAX RESIDENCE AND FISCAL DOMICILE
UK residence is central to the taxation of businesses. A UK-resident company is subject to UK corporation tax on all its worldwide profits, wherever they arise. A non-UK-resident company that carries on a trade in the United Kingdom through a UK PE is also subject to UK corporation tax on its profits, wherever they arise, but only to the extent such profits are properly attributable to such PE.
Chapter 3A in Part 2 of the Corporation Tax Act 2009 exempts all profits (including chargeable gains) attributable to non-UK PEs of UK-resident companies from UK corporation tax. To apply, the UK company must make an irrevocable election. Elections are made on an individual company basis, covering all PEs of the electing company. The relevant profits of the non-UK PEs are determined in accordance with the relevant double taxation treaty (DTT) with the jurisdiction where the PE is based. The regime contains anti-avoidance rules to prevent the artificial diversion of profit from the UK to an exempt PE.
If a company is not UK-resident, nor has a UK trade carried on through a UK PE, its exposure to UK tax is limited primarily to taxes on UK-sourced income.
i Corporate residence
A company can be UK-resident either by being incorporated in the United Kingdom under the UK Companies Acts or, if incorporated outside the UK, by virtue of having its central ‘management and control’ exercised in the United Kingdom.
This test derives from case law, notably the leading case of De Beers Consolidated Mines v. Howe,2 in which the House of Lords adopted a fact-based test of UK residence that became known as the central management and control test.
The De Beers case laid down two important principles: that a company is UK-resident if managed and controlled in the United Kingdom, and that where such management and control is exercised is a question of fact. These principles were expanded and clarified in later cases.
In the case of American Thread Co v. Joyce,3 the House of Lords made it clear that management and control is not day-to-day management but strategic and policy decisions, and that such decisions are generally as a matter of fact taken by directors. HMRC is threatening to change this test so it is more akin to the OECD test for a ‘place of effective management’, which takes into account wider management functions.
However, while the presumption is that management and control are exercised by a company’s board, the facts are still paramount, so if, factually, control is exercised outside the board, one looks to where that control is actually exercised. When considering where the ‘central management and control’ exists, it is essential to distinguish cases where management and control are exercised through a company’s constitutional organs from cases where the decisions of those constitutional organs are usurped, and to further distinguish between cases where an ‘outsider’ proposed, advised and influenced decisions taken by the constitutional organs, and cases where such an outsider dictated the decisions and ‘usurped’ such constitutional organs.
The cases illustrate the importance of ensuring that the board exercises real discretion and does not merely rubber-stamp decisions taken elsewhere, and that contemporaneous records supporting this are kept.
Residence questions are rarely clear-cut, and the determination will be dependent on what occurs in practice and on the supporting evidence.
Sometimes different tests of residence are applied in different jurisdictions, with the result that a company may be regarded as resident in more than one jurisdiction. In such cases the company is dual-resident, and one has to look to DTTs to avoid exposure to double taxation. Treaties that follow the OECD model usually contain a clause that refers to a company being resident in the jurisdiction where it has its ‘place of effective management’. The OECD commentary states that the place of effective management is the place where key management and commercial decisions necessary for the conduct of the company’s business are made, which is normally where the board of directors makes its decisions, but stresses that one must consider all facts and circumstances. HMRC takes the view that this means that, when looking at the ‘place of effective management’, one has to have regard for the day-to-day management of the company, and not just the highest level of decision-making required by the UK management and control test.
ii Residence through a UK branch or PE
As stated above, a non-resident company is only subject to UK corporation tax if it carries on a trade in the United Kingdom and such trade is conducted through a UK PE. What constitutes a trade is a question of fact determined by looking at certain criteria known as ‘the badges of trade’ laid down by UK case law, as there is no satisfactory statutory definition of what constitutes trading.
The UK definition of a PE is based on the OECD Model Treaty definition, and means a fixed place of business through which its business is wholly or partly carried on. A fixed place of business includes:
- a a place of management;
- b a branch;
- c an office;
- d a factory;
- e a workshop;
- f an installation or structure for the exploration of natural resources;
- g a mine, an oil or gas well, a quarry or any other place of extraction of natural resources; or
- h a building site or construction or installation project.
