This chapter looks at tax issues relating to franchising. Specifically, it focuses on the tax rules that commonly apply to franchising arrangements, the tax parameters under which franchising operations should be structured, the tax structuring options to consider and the anti-avoidance rules, which are increasingly focusing on international tax structuring. In this respect the main rules to be considered are those concerning the tax treatment of trading transactions and intellectual property (IP), as these are at the heart of any franchising arrangement.
In looking at these tax rules, we consider corporate franchisors and franchisees – partly for the sake of brevity and partly because (as far as franchisors are concerned) these are the entities most commonly involved in franchising arrangements.
We also look in this chapter at the rules from a UK perspective. While many of the principles of international taxation can be applied generically in a number of jurisdictions, tax is by its very nature highly jurisdiction-specific. In looking at the UK rules we hope to highlight those principles while grounding them in a real-life legal framework. This approach will give the reader a broad understanding of the tax principles that apply to any situation while leaving him or her free to take more detailed local advice in any specific circumstance. It should be noted, however, that on 23 June 2016 the United Kingdom voted to leave the European Union (EU). The United Kingdom is due to leave the EU on 31 January 2020, and has reached agreement with the EU regarding the proposed terms of the withdrawal agreement. In spite of the uncertainty regarding the terms of Brexit, we have, where possible, set out how the proposed withdrawal agreement will affect certain areas discussed in this chapter, in particular access to EU treaties and those UK tax laws that are based upon EU law, such as value added tax (VAT).
Finally, franchisors and franchisees are businesses and as such are concerned with all the tax issues that any business would be. This is not a tax book and we have therefore focused only on those issues that are specific to franchising businesses, namely the tax issues arising from the assets and services that make up the franchising arrangements. While we have in parts mentioned other tax issues that may be relevant, we have only done so in passing.
In broad outline, this chapter will consider the following tax issues in order:
- the general framework for the taxation of companies;
- withholding taxes that may be applicable on payment of franchise fees and royalties;
- the franchisor's tax position;
- franchisor tax planning;
- the franchisee's tax position;
- transfer pricing; and
- value added tax.
II THE GENERAL FRAMEWORK FOR THE TAXATION OF COMPANIES IN THE United Kingdom
To understand how corporate franchisors and franchisees are taxed in the United Kingdom requires a broad understanding of the UK corporation tax regime – in particular as it applies to IP-based trading entities. We therefore commence with a very broad overview of the relevant UK corporation tax rules before applying these to the franchising context.
The corporation tax regime in the United Kingdom operates to tax companies. A company is defined as any body corporate or unincorporated association but does not include a partnership, a local authority or local authority association.2 The amount on which corporation tax is chargeable is the sum of income computed under the various charging provisions and chargeable gains computed in accordance with the rules in the Taxation of Chargeable Gains Act 1992 (TCGA).
A company is subject to corporation tax in the United Kingdom:
- if it is a UK resident – on all its profits and gains regardless of the source of the profits or gains or whether they are remitted to the United Kingdom3 unless such profits or gains arise in a permanent establishment situated outside the United Kingdom in which case they may be exempt from tax under the branch exemption rules contained in Part 2 Chapter 3A of the CTA 2009; or
- if it is non-UK resident but carries on a trade through a permanent establishment in the United Kingdom – on all its profits arising from its trade through that establishment4 and chargeable gains on assets situated in the United Kingdom and used for the trade or permanent establishment.5 The Finance Act 2019 introduced provisions preventing non-UK resident companies from artificially organising their business to avoid falling under the definition of a UK permanent establishment and, with effect from 6 April 2020, extended corporation tax to the UK property income of non-resident companies. Corporation tax also applies to non-resident property trading or developing companies, even if the company does not have a permanent establishment.
Companies that are not within the charge to corporation tax can still be subject to income tax on certain UK-sourced income (generally where tax is deducted at source).
Broadly speaking, a company is a resident of the United Kingdom if it is either:
- incorporated in the United Kingdom;6 or
- has its central management and control in the United Kingdom.7
Where a company is resident in both the United Kingdom and elsewhere (e.g., because it is incorporated in the United Kingdom but managed and controlled in another jurisdiction), it is necessary to consider whether there is a tiebreaker clause in the relevant double-taxation treaty. Action 6 of the Action Plan on Base Erosion and Profit Shifting (BEPS) project introduced a tie-breaker provision based on a mutual agreement between the relevant tax authorities rather than the previous provision based on the place of 'effective management'.
Subject to certain exemptions for preparatory or auxiliary activities, a company will have a permanent establishment in the United Kingdom if it has a fixed place of business in the United Kingdom through which its business is wholly or partly carried on, or its agent (other than an independent agent acting in the ordinary course of its business) has and habitually exercises in the United Kingdom authority to do business on its behalf. A fixed place of business includes a branch, office, factory, workshop, place of management or a building site.8 The final report for Action 7 of the BEPS project (see Section V.iv) significantly expanded the Organisation for Economic Co-operation and Development (OECD) definition of permanent establishment to include situations in which the agent plays the principal role leading to the conclusion of contracts that are routinely concluded without modification, whether the contracts are in the name of the enterprise or for supplies of goods, rights, property or services by the enterprise. Although the United Kingdom has decided against amending its domestic definition of permanent establishment to reflect Action 7, the new OECD definition has been adopted in certain jurisdictions and thus has an impact on the overseas operations of UK companies.
i Profits chargeable to corporation tax
Corporation tax applies to profits of a company. The term profit is defined as income and chargeable gains except insofar as the context otherwise requires9 and is as adjusted for tax purposes. In the case of a non-resident company with a permanent establishment in the United Kingdom, its chargeable profits will be profits from its trading income arising directly or indirectly through, or income from property or rights used or held by or for, the permanent establishment and chargeable gains subject to corporation tax.10 However, there is an exemption from tax for most dividends or other distributions received from other companies (unless, generally speaking, the dividends or distributions are out of untaxed income).
Under the corporation tax regime, income is classified into different charging provisions, such as:
- trading income;
- property income;
- loan relationships and derivative contracts;
- intangible fixed assets;
- intellectual property, know-how and patents; and
- miscellaneous income.
As profits include chargeable gains, corporation tax applies to chargeable gains rather than capital gains tax11 (which applies for individuals). Chargeable gains are generally calculated in accordance with the capital gains tax rules. However, the intangible fixed assets regime covers gains from assets included within that regime instead of the chargeable gains rules.
Expenditure that is allowed for tax purposes to reduce profits is determined in accordance with specific charging provisions. So, any disbursement or expense of an income nature wholly and exclusively laid out or expended for the purposes of trade is deductible against profits of that trade for corporation tax purposes in the same manner as for income tax.
Additionally, there are specific rules outside the charging provisions that allow tax deductions against total profits; for example:
- capital allowances; and
- relief for accounting losses on loan relationships and derivative contracts.
The rules on trading income generally take precedence over other charging provisions.
The taxable profits of a trade must be calculated in accordance with generally accepted accounting practice but are subject to any tax adjustments.12 Therefore, the starting point for determining taxable trading profits is to use the profit before tax as disclosed in the accounts and adjust it for tax.
Some income and expenses may be excluded. For example, depreciation will not be allowed as a deduction for tax purposes,13 although expenditure 'capitalised' in accounts may be deferred revenue expenditure that could be deducted when amortised under generally accepted accounting principles. For capital expenditure, capital allowances relief may be available. Also, capital receipts are not chargeable to tax as income and should, therefore, not be included in calculating the trading profits unless there is a specific rule to the contrary.14
What is a 'trade'?
There is no statutory definition for 'trade' provided in the legislation and hence the term is interpreted in accordance with its ordinary meaning. The final report of the Royal Commission on the Taxation of Profits and Income in 1955 summarised the most important considerations in determining whether a taxpayer has engaged in trade (termed 'badges of trade'). The main factors to look at to indicate whether a transaction is trading in nature are as follows:15
- frequency of transaction – repeated transactions (as distinct from a one-off transaction) would be indicative of trading;
- relationship to the taxpayer's trade – a transaction relating to the trade that the taxpayer already carries on suggests that activity as being in the course of trade;
- subject matter – a transaction involving assets that are normally the subject matter of trading would be suggestive of trading (e.g., a bulk purchase of whisky or toilet paper is essentially a subject matter of trade, not of enjoyment);
- supplementary work – work done to repair or improve the item prior to sale suggests the transaction as being in the nature of trade; and
- profit motive and intention – purchases made with a view to resale at a profit or with the intention to resell in the short term indicates that the transactions are not by way of investment so should be trading.
In Ransom (Inspector of Taxes) v. Higgs16 Lord Reid observed that the term 'trade' is used to 'denote operations of a commercial character by which the trader provides to customers for reward some kind of goods or services'.
Relief for trading expenditure
Expenditure is deductible against trading profits for tax purposes if it is of an income nature and incurred wholly and exclusively for the purposes of trade.17 If expenditure is incurred for more than one reason, one of which is a non-business reason, then, an identifiable part of the expense that can be attributed as being wholly and exclusively for the purposes of trade will not be disallowed.
ii Intangible fixed assets regime
The intangible fixed assets regime in Part 8 of the CTA 2009 provides a broad base for taxation of IP and relief in respect of IP expenditure. It is based on the accounting treatment, thereby generally eliminating the need to make capital and income distinctions. The regime generally takes priority for corporation tax purposes against other charging regimes.18
It applies to intangible fixed assets that are:
- created by the company on or after 1 April 2002;
- acquired by the company on or after 1 April 2002 from an unrelated party; or
- acquired by the company on or after 1 April 2002 from a related party and either:
- the asset was a chargeable intangible asset within Part 8 immediately before acquisition;
- the seller acquired the asset on or after 1 April 2002 from a person who was not related to the seller or the acquiring company; or
- the asset was created on or after 1 April 2002.19
It is therefore often referred to as the 'post-April 2002' regime for IP.
Broadly speaking, an intangible asset is regarded as created or acquired on or after 1 April 2002 to the extent that expenditure on its creation or acquisition was incurred on or after that date.20
If part of the expenditure was incurred prior to and some on or after 1 April 2002, the asset is treated as being two separate assets with apportionment being on a just and reasonable basis.21 Internally generated goodwill is treated as created before 1 April 2002 if the business was carried on before that date.22
An intangible fixed asset is 'an intangible asset acquired or created by the company for use on a continuing basis in the course of the company's activities'.23 The term intangible asset adopts the meaning used in UK generally accepted accounting principles (GAAP).24
From 2015, companies have had to adopt the UK GAAP contained in FRS 101 and 102, and since 2016 a small-company regime within FRS 102 applies, although certain 'micro' entities can account under a new simplified accounting standard, FRS 105. FRS 101 is effectively International Financial Reporting Standards (IFRS) with simplified disclosure. FRS 102 is a new regime based upon IFRS for small and medium-sized enterprises (SMEs). Under both FRS 102 and FRS 105, an intangible asset is an identifiable non-monetary asset without physical substance. Such an asset is identifiable when:
- it is separable (i.e., capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability); or
- it arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
Under IFRS, 'intangible assets' are identifiable non-monetary assets without physical substance. Assets are identifiable if they are separable or arise from contractual or other legal rights (regardless of whether those rights are separable from the entity (paragraphs 8 and 12 of International Accounting Standard 38).
Intangible assets include any IP, which means:
- any patent, trademark, registered design, copyright or design right, plant breeders' rights or rights under Section 7 of the Plant Varieties Act 1997;
- any right under the law of a country or territory outside the United Kingdom corresponding to, or similar to, a right within paragraph (a);
- any information or technique not protected by a right within (a) or (b) but having industrial, commercial or other economic value; or
- any licence or other right in respect of anything within paragraphs (a) to (c) inclusive, such as a licence to exploit a patent or copyright material.
The rules also apply to goodwill (which takes its accounting meaning).25
The regime does not apply to an asset held:
- for a purpose that is not a business or commercial purpose; or
- for the purpose of activities that are not subject to UK corporation tax (other than where held for an exempt foreign branch).26
Even though an asset may fall into the definition, there are exclusions such as assets for which plant and machinery capital allowances have previously been made, rights over tangible movable property, rights enjoyed by virtue of an estate, interest or right in or over land, etc.
Royalties and other credits
The post-April 2002 regime treats all royalties and disposal proceeds (credits) as income and treats most costs (debits) on the acquisition and development of intangible fixed assets as expenses on the same basis as for accounting purposes.
Credits can arise as follows:
- receipts or royalties recognised in the company's profit and loss account;27
- accounting gains in respect of the revaluation of intangible fixed assets28 (up to the debits previously brought into account). No gain would be brought into account if the asset is depreciated for tax purposes on a fixed 4 per cent basis (see below);
- accounting gains in respect of negative goodwill written back following a business acquisition;29
- accounting gains in respect of the reversal of previous accounting losses that led to deductible debits;30 and
- accounting gains in respect of realisation of intangible fixed assets.31 A realisation means an asset ceases to be recognised in the company's balance sheet because it has been sold or there is a reduction in the accounting value of the asset as the result of a transaction (in accordance with UK GAAP). Assets with no balance sheet value are deemed to have one for these purposes.