UK law also follows the OECD Model in excluding from the definition of what constitutes a UK PE activities carried on at a place of business that are preparatory or auxiliary in character. Such activities include:
- a storing, displaying or delivering the company’s goods or merchandise;
- b maintaining the company’s goods or merchandise for the purpose of storage, display or delivery, or processing by another person;
- c purchasing goods or merchandise for the company; and
- d collecting information for the company.
In addition, if a non-UK company has a UK agent that habitually exercises authority to conduct the company’s business in the United Kingdom, such agent will also be a PE of the company unless such agent has independent status and acts for the non-UK company in the ordinary course of its (the agent’s) business.
It is not enough for a company to have a PE in the United Kingdom: it must also be trading in the United Kingdom, not just with it. To determine this, one must look at where the operations take place and where the profits arise, and a key factor is where the contracts are entered into (see Firestone v. Llewellin).4
V TAX INCENTIVES, SPECIAL REGIMES AND RELIEF THAT MAY ENCOURAGE INWARD INVESTMENT
As stated elsewhere in this chapter, the United Kingdom can be attractive as it has:
- a low corporate tax rates;
- b no withholding from dividend payments and a wide exemption from tax on receipt of dividends;
- c a wide treaty network that offers treaty relief from withholding from interest and royalties;
- d generous rules for allowing deductions for borrowing costs even if such borrowing was for a capital purpose such as acquiring a subsidiary; and
- e substantial shareholder exemption that can exempt gains on the sale of 10 per cent (or more) shareholdings in trading companies.
The United Kingdom introduced a patent box regime from 1 April 2013 that applies to all patents (but not copyright, know-how, etc.) first commercialised after 29 November 2010.
The regime applies a 10 per cent tax rate to all relevant profits (royalties, fees, sale proceeds, sales of products with embedded patent rights and compensation) derived from the active exploitation of qualifying patent rights. The full benefit of the lower tax rate will be phased in over a five-year period during which one needs to apply an appropriate percentage to the profits the company earns from its patented inventions.
The appropriate percentages for each financial year are:
- a 1 April 2015 to 31 March 2016: 80 per cent;
- b 1 April 2016 to 31 March 2017: 90 per cent; and
- c from 1 April 2017: 100 per cent.
Qualifying patents will be restricted to those registered with the European Patent Office or United Kingdom Intellectual Property Office. The party claiming relief need only to have a beneficial interest.
The regime has been subject to a challenge by the EU’s Code of Conduct Group, which determined that it violates the EU Code of Conduct on Business Taxation. In addition, some OECD members have raised objections to the UK and other EU Member States’ patent box regimes on the basis that they were potential ‘harmful tax practices’, and Action 5 of the OECD BEPS also had an impact. In response, HMRC has introduced changes to the UK regime, including proposals that for new entrants to the regime (post 1 July 2016), the majority of (R&D) activities must be conducted in the UK (the nexus principle). These proposals will require material administration and record-keeping to accurately identify qualifying expenditure.
VI WITHHOLDING AND TAXATION OF NON-LOCAL SOURCE INCOME STREAMS
There is no UK withholding tax from dividends paid by a UK company irrespective of the status or location of the holder. Since 1 July 2009, the United Kingdom has operated an exemption regime (prior to 2009, it operated a credit scheme) for dividends received by a UK company, the effect of which is broadly that, provided the company is not involved in a tax-avoidance scheme of which the dividends form part, dividends are exempt upon receipt. To be exempt, a dividend must meet a number of conditions apart from the tax-avoidance condition. The exemption will not prevent dividends received by share traders and others receiving dividends on trading account being taxed in the normal way.
A small company (one that has fewer than 50 employees, and whose annual turnover or annual balance sheet total (or both) does not exceed €10 million) can receive all dividends free of tax provided the dividend is not capital in nature and is not deductible for the payer, and the payer is not based outside the United Kingdom in a non-‘qualifying territory’. A qualifying territory is one with which the United Kingdom has a DTT containing a non-discrimination provision.
All other companies can receive dividends on an exempt basis if, as well as meeting the anti-avoidance test and the dividend being non-deductible for the payer, the dividend falls into an exempt class.