Debits are brought into account for tax purposes in respect of expenditure on intangible fixed assets when recognised for accounting purposes. For example, debits can arise:
- where expenditure is recognised in the profit and loss account;32
- where an accounting loss arises from capitalised expenditure because of amortisation or an impairment review;33
- on the realisation of an intangible asset;34 and
- on reversals of previous accounting gains.35
Alternatively, a company may elect to write down an intangible fixed asset for tax purposes at a fixed 4 per cent per annum instead of the accounting rate of amortisation. An irrevocable election must be made in writing to HM Revenue & Customs (HMRC) within two years of the end of the accounting period in which the asset is created or acquired.36 The election will take effect with respect to all capitalised expenditure in respect of that asset.
Following changes made in 2015, it was no longer possible to obtain a debit for the cost of acquired goodwill or similar IP. However, the Finance Act 2019 has reinstated the relief for goodwill and customer-related IP acquired on or after 1 April 2019 as part of a business acquisition with eligible IP assets and the goodwill is neither a 'pre-FA 2019 relevant asset' nor acquired as part of a business incorporation.
Where transfers of intangible assets take place between related parties, the transfer is generally treated as taking place at market value, either under Section 845 of the CTA 2009 or under transfer pricing rules.
The manner in which debits and credits are brought into account will depend on the use to which the IP is put. Assets held for the purposes of a trade will give rise to trading credits or debits. Assets held for a property business are taxed as profits or losses of that business. Non-trading assets give rise to a separate head of non-trading profits. If there is a non-trading loss then the taxpayer is entitled to deduct the non-trading loss against total profits of the relevant accounting period, surrender it by group relief or carry it forward to relieve in future periods.37
iii Pre-April 2002 regime
For IP that is not within the intangible fixed assets regime (see above), the old corporation tax rules continue to apply, which are in many cases equivalent to income tax rules. We refer to these rules as the 'pre-April 2002 regime'.
Under the pre-April 2002 regime for corporation tax, amounts are generally included in or deducted from income to the extent that such items are not capital in nature and amounts are within the chargeable gains rules to the extent that they are capital in nature. So it is crucial to determine whether a receipt or expense is income or capital in nature. The distinction must be interpreted in accordance with the ordinary meaning of the terms by having regard to case law.
A leading authority on this topic, Inland Revenue Commissioners v. John Lewis Properties plc38 provides the following considerations to determine whether a receipt is income or capital in nature:
- if the payment is for the disposal of an asset that has an enduring or long-lasting quality then the payment is likely to be capital;
- if the payment is of a single lump sum for the once and all disposal of a particular asset, it is more likely to be a capital payment. If the payment is one of a series of recurring payments made at frequent intervals, it is likely to be income in the hands of the payee; and
- if the disposal of the asset is accompanied by a transfer of risk in relation to it, this suggests that the sum paid for the asset is capital.
The following receipts have been held to be income:
- payments from a number of overseas companies for the sale of know-how relating to aero-engine manufacture, where the repetitive exploitation of know-how was seen as an extension of trade;39
- payment (comprising lump sum and royalty) for a non-exclusive licence to manufacture not more than 75,000 ammunition boxes on a non-exclusive basis at a specific royalty;40 and
- lump sum consideration for information consisting of secret processes and formulae.41
The following receipts have been held to be capital:
- lump sum for the grant of a 10-year sole licence in the United Kingdom;42
- lump sum payments in respect of exclusive licences to foreign companies in various countries in which the taxpayer covenanted to keep out of that country;43 and
- lump sum payment for the taxpayer agreeing not to establish another tyre soling plant, which was effectively an exclusive covenant not to compete.44
Expenditure will be classified as capital if it is incurred with a view to bringing into existence an asset or advantage for the enduring benefit of the trade.45 For example, a sum paid for the acquisition of a business was held to be capital in nature.46 In Tucker v. Granada Motorway Services Limited,47 the House of Lords determined that expenditure incurred for a variation of a lease was capital in nature even though it had no balance sheet value. Having regard to the case law,48 HMRC offers the following guidance to indicate capital expenditure:
- expenditure on an intangible benefit or advantage (for example, trading agreements, licences or other intangibles) in which the identifiable asset is sufficiently substantial and enduring;49
- expenditure that secures a permanent commercial advantage such as the closing down of a potentially damaging competitor;50
- expenditure incurred in connection with the acquisition, alteration, enhancement or defence of the fundamental structure of a business;51 and
- a payment that secures an enduring benefit to the business in terms of a change in organisation or structure is likely to be capital52 as distinct from one that has the effect of preserving the existing business, its goodwill or assets (which would be on revenue account).53
Other specific charging provisions
If a company receives income or gains from IP rights, which do not amount to profits of its trade, then there are a number of specific charging provisions that could catch such receipts.
However, as the intangible fixed asset regime also applies to royalties relating to pre-April 2002 IP,54 the pre-April 2002 corporation tax regime for intangibles is in almost all circumstances limited to rules relating to capital disposals of such IP and certain specific circumstances, which are excluded from the regime. The general position would be that capital disposals of pre-April 2002 IP should be within the chargeable gains rules. There are, however, some specific rules that override this treatment. We now consider these specific rules.
Disposals of know-how
There are four specific tax rules that could apply to disposals of pre-April 2002 know-how:
- disposals in the course of a trade: Section 177 of the CTA 2009;
- disposals of know-how as part of a disposal of trade: Section 178 of the CTA 2009;
- other disposals of know-how: Sections 408–410 of the CTA 2009; and
- capital allowances charges: Section 462 of the Capital Allowances Act 2001 (CAA 2001).
In respect of the first rule, receipts from the disposal of know-how in the course of trade55 are specifically treated as trading income – even if capital in nature – under Section 177 of the CTA 2009 unless brought into account under Section 462 of the CAA 2001. Where the trade is also disposed of, the receipt is treated as a capital payment for goodwill although this may be disapplied by election.56 The ability to make such an election and the more general trading treatment under Section 177 of the CTA 2009 is disapplied where the transfer is between connected parties.
Profits arising in a year on the disposal of know-how otherwise than in the course of a trade, or for giving or fulfilling an undertaking in connection with such a disposal that restricts any person's activities (whether or not enforceable), are taxed under Sections 908–910 of the CTA 2009. A deduction is allowed for expenditure wholly and exclusively incurred in the acquisition or disposal of know-how (so long as it is only taken into account once). This tax charge does not apply where:
- the disposal is taxed as trading income under Section 177 of the CTA 2009;
- the consideration is taxed under Section 462 of the CAA 2001 on disposal of the know-how;
- where the consideration is treated as a capital receipt for goodwill on the disposal of a trade under Section 178 of the CTA 2009; or
- where the disposal is by way of sale between bodies of persons under common control.57
The term 'know-how' for the above tax charges is defined as any industrial information or techniques likely to assist in:
- manufacturing or processing goods or materials;
- working a source of mineral deposits (including searching for, discovering or testing mineral deposits or obtaining access to them); or
- carrying out any agricultural, forestry or fishing operations.
There is also a specific capital allowance regime for know-how (see Section VI). Where such capital allowances have been obtained and the know-how disposed of, then the disposal value on such know-how has to be brought into account under Section 462 of the CAA 2001, in which case it will reduce the capital allowances available in the period or, if the company is liable to a balancing charge, be treated as a receipt of the trade.
Disposals of patent rights
Tax is charged on any non-trading profits from the sale of the whole or part of any patent rights.58 For non-residents, the tax is charged only on the sale of UK patent rights. The term patent rights means the right to do or authorise the doing of anything that, but for the right, would be an infringement of a patent.59 Licences are treated as sales. The grantor of a licence is treated as making a part sale unless the licence is exclusive and for the remaining period of the rights, in which case it is treated as the sale of the whole of those rights.
The profit brought into charge is the difference between any capital sums comprised in the proceeds of sale less any deductible costs.60 The deductible costs are the capital costs of the rights sold (less amounts met by certain other persons – e.g., public bodies) and incidental expenses incurred by the seller in connection with the sale of the patent rights.61
Under spreading rules, the seller (if UK tax-resident) must spread the profits over six years for tax purposes unless he or she elects to tax it all in the year of receipt.62 Non-residents selling UK patent rights will be taxed in the year of receipt unless they elect to spread the income over six years.63 Any such election for income tax purposes must be made on or before the first anniversary of the self-assessment filing date for the year of receipt.
Where non-residents are charged to tax under these rules, the person paying the consideration may have to deduct tax at source.
Capital allowances are available for capital expenditure incurred to acquire patent rights for the purpose of a trade within the charge to UK tax64 or for patent rights that give rise to UK taxable income.65 Where there is a disposal of patents for which such allowances have been given, then the disposal value will need to be bought into account for capital allowances purposes (limited to the capital expenditure incurred on the patent). If this gives rise to a balancing charge, it would again be taxed as a receipt of the trade (or potentially non-trading income).
A company will be within the charge to corporation tax on its chargeable gains if it is resident in the United Kingdom, trading in the United Kingdom through a permanent establishment or, from 6 April 2020, carrying on a UK property business. If trading in the United Kingdom through a permanent establishment, corporation tax on chargeable gains will apply to any UK-situated assets used in or for the purposes of the permanent establishment.66
The rules as to whether an IP asset is a UK asset or a non-UK asset are summarised below:67
|Asset type||UK asset if:|
|Goodwill||Trade, business or profession carried on in the United Kingdom|
|Patents, trademarks and registered designs||Registered in the United Kingdom|
|Rights or licences to use a patent, trademark or registered design||Rights exercisable in the United Kingdom|
|Copyright, design right, franchises||Rights exercisable in the United Kingdom|
|Rights or licence to use the copyright, work or design in which the design right subsists||Rights exercisable in the United Kingdom|
Capital gains tax (and corporation tax on chargeable gains) applies on a disposal of an asset.68 Disposals include part disposals69 as well as situations where capital sums are derived from assets,70 which includes capital sums received as consideration for use or exploitation of assets and capital sums received for forfeiture, surrender or refraining from exercise of rights. Similarly, the extinction or abrogation of a right or restriction over an asset by the person entitled to enforce it is considered a disposal of such a right or restriction.71
A chargeable gain or loss is calculated as the proceeds received on disposal (consideration) less the base cost (cost of the asset, expenditure wholly and exclusively incurred for the purpose of enhancing the value of the asset, costs incidental to the acquisition and costs incidental to making the disposal).72 For a corporate taxpayer, the base cost can be increased by indexation (i.e., the base cost is increased in line with the retail price index) from the date of acquisition until 31 December 2017 (the allowance being frozen from that date). The consideration will be deemed to be the market value (as distinct from the actual amount received) where the transaction is between connected parties or not at arm's length.73 Gains are not chargeable to corporation tax on chargeable gains if they are subject to tax as income.74
To allow intra-group transactions to be effected in a tax-neutral manner, there are specific rules that allow assets to be transferred within a UK group without crystallising capital gains tax or a tax charge under the intangible fixed asset rules75 subject to 'de-grouping charges' if the transferee leaves the group within six years of the date of the transfer.76 A condition of such transfers is that the transferee is within the scope of corporation tax in respect of the asset after the transfer.77 The Finance Act 2019 introduced changes to the de-grouping charge, which will no longer apply where a company that owns intangibles leaves a group as part of a share disposal that qualifies for the Substantial Shareholdings Exemption. In these cases, assets that would otherwise have been subject to the charge remain at their written-down value.
To prevent assets being taken out of the UK tax net by migrating companies offshore, there are also charges under capital gains and chargeable intangible asset rules should a company migrate its tax residence offshore,78 albeit with potential to postpone any charge if the company remains a 75 per cent subsidiary of a UK company.79 Following ECJ case law80 and a request from the European Commission to change UK law, the Finance Act 2013 saw an amendment to the migration rules whereby a company can either pay the exit charge in instalments or can pay the tax 10 years after migration or, if earlier, on disposal of the assets.
For chargeable gains assets and for chargeable intangible assets, there are in certain circumstances rules that allow assets to be transferred to companies resident offshore in a tax-neutral manner provided in Section 140, Section 140A, Section 140C, Section 140E and Section 140F of the TCGA and equivalent rules Chapter 11 of Part 8 of the CTA 2009. For example, Section 140 applies to a UK company carrying on a trade outside the United Kingdom through a permanent establishment that transfers the trade for an issue of shares or shares and loan stock whereby it owns after the transaction at least 25 per cent of the transferee's ordinary share capital. Any gain is rolled over into the shares although may still be payable if any of the assets are transferred within six years. The rules in Section 140A to 140F of the TCGA cover situations set out in the EU Merger Directive and EU Tax Merger Directive81 as well as the European Directive establishing the European Company and European Cooperative Society. The rules on mergers are outside the scope of this chapter, but a franchisor seeking to migrate part of its trade offshore will need to consider whether it could fall within any of these particular rules. It might also consider transferring assets to a foreign permanent establishment, which could be exempt from tax under the exemption in Chapter 3A of the CTA 2009.