The main exempt classes of dividend are:
- a the ‘control exemption’: dividends paid by a company to a company that controls it;
- b the ‘ordinary shares exemption’: dividends paid in respect of (non-redeemable) ordinary shares;
- c the ‘portfolio exemption’: dividends paid on portfolio shareholdings where the shareholder holds less than 10 per cent of the issued share capital of the paying company; and
- d the ‘relevant profits exemption’: dividends paid out of ‘relevant profits’ being effectively ordinary profits derived from transactions that do not have the effect and main purpose of having a more-than-negligible reduction in UK tax.
Non-exempt dividends are taxed at the normal rates of corporation tax subject to potential credits for withholding and underlying taxes. UK individuals are taxed on dividends received, and the corporate exemption has no equivalent.
The United Kingdom imposes withholding tax (currently at 20 per cent) on payments of annual interest by a UK resident (interest on loans with a term of less than a year can be paid gross). There are a number of important exceptions to the obligation on the payer to withhold and account for tax, notably on:
- a interest paid on bonds listed on a recognised stock exchange;
- b interest paid to UK corporates;
- c interest paid to a UK PE of a non-UK corporate where the UK PE brings such interest into the charge to UK tax; and
- d interest paid to a UK ‘bank’ and interest where it is paid without withholding because of the application of a relevant DTT.
Many (but not all) UK treaties eliminate UK withholding tax from interest; however, for the relief under a DTT to be applied, the UK payer and non-UK payee must submit an application that can take a number of months to process, and which often causes problems with the first interest payment when interest is payable quarterly or more frequently.
Interest is generally deductible for a UK business payer, subject to thin capitalisation and debt cap rules, provided that the loan does not have equity characteristics that result in the interest being recharacterised as a distribution (e.g., interest that varies in line with the payer’s profits).
Payments of copyright royalties to non-UK residents and payments of patent royalties are subject to withholding tax (currently at 20 per cent), but many UK DTTs eliminate such withholding. Certain payments between 25 per cent-associated companies within the EU can be made free of withholding from royalties (and interest).
iv Tax treaties
The United Kingdom has an extensive network of treaties with all developed non-tax haven countries and the majority of countries in the developing world. Most treaties are based on the OECD Model, and some have provisions against treaty shopping.
VII TAXATION OF FUNDING STRUCTURES
i Thin capitalisation
The UK no longer has a specific thin capitalisation rule, although, de facto, there is such a regime included within the transfer pricing regime. Where there are financing transactions between connected parties, transfer pricing rules require tax to be calculated on the basis of what the arm’s-length financing provision would have been should the actual financing confer a tax advantage in comparison with an arm’s-length result. These rules apply to transactions between UK taxpayers, as well as cross-border transactions.
For the transfer pricing rules to apply, there has to be a ‘special relationship’ between the companies concerned. A special relationship is defined as a relationship where one company controls the other, or both are controlled by the same person or persons. This is a narrower definition of special relationship than one typically finds in the United Kingdom’s DTTs. If there is a special relationship, one has to consider if the financing is at arm’s length. One is required to ask a number of questions, most notably:
- a whether the loan would have been made at all in the absence of the special relationship;
- b the amount of the loan that would have been made in the absence of the special relationship; and
- c the rate of interest and other terms that would have been agreed in the absence of that relationship.
Thus, if, for example, X lends its subsidiary Y £300 million at an arm’s-length interest rate on normal commercial terms, but the loan would not have exceeded £200 million had there been no special relationship between X and Y, then the interest paid on the £100 million of debt that exceeds the arm’s-length facility may be disallowed. If the principal was at an arm’s-length amount but the interest rate is, say, 5 per cent, whereas the arm’s-length rate would be 4.75 per cent, then the 0.25 per cent excess rate paid by virtue of the special relationship is likely to be disallowed.
In addition to the thin capitalisation rules in the transfer pricing regime described above, interest costs may be disallowed as a tax deduction under the United Kingdom’s debt cap regime.
The debt cap rules only apply to ‘large’ groups. A group is considered to be large if it has a member that either employs at least 250 members of staff, has an annual turnover of greater than €50 million or has balance sheet gross assets of greater than €43 million.
The principle of the debt cap is to limit deductions in respect of excessive debt owed by the UK members of a group. Whether a debt is excessive is established by comparing the net borrowing costs of the UK members of the group with the gross borrowing costs of the group as a whole (i.e., broadly establishing whether the UK part of a group has a disproportionate debt burden). A group is defined by reference to companies that produce consolidated accounts under international accounting standards.