III Deduction of tax at source
There are a number of provisions that give rise to deduction of tax at source on IP royalties that could apply to franchising arrangements. Section 906 of the Income Tax Act 2007 (ITA) requires a person who pays a royalty or other sum for the use of IP that is within the charge to income tax or corporation tax to a person whose usual place of abode is outside the United Kingdom (or makes a periodic payment to certain persons who have acquired their rights from such a UK person) to withhold tax at the basic rate and to account for that tax to HMRC.
For this purpose, IP means:
- copyright of literary, artistic or scientific work;
- any patent, trademark, design, model, plan or secret formula or process;
- any information concerning industrial, commercial or scientific experience; or
- public lending right in respect of a book.
There are exclusions for copyright payments relating to cinematographic films or video recordings, or their soundtracks.
If a payment does not fall within the provisions of Section 906, it may nevertheless give rise to an obligation to deduct tax at source under:
- qualifying annual payments (ITA, Sections 900 and 901);
- patent royalties (ITA, Section 903); and
- capital payments made for patents (ITA, Section 910).
We consider these in more detail below.
i Qualifying annual payments
Qualifying annual payments are subject to deduction of tax under Sections 900 (payments by individuals) and 901 (other payers) ITA. Under Section 899 ITA, a qualifying annual payment must meet the following conditions:
- it must be an annual payment;
- it must arise in the United Kingdom;
- the payment must be charged to tax under various provisions, including:
- to income tax under:
- ITTOIA, Section 579 (royalties from IP);
- ITTOIA, Chapter 4 of Part 5 (telecommunications rights);
- ITTOIA, Chapter 7 of Part 5 (annual payments not otherwise charged); or
- to corporation tax under Chapter 7 of Part 10 CTA 2009 if the recipient is a company (annual payments not otherwise charged to tax); and
- the payment must not constitute interest and must not include certain other payments (e.g., charitable donations).
An annual payment is one that is payable under a legal obligation and is capable of recurring over a period of more than 12 months.82 The amounts must be income receipts, and not a capital receipt, so a capital amount paid in instalments would not constitute an annual payment. The amounts must also be 'pure income profit' in the hands of the recipient. Broadly speaking, pure income profit comes to the recipient without the recipient having to do anything in return. Therefore, payments for goods or services cannot be an annual payment.83
An individual who makes a qualifying annual payment will only be required to deduct tax if the payment is made for genuine commercial reasons in connection with the individual's trade, profession or vocation.84 There is no similar test for companies.
In the franchising context, this is unlikely to apply following the changes to the deduction of tax rules enacted in the Finance Act 2016. These changes effectively broadened the definition of royalty, simplifying the withholding tax treatment where payments are being made to a person whose usual place of abode is outside the United Kingdom. Therefore, payments to non-residents will be covered by Section 906 ITA and payments to UK companies will generally be excluded from the obligation to deduct tax (see Section III.iv). The qualifying annual payment withholding tax charge will therefore only apply where the franchisor is a UK unincorporated business.
ii Patent royalties
To the extent that a patent royalty is not a qualifying annual payment and is not covered by Section 904 (annual payments made in consideration of dividends or exempt consideration, which is unlikely to be applicable in the context of franchising), it may be subject to deduction of tax under Section 903 of the ITA. This section applies to a royalty or other sum in respect of the use of a patent, which arises in the United Kingdom and is charged to income tax or corporation tax. Again, following the 2016 changes, this will only apply where the franchisor is a UK unincorporated business.
iii Sales of UK patent rights
If a UK person buys rights in a patent from a non-resident seller that is liable for UK tax in respect of the sale under Section 587 of the ITTOIA 2005 or Section 912 of the CTA 2009, then the purchaser is obliged to deduct basic rate tax from the purchase price and account for this to HMRC.85 For these purposes 'patent rights' means a right to do or authorise the doing of any thing that, but for the right, would be an infringement of a patent, and thus includes licences. For non-resident sellers the charges only apply to patents granted under UK law.
iv Excepted payments
The above requirements to deduct tax under Sections 901 (qualifying annual payments), 903 (patent royalties), 906 (IP royalties) and 910 (proceeds of sale of patent rights) do not apply where the payer is a company, local authority or partnership (with a corporate or local authority partner) if such a payer has a reasonable belief that the payment is an excepted payment and, in the case of deductions under Sections 901 and 903, the payer itself has no 'modified net income' (calculated under Section 1025 of the ITA) that would be subject to income tax.
Excepted payments include payments where the person beneficially entitled to the income is:
- a company resident in the United Kingdom;
- a company not resident in the United Kingdom that carries on a trade in the United Kingdom through a permanent establishment and the payment will be brought into account in computing the UK chargeable profits of the non-resident company;
- a body of the type listed in Section 936 of the ITA (broadly, certain public bodies and entities that are generally tax exempt; e.g., charities); or
- a partnership beneficially entitled to the income, each partner in which must be an entity within (a) to (c) or the European Investment Fund.
If the payer 'reasonably believes' that an exemption applies it may pay gross, but if that belief proves incorrect, the withholding obligation is re-imposed so the payer is at risk. There is no general mechanism for HMRC to certify that payments may be made gross under these rules.
v Source of royalty
The Finance Act 2016 also introduced rules to define the source of royalties or other sums paid in respect of IP where the payer is non-UK resident but the payment is made in connection partly with a trade carried on by a UK permanent establishment of the payer. Under these new rules, the entity will need to apportion on a just and reasonable basis the proportion of the payment that relates to the trade carried on through the UK permanent establishment.
vi Anti-treaty shopping rules
The 2016 changes also introduced anti-treaty shopping rules.86 Under these rules, relief will not be available under a double-tax treaty where a payment to a connected person is made under a double-tax treaty tax avoidance arrangement (where obtaining treaty relief is contrary to the object and purpose of the treaty and is the main, or one of the main, purposes of the arrangements) and any tax so deducted is not creditable against corporation tax of a recipient company.
vii EU Interest and Royalties Directive
Council Directive (EC) No. 2003/49 (the Interest and Royalties Directive) introduced a common system of taxation applicable to interest and royalty payments made between associated companies of Member States. These provisions have force in the United Kingdom (ITTOIA, Sections 757–767 and Section 914 of the ITA) and provide an exemption from income tax on royalties where:
- the payer of the royalty is a UK company or a UK permanent establishment of an EU company; and
- the person beneficially entitled to the income is an EU company but not such a company's UK permanent establishment or non-EU permanent establishment.
Both companies must be 25 per cent associates, that is, one company holds at least 25 per cent of the capital or voting rights in the other or there must be a parent company of both companies that holds such a share in each.
Payment gross is permitted where the payer reasonably believes the exemption applies, but (as for the excepted payments rules) the payer is at risk if that belief is incorrect. As a practical matter, if the payee is an EU company, the payer's risk can be eliminated as the payee company could make a claim under the applicable double-tax treaty that should result in HMRC issuing a payment direction to the payer to apply a reduced or zero rate of withholding (see further below).
Under the terms of the proposed EU withdrawal agreement, the United Kingdom would cease to be a Member State of the EU and UK companies receiving payments from associated companies in EU Member States would no longer benefit under the Interest and Royalties Directive. However, UK companies would still rely on Sections 757–767 ITTOIA and Section 914 ITA to eliminate withholding tax on payments of royalties to associated companies in EU Member States. Any change to this arrangement will require a further change to UK domestic law.
viii Double-tax treaties
Royalties paid by a UK resident to a resident of a country with which the United Kingdom has a double-tax treaty (DTT) may be exempt from withholding taxes as a result of the operation of a royalty article of that DTT. Even if the royalty article does not extinguish the withholding tax liability it will normally impose a restriction on the amount that can be deducted. There are, broadly speaking, three main types of tax treaty upon which most are based; these are the OECD Model Tax Convention, the UN Model Tax Convention (usually adopted by developing nations) and the US Model Tax Convention.
In respect of royalties, Article 12 of the OECD Model Tax Convention provides as follows:
1 Royalties arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State.
[The UN Model treaty specifically allows tax to be deducted at source up to a percentage.]
2 The term 'royalties' as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.
[The US Model treaty also covers 'other works' as well as certain gains derived from the alienation of any of the above property. The UN Model treaty also applies the royalty provisions to fees for the use of or right to use industrial, commercial or scientific equipment.]
3 The provisions of paragraph 1 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise through a permanent establishment situated therein and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment. In such case the provisions of Article 7 (business profits) shall apply.
[The UN Model is similar in this respect save that it also has a carve-out for independent personal services supplied in the state and for other business activities carried on in the state of the same or similar kind as those effected through the permanent establishment.]
4 Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the royalties, having regard to the use, right or information for which they are paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention.
A non-resident licensor must, unless Section 911 of the ITA applies (see below), make an application to its own domestic tax authorities claiming relief under the relevant article of the DTT and demonstrating that it fulfils the requirements of that article. Following the joint project by the OECD and G20 countries to reduce global tax avoidance (or BEPS), 82 countries (including the United Kingdom) signed a multilateral instrument (MLI) to amend their DTTs. These changes tackled a number of key action points arising from the BEPS project, one of which is 'treaty shopping, namely putting a company in a jurisdiction to take advantage of its DTT network. Where both parties to a DTT have signed and implemented the MLI, that DTT will now include a 'principal purpose test', which effectively denies treaty benefits where it is 'reasonable to conclude that obtaining that benefit was one of the principal purposes of any arrangement or transaction'. Even without the principal purpose test, if the recipient is a 'conduit' vehicle, it may struggle to satisfy the beneficial ownership requirement following the case of Indofood International Finance Ltd v. JPMorgan Chase Bank NA.87 This UK case (the principle in which is being applied generally by many tax authorities – although cf. the Canadian cases of Prevost88 and Velcro89) suggests that the meaning of beneficial ownership in tax treaties is more limited than the legal test and will not apply where a conduit vehicle has back-to-back arrangements to pay on receipts of interest or royalties.
Once satisfied the treaty conditions apply, the non-resident's tax authority will certify to HMRC that the licensor is entitled to relief under the relevant DTT and HMRC will then direct the payer to make future payments at the rate specified under the relevant DTT.
Under Section 911 ITA, a UK company that makes a payment of royalties otherwise subject to deduction of tax may, if it thinks fit, calculate the sum of income tax to be deducted by reference to the rate applicable in the relevant tax treaty (if lower than the UK rate) and make the payment on that basis (that is, without receiving a payment direction from HMRC following a treaty claim). However, the company must reasonably believe that, at the time the payment is made, the payee is entitled to relief in respect of the payment under a relevant tax treaty. As before, the payer is at risk if the payee is not entitled to a reduced rate of withholding under the treaty. However, the payee can make a claim under the treaty that will result in the payer receiving a direction to pay at a reduced rate from HMRC and hence, if there is any doubt, mitigate risk.
ix Offshore receipts
Originally proposed as an extension to royalty withholding tax, new rules enacted by Section 15 of and Schedule 3 to the Finance Act 2019 impose an income tax charge on gross receipts received by a non-UK entity where that entity owns IP used to generate sales revenue in the United Kingdom. Although not technically a withholding tax, the tax (which came into effect on 6 April 2019) is collected through self-assessment from the non-UK resident, but members of the same 'control group' (see below) are jointly and severally liable. The rules have been designed to target multinational groups that hold intangible property in low-tax offshore jurisdictions and use that IP to generate revenue from UK customers or provide sales in the UK. They target groups that realise income from UK sales in low-tax offshore jurisdictions that do not have a full tax treaty with the UK.
There are three exemptions from the income tax charge: where the foreign tax is at least half of the UK tax, where there is business undertaken in the non-UK territory and where the UK sales do not exceed £10 million in the year.
These rules are targeted at multinational groups, but franchisees should be aware that the joint and several liability provisions are widely drawn (Section 608O ITTOIA). If the tax remains unpaid for six months after the payable date, the UK tax authorities can collect that tax from a person in the same control group as the non-UK resident entity at any time in the tax year to which the payment applies. Section 608S ITTOIA provides that two persons will be in the same control group if they are consolidated for accounting purposes, one of them has a 51 per cent investment in the other, or a third person has a 51 per cent investment in each of them.
x Issues relating to royalty payments in the franchising context
A major component in any franchising agreement will be a payment of royalties for use of the brand and other IP licensed to the franchisee. As stated above, a franchisee paying a royalty for use of IP may have to deduct tax at source. The manner in which a deduction will be required will depend on the type of IP and the residence of the payee. In the context of a franchising arrangement, payments are likely to be made to a corporate franchisor that will either be UK tax-resident or non-resident. Payments to UK tax-resident corporate franchisors by UK franchisees should not give rise to any withholding tax issues.