There is a gateway test that aggregates the total net debt of UK group members (ignoring UK group members with net cash assets), and if the resulting UK net debt figure is less than 75 per cent of the worldwide group’s consolidated gross external debt, then the gateway is closed and the debt cap regime does not apply. The debt figures are based on the average of the opening and closing figures on the balance sheet for any given period.
If the gateway test is met and the regime applies, one calculates the worldwide debt (the ‘available amount’) based on figures that make up the consolidated accounts of the worldwide group. This accounts-based figure is then compared with a UK tax-based debt figure (the ‘tested expense amount’), which is based on amounts that would otherwise be claimed as a deduction for UK corporation tax purposes. Where a group company has net finance expenses of less than £500,000, they are ignored for the purposes of the calculation.
If the UK-tested expense amount is greater than the worldwide available amount, the excess is disallowed (this is referred to as the ‘total disallowed amount’).
The UK has announced its intention to abolish the debt cap regime from 2017 to implement proposals made by the BEPS project. The key proposal is to introduce a fixed ratio rule limiting a corporation tax deduction for net interest expense to 30 per cent of a group’s UK earnings before interest, tax depreciation and amortisation (EBITDA). There will also be a group ratio rule based on the net interest to EBITDA ratio for the worldwide group, subject to a number of exclusions notably for UK net interest of less than £2 million and for financing of public infrastructure projects.
ii Deduction of finance costs
Subject to thin capitalisation and debt cap considerations, the costs of acquisition finance are generally deductible (this includes not only interest but ancillary costs such as arrangement fees). The United Kingdom does not disallow funding costs because they are incurred for a capital purpose rather than for the trade itself.
An exception to the rule that interest costs are deductible is where the debt has equity characteristics that render the interest liable to being recharacterised as a (non-deductible) distribution, such as a coupon that is to any extent linked to the results of the issuer’s business or interest on convertible securities. Apart from the notable exception of interest at an excessive rate, if an interest coupon is liable to be treated as a distribution it generally will not be where the recipient is a UK corporate or a UK PE that brings the coupon received into the charge to UK corporation tax.
iii Restrictions on payments
Apart from potential restrictions on paying dividends in a company’s constitution, its directors are under a duty to safeguard a company’s assets and settle debts as they fall due, so must consider how paying a dividend may affect these areas. Those factors apart, and subject to additional considerations for public companies, the general rule is that a UK company can only pay a dividend to the extent it has ‘distributable reserves’, which are such company’s accumulated, realised profits (as far as not previously used by distribution or capitalisation) less its accumulated, realised losses (as far as not previously written off in a reduction or reorganisation of capital). Whether a profit is a ‘realised profit’ is determined in accordance with GAAP. Thus, unlike many jurisdictions, even if a UK company has material current-year profits, it cannot pay a dividend if it has accumulated deficits that exceed the profit. If the accumulated deficit is, say, £100, and the current year profit is, say, £150, only the excess £50 is distributable, leaving cash of £100 in the company – a situation often referred to as a dividend trap. There are a number of possible solutions, one of which is described below.
Public companies must also beware of an issue called financial assistance, which is designed to stop a target assisting in its own sale (e.g., by waiving debt it is owed by its selling parent). Financial assistance no longer applies to private companies.
iv Return of capital
UK companies can return cash to shareholders by reducing their equity capital. This may be done for a variety of reasons, such as where there are a large number of UK-resident individual shareholders for whom a return of capital is more tax-efficient, but it is often used by companies who have insufficient distributable reserves to return the cash they want to return to their shareholders by way of dividend.
The reserve created by reducing capital is generally treated as a realised profit that can thus be offset against accumulated realised losses, or can increase distributable reserves, or both. Some UK-listed companies have reduced capital to counter the deficits created by their pension funds following changes to the rules on how such funds should be accounted for.
Public companies have to reduce capital through a court scheme, but since 2008 private companies can also use a non-court scheme, provided the directors are satisfied that returning capital will not affect the company’s solvency over the next 12 months. This latter route is known as the solvency statement route.