If the payment is to a non-UK tax-resident company by a UK-based franchisee, withholding tax applies to all royalties and other payments in respect of IP. Assuming that the recipient is not trading in the United Kingdom through a permanent establishment, royalties will give rise to an obligation to deduct tax unless the UK rules are overridden by a tax treaty or, assuming there is no specific change of law post-Brexit, the Interest and Royalties Directive (as implemented into UK law in ITTOIA and ITA).
In any event, the franchisor will be carrying out significant activities under the franchising agreement, including exercising control functions and providing support and assistance services on a recurring basis. The manner in which the franchisor carries out these functions may give rise to a permanent establishment of the franchisor in the United Kingdom. In this event, the payments may be treated as received by such a permanent establishment and therefore as excepted payments.
As the franchisee's obligation to deduct tax at source is heavily dependent on the franchisor's tax status (e.g., whether it has a taxable permanent establishment in the United Kingdom), the franchisee must investigate the treatment of the payments it makes in this respect to ensure that it correctly deducts and accounts for any tax. If the franchisee fails to deduct tax at source, it will still have to account for the tax to HMRC together with interest and penalties. It may, depending on the terms of the agreement, be able to deduct the amount it has failed to deduct at source from future payments, but this is likely to be possible only where there has been a genuine error of fact.90 Additionally, the franchisee may under the terms of the franchising agreement have a 'gross-up obligation' for any tax deducted on payments. While an agreement to pay royalties without deducting tax under Section 906 is void under Section 909 of the ITA, this is unlikely to apply to a gross-up provision as such a provision will increase the amount payable and therefore also increase the tax deducted at source – so it is not an agreement to pay without deduction of tax.
In practice, even where UK law dictates that there should be a deduction of tax at source for the royalty element of any fees, an appropriate DTT may well apply to give rise to zero or a reduced rate of withholding tax. Under Section 911 the payer need not deduct tax so long as it reasonably believes that at the time the payment is made the payee is entitled to relief under an applicable DTT. The franchisee should therefore seek to ensure that the franchisor (or if different, the relevant entity licensing the IP rights) benefits from relief under the applicable treaty. This may include ascertaining its country of residence, ensuring it is taxable in that country under relevant rules (e.g., not receiving the income in a branch in a third country that is exempt from tax in the country of residence), ensuring that the royalties are 'beneficially' owned by the recipient for treaty purposes and that the franchisor does not have a permanent establishment in the United Kingdom or, if it does, that the royalties are not effectively connected with such a permanent establishment, as well as ascertaining whether anti-avoidance rules, such as Section 917A ITA, apply. As well as investigating the franchisor's ability to obtain treaty relief, the franchisee may seek to obtain warranty protection in this respect under the franchising agreement.
IV TAX PRINCIPLES FOR FRANCHISORS
i Tax treatment of receipts
Although UK franchisors will be taxable on all fees received or receivable, the nature of such taxation will depend on the type of fee. A UK franchisor will therefore need to know how its fees are to be treated for tax purposes.
In this respect a typical franchise agreement will comprise fees payable for the following:
- reimbursement of expenses;
- royalties for use of trademarks;
- payments for know-how;
- payments for show-how;
- patent royalties;
- payments for copyrighted material (e.g., instruction manuals); and
- contributions to advertising materials.
The fees are likely to comprise both an initial fee and regular ongoing payments. In practice, the fees are often not separated out in the above constituent elements in the documentation but are simply an 'initial fee' and ongoing 'service fees' plus additional amounts for reimbursement of expenditure and contributions to advertising.
As we have seen, a UK franchisor will, broadly speaking, be paying corporation tax on all its profits albeit under different schedules. UK franchisors will generally be carrying on a trade in the United Kingdom and their profits will be subject to corporation tax as trading profits.
For UK franchisors whose IP was created or acquired on or after 1 April 2002, the profits and losses relating to any intangible assets will be calculated under the intangible fixed asset regime whether the receipt is capital in nature or not, but such profits and losses will in any event be taxed as part of the franchisor's trading profits to the extent that the relevant IP assets are held for the purposes of a trade carried on by the transferor,91 which will almost certainly be the case. Therefore, the franchisor should be subject to corporation tax on the profits in its accounts subject to any standard tax adjustments (e.g., for disallowable expenditure or transfer pricing). If the transaction involves a 'realisation' of a chargeable intangible asset, then it is possible that a tax charge under the chargeable intangible assets regime could qualify for rollover relief if reinvested in new IP.92 However, realisation for the purposes of these rules means a transaction resulting, in accordance with generally accepted accounting practice, in the asset ceasing to be on the company's balance sheet or in a reduction in the accounting value of the asset (or would do if it had a balance sheet value).93 On this basis it is unlikely in the vast majority of franchising arrangements that a realisation would occur for the purposes of these rules in respect of its activities carried out in the course of its general franchising business.
UK franchisors, whose IP does not fall within the intangible fixed assets regime, may need to analyse transactions in more detail to determine the manner of taxation. For many franchisors, HMRC are likely to accept that all fees simply constitute part of the franchisor's trading profits for corporation tax purposes so in practice, in the vast majority of cases, the tax treatment will be the same as for those in the intangible fixed assets regime. Franchisors may, however, seek to separate the fees into their component parts and tax them accordingly. If HMRC or a taxpayer wish to segregate the income between trading and other elements, the allocation would need to be a reasonable apportionment and justifiable.94 If the relevant IP assets are segregated from the trade (e.g., held in a different company from the employees responsible for providing services), then a more detailed analysis of the components of any charge will be necessary.
Should the consideration be split into its component elements these could be taxed as follows.