VIII ACQUISITION STRUCTURES, RESTRUCTURING AND EXIT CHARGES
A UK holding company is often used to acquire a UK target. This enables the acquirer to push acquisition debt into the holding company, the ongoing cost of which can be surrendered into the target group and offset against future trading profit. In cases where a deduction is also potentially available elsewhere in the acquirer’s group, the taxpayer needs to consider UK anti-avoidance rules that can prevent a double deduction of interest costs.
The amount of debt that can be successfully injected needs careful thought in the light of thin capitalisation and debt cap considerations and, from 2017, the new debt ratio rules.
Subject to certain conditions, UK selling shareholders can roll over gains on the sale of shares to the extent they receive shares in the acquirer or the acquirer’s loan notes. Even if there is a large cash element, a proportionate part of the gain can still be rolled over. The shares or loan notes must be issued by the acquirer (i.e., if X Inc acquires the target but X Inc’s parent Y issues the consideration shares, roll over will not be available; there may be an exception to this rule if the acquisition is structured through a cancellation scheme through the court rather than the more usual tender or exchange offer).
As previously stated, the United Kingdom allows UK companies under a common parent to be grouped even if such common parent is not a UK company. This means that it is generally possible to consolidate any newly acquired UK group into the purchaser’s existing UK group on a tax-free basis. There are also rules that now facilitate merging or consolidation across borders within the EU. It is unclear at the time of writing what impact Brexit will have on such rules.
If the purchaser wants to move parts of a newly acquired group out of the United Kingdom into another jurisdiction, then the general rule and starting point is that any such transfer will be treated as taking place at market value, and the difference in value between the historical tax basis and current market value will be recognised as a taxable gain. The United Kingdom’s SSE relief may assist, as may the rules facilitating mergers and transfers within the EU.
A point to note in this context is that under UK tax law, if a target company is acquired at market value, the tax basis that the target company has in underlying subsidiaries’ shares and assets remains at the historical tax basis, and assets cannot be rebased to reflect the open market price paid for the shares in the target. The United Kingdom has no equivalent to the US Section 338 election.
IX ANTI-AVOIDANCE AND OTHER RELEVANT LEGISLATION
i General anti-avoidance
On 17 July 2013, the United Kingdom introduced its first general anti-avoidance rules (GAAR) to ensure that there was a comprehensive rule for combating abusive tax avoidance encompassing present and future tax provisions. A study group commissioned in 2010 to study the benefits of such a regime did not recommend a ‘broad spectrum’ GAAR, which it was felt would undermine sensible and responsible tax planning, and would require an onerous, comprehensive clearance system that would give an excess of power to HMRC. The report recommended a more measured, targeted approach aimed at highly abusive, contrived and artificial schemes that are widely regarded as intolerable, but which would not affect responsible tax planning. This was generally accepted in the Finance Act 2013 and has been confirmed by guidance provided by HMRC, which accepts that there may be tax avoidance arrangements that are not within the scope of GAAR because they are not abusive.5 Under the United Kingdom’s Tax Code, in many circumstances, there are different courses of action from which a taxpayer may choose; HMRC has emphasised that any reasonable choice of a course of action is outside the scope of GAAR.6 In contrast, arrangements will fall within its scope if they are demonstrably contrary to the spirit or policy of the law, seek to exploit shortcomings in legislation, or are contrived or abnormal arrangements that produce tax results inconsistent with the economic effect of the underlying transactions.7
The Scottish government has its own GAAR for taxes devolved to Scotland.
The United Kingdom currently has a wide range of specific anti-avoidance rules contained in both statute and common law that are detailed and complex and beyond the scope of this chapter. Particular points to note are that there is a regime designed to stop ‘double-dip’ structures using hybrid instruments or entities, and a regime requiring disclosure where certain classic hallmarks of avoidance are present, such as premium fee arrangements and confidentiality agreements surrounding the arrangements.
The UK also introduced a diverted profits tax (DPT) from 1 April 2015. The tax (at a rate of 25 per cent, so 5 per cent higher than the normal corporate tax rate), applies in two cases:
- a where a person carries on UK economic activity but avoids carrying it on through a UK PE; or
- b where there is an intragroup expense (or diversion of intragroup income) in circumstances lacking economic substance where the arrangements exploit a tax mismatch and it is reasonable to assume that without the tax benefit, the expense would not have been incurred (or the income would have been UK income).