If payable to a trading company rather than an IP holding company, this is likely to constitute a trading receipt. Arguably there may be a capital sum for a part disposal of goodwill or a capital sum derived from an asset and taxable under Section 22(c) or (d) or Section 29(5) of the TCGA. Where the franchise relates to a new jurisdiction, it will be difficult to say that there has been any disposal of a capital asset; HMRC's view is that there is not generally any reduction in the franchisor's goodwill as a result of entering into any new franchise agreements – on the contrary its goodwill is usually enhanced.95 Additionally, under normal principles it would generally be difficult to say for a franchisor that the fees it generates are capital in nature. Therefore, the payment is most likely to be liable to corporation tax on income as a trading profit rather than a capital receipt. HMRC in its guidance cites Jeffrey v. Rolls-Royce 96 as authority for treating the initial fee as a trading receipt in normal circumstances. Specifically, it highlights that in this case (concerning disposals of know-how that were treated as income) the circumstances have similarities to many franchising cases, in particular:
- the transactions were repeated;
- there was a deliberate policy of expansion by granting licences;
- benefits other than know-how were provided; and
- no capital asset diminished in value.97
It is irrelevant that the payment is in instalments.98
However, if it can be shown that there has been a part disposal of existing goodwill, then this could be taxed within the capital gains rules – for example where the franchisor disposes of existing trading sites to a franchisee. To the extent that there has been a disposal of goodwill subject to capital gains tax (or corporation tax on chargeable gains), then any gain could be subject to rollover relief if the franchisor reinvests the gain in chargeable intangible assets 12 months before or within three years after the disposal.99 Similarly, if there has been a realisation of goodwill or other IP within the intangible fixed asset regime, the gain can be rolled over into a new chargeable intangible asset.100
A disposal of know-how may be taxed as income under Section 908 of the CTA 2009 or as part of the trading profits of the company under Section 177(2) of the CTA 2009 (disposal of know-how where trade continues). This will not, however, be the case where the know-how has qualified for capital allowances and is brought into account under Section 462 of the CAA 2001, or it is taxed on disposal of a trade as part of the goodwill of the trade under Section 178 of the CTA 2009 or the disposal is a sale between connected persons.
Fees for training the franchisee's staff and ongoing training will normally be part of the trading receipts of the franchisor.
Where franchisees contribute to central advertising costs incurred by the franchisor, the receipts will typically be revenue receipts taxable as trading profits with a corresponding deduction allowed for the advertising spend. One would expect the income and expenditure to be matched for accounting purposes and generally one would expect advertising expenditure to be an income expense such that there is no net tax payable (unless the franchisor is receiving more than it is spending). To the extent that the expenditure has not been paid, any provision in the accounts will need to be sufficiently accurate to allow a deduction.101
Capital payments in respect of patent rights
Where patent rights are transferred, any receipt could give rise to a taxable receipt under Section 912 of the CTA 2009, spread over six years unless tax is elected to be paid earlier.
As stated, save for franchisors that may hold the IP separately from the rest of the trade, all receipts are likely to constitute taxable trading profits. Therefore, characterising the receipts as royalties is unlikely to have a practical effect for corporation tax purposes. It may, however, affect whether tax needs to be withheld at source from the payments (as discussed above).
Certain franchisors will seek to provide a franchisee with suitably fitted out and branded premises. The tax treatment of any fees for doing this will depend on the nature of these arrangements.
ii International issues
We now look at the options available for a UK taxpayer when carrying on an international trade. If the franchisor is carrying out its full franchising business, including providing services and licensing all IP from one entity in the United Kingdom, it will be receiving the above mixed supply of services and payments for use of IP. Assuming that the franchisor's activities are not undertaken through a permanent establishment in a different jurisdiction, the fees should all be taxable under the UK corporation tax rules either as trading income, profits from IP or potentially, for the initial fee, chargeable gains (if the franchisor's IP is pre-April 2002 IP).
There used to be a distinction between foreign source income (which was taxed under Schedule D Case V) and UK source income (which was taxed under other schedules – e.g., Schedule D Case I for UK trading income, Schedule D Case III for most UK source royalty payments). This distinction, broadly speaking, disappeared for corporation tax purposes when the tax rules were rewritten into CTA 2009 and CTA 2010. Therefore, all trading income is dealt with under the same provisions of CTA 2009, as is all IP income. There is now no longer a general distinction between UK and foreign source income save that double-tax relief is available on foreign-sourced income.
Double-tax relief in the United Kingdom takes two forms: treaty relief and unilateral relief. Treaty relief is relief granted under an applicable double-tax treaty. Section 2 of the Taxation (International and Other Provisions) Act 2010 (TIOPA) provides for double-tax arrangements in respect of a territory outside the United Kingdom with a view to affording relief from double taxation to have effect by means of an Order in Council. The taxes covered by such arrangements include income tax, corporation tax, capital gains tax and taxes imposed outside the United Kingdom of a similar character to these taxes. As well as invoking the 'royalties' provision of any applicable tax treaty, a number of other provisions may be applicable to a franchisor, such as (in the case of the OECD Model Treaty):
- Article 7 (Business Profits) – which, broadly speaking, restricts the right of a territory to tax business profits unless earned through a permanent establishment in that territory (which is in turn defined in Article 5);
- Article 13 (Capital Gains) – which again restricts the right of a territory to tax capital gains to those accruing to a permanent establishment in that territory although in this case it can also tax gains from immovable property situated in that territory; and
- Article 23 (Double Taxation) – which seeks to avoid double taxation and provide relief through exemption or credit.
Unilateral relief (i.e., double-tax relief given in the absence of any protection under a double-tax treaty) is provided under Section 9 of the TIOPA in respect of income 'arising' and gains 'accruing' in the territory for which tax relief is sought. Unilateral relief is provided in respect of tax on income or capital gains that corresponds to income tax, capital gains tax or corporation tax and includes state, provincial or local income taxes or taxes levied by a municipality or any other local body.102
Double-tax relief can be problematic in the following respects:
- where the receipts relate to a trade exercised in the United Kingdom, HMRC may seek to argue that the source of the income is the UK trade and not the payments for IP arising offshore. Equally where the IP rights are, say, UK registered rights for which the franchisor could but has not yet made subsequent registrations locally, then arguably the source of the income would be the UK rights. In these circumstances income from overseas franchisees is technically UK source income. However, this is covered by extra-statutory concession B8.103 This states as follows:
A UK resident may receive income consisting of royalties or 'know-how' payments from a foreign resident. While in particular cases there may be special circumstances that will require to be taken into account, in general such income should be dealt with as follows.
a) Payments made by a person resident in a foreign country to a person carrying on a trade in the UK as consideration for the use of, or for the privilege of using, in the foreign country any copyright, patent, design, secret process or formula, trademark or other like property may be treated for the purpose of credit (whether under double-taxation agreements or by way of unilateral relief) as income arising outside the UK, except to the extent that they represent consideration for services (other than merely incidental services) rendered in this country by the recipient to the payer. b) Traders resident in the UK are not entitled to claim credit for any tax which is levied in the foreign country in respect of payments for services which are rendered in the UK and are not merely incidental services. In any such case the net amount of the payment (after deduction of any foreign tax borne