DPT does not apply to SMEs or to PEs with annual sales of less than £10 million or where profit is diverted to a jurisdiction whose tax rate is 80 per cent or more of the UK corporation tax rate.
ii Controlled foreign corporations (CFCs)
The UK CFC regime has been considerably revised and made more taxpayer-friendly (by providing a number of gateways and exemptions), and came into force for accounting periods starting after 1 January 2013. Although quite complicated, the basis of the regime is that most bona fide non-UK companies not being used to artificially divert profit from the UK should fall outside the regime. In response to the final OECD Report on strengthening the transfer pricing rules, published in October 2015, the UK government has stated that it is not proposing any change to the UK regime that it regards as already covering the points made by the OECD.
Subject to exceptions, a non-UK company with a UK parent (or one that is controlled by UK persons) is potentially subject to the UK CFC regime. If not excluded by one of the gateways that has to be passed through to be potentially caught by the regime, or if not excluded by one of the many exemptions, a CFC’s profits are deemed apportioned to the UK parent and taxed in the United Kingdom, subject to credit for non-UK tax paid.
There are a series of exemptions, notably:
- a the low tax exemption: a company is only subject to CFC treatment if it is subject to a headline tax rate of less than 75 per cent of the equivalent UK tax rate;
- b the de minimis exemption: a CFC is ignored if it has accounting profits of less than £500,000 and non-trading profits of less than £50,000;
- c the exempt activities test: there is a safe harbour if the CFC has business premises in a low-tax jurisdiction, less than 20 per cent of its income, management and exports derive from the United Kingdom, and it has no IP transferred from a related party in the past six years; and
- d the excluded countries list test: the CFC is based in a jurisdiction on a published list.
There is also a high-level gateway and a number of specific gateways that can exclude the application of the regime, but as these are more subjective, an adviser generally prefers to see if one of the exemptions applies in the first instance.
The general gateway is subject to a number of safe harbours that if all the conditions are met mean the gateway is not passed through and the CFC regime does not apply, making it unnecessary to consider other gateways and exemptions. The safe harbour conditions include:
- a the main purposes safe harbour: broadly, a series of questions aimed at establishing whether arrangements exist that are intended to reduce or eliminate United Kingdom taxation;
- b the UK-managed assets or risks safe harbour: broadly, aimed at establishing whether the CFC’s assets and risks are independently managed. The test is failed if assets or risks are significantly managed in the United Kingdom by connected parties unless they could be replaced by non-connected companies; and
- c the commercially effective safe harbour: even if assets and risks are UK-managed, the test may still be satisfied if the CFC could effectively commercially manage the assets or risks were the UK-connected company to cease such management.
There are a series of specific gateways that can apply based on specific activities the CFC carries out.
iii Transfer pricing
Since 2004, to comply with EU laws on discrimination, the UK transfer pricing rules have applied to all transactions even if all the parties are subject to UK tax. The UK transfer pricing rules are expressly based on OECD guidelines and provide that the UK law in this area must be construed in the light of such OECD guidelines. Thus, as one would expect, the UK legislation requires that transactions between related parties be undertaken in accordance with the arm’s-length principle in Article 9 of the OECD Model Law.
Basic UK law
The UK transfer pricing regime applies to ‘provisions’ (broadly equivalent to OECD conditions) of transactions (transactions being defined widely to include arrangements, understandings and mutual practices as well as matters such as contracts), or series of transactions, between certain specified parties. In common with many transfer pricing regimes, the UK regime requires comparison of the actual provision (price, terms and conditions of supply, etc.) with the arm’s-length provision that would have applied in the same transaction between independent parties. The basic rule will apply where the actual provision has created a potential UK advantage because income or profits are less or losses greater than they would have been had the transaction been at arm’s length.
The rules apply where one of the parties to a transaction directly or indirectly participates in the management, control or capital of the other, or where the same person (or persons) directly or indirectly participates in the management, control or capital of the parties. A person is treated as directly participating if that person is a corporate or a partnership and ‘controls’ the other person. In evaluating whether a person (e.g., X Ltd) has control, one takes into account not just current voting power exercisable by X Ltd, but also factors including rights and power that X Ltd is entitled to acquire, or will become entitled to acquire, at a future date, and rights and powers held by a person connected with X Ltd.
The transfer pricing rules also apply if X Ltd exercises indirect control over another person through rights held by connected persons, rights exercised on X Ltd’s behalf or through deeming entitlements to future rights to have been exercised, or because X Ltd is a ‘major participant’.
X Ltd is a major participant if it and another person (taken together) have control and each has at least 40 per cent control of the relevant entity – this is particularly relevant to joint ventures.
Where there are two UK companies, it is likely that in many cases there will be no loss to the UK Treasury, as a deduction in one company will be matched by a corresponding receipt in another. In recognition of this, the regime allows the company that is disadvantaged by the pricing adjustment to make a claim to have its tax calculated on the same deemed arm’s-length terms as the company that obtained an advantage as a result of the adjustment, and tax-free compensatory payments to be made.
The United Kingdom adopts OECD methodology to determine an arm’s-length price, notably the transactional methods (the comparable uncontrolled price method, resale price method and cost plus method) and the profit-based methods (the profit split method and transactional net margin method). In the 2016 Finance Bill, the UK government adopted the revised 2016 OECD guidelines on transfer pricing. In addition the UK introduced legislation (Taxes (Base Erosion and Profit Shifting) (Country-by-Country Reporting Regulations 2016) that requires a UK resident parent company to report prescribed information, so implementing another OECD BEPS recommendation.
The UK does permit advance pricing agreements (APAs) under which the taxpayer agrees with HMRC an acceptable pricing method in advance of the relevant transactions taking place. These are typically used in more complex transactions, and HMRC has detailed guidelines on the mechanics of negotiating and agreeing an APA. Given recent European Court of Justice (ECJ) attacks on tax rulings, the position of UK APAs needs to be monitored.
iv Tax clearances and rulings
Of particular relevance in the context of this book is that HMRC will provide advance rulings where there is significant inward investment into the United Kingdom amounting to more than £30 million or that, while less than that figure, may be regarded as significant to a particular region or in the wider public interest (SP2/2012). Under such rulings, HMRC will provide written confirmation of how HMRC will apply UK tax law to specific transactions or events. As stated above, the current attacks by the ECJ on tax rulings means the position needs to be monitored.
Statutory clearances can be sought under a number of statutory provisions, notably on share exchanges and certain types of restructuring and merger. Typically, these clearances do not confirm to the taxpayer that the conditions for relief are met, but simply that the relief’s availability will not be challenged on the basis that it is for tax-avoidance rather than for bona fide commercial purposes. Clearances are only effective if the taxpayer makes a full and frank disclosure. There is generally a clear timetable that requires HMRC to respond within 30 days, although if HMRC feels that more information is needed, it can ask for such information, and when the taxpayer responds, the 30-day clock starts again from zero.
As well as formal statutory clearance, there is a procedure known as a Code of Practice 10 Ruling, which allows a taxpayer to seek clarification of how recent (in the past four years) legislation applies to it where there is material uncertainty. It is possible to request such a ruling going back beyond four years, but in such cases the taxpayer must show that the uncertainty is commercially significant to its business. HMRC will not give a ruling where it believes that the transaction that creates uncertainty is not a primarily commercial one, but is rather a tax-driven transaction or a tax-planning exercise.
A taxpayer may also approach HMRC informally, but is only likely to receive a satisfactory response if the informal ruling is a question in respect of a transaction that has already happened and the taxpayer is looking for guidance on how it should deal with an aspect of such transaction in its tax returns.
X YEAR IN REVIEW
In 2016, the United Kingdom continued to enthusiastically pass legislation to implement BEPS recommendations. In addition, measures aimed at tackling tax avoidance have been strengthened. Many such measures are highly complex and require UK businesses to invest heavily in tax compliance.
XI OUTLOOK AND CONCLUSIONS
As mentioned above, the United Kingdom has embraced BEPS. Measures being introduced to implement BEPS coupled with measures designed to ensure that taxpayers pay what is regarded as an acceptable level of taxation can be expected to multiply in 2017. In principle, it is hard to object to measures designed to counteract harmful tax practices, but the practical impact is to create uncertainty, if only because some legislation is so complex. In addition, such legislation imposes a material additional administrative and tax compliance burden. When coupled with uncertainty caused by Brexit, there is a risk that the attractiveness of the UK business tax regime that has been growing over recent years will be undermined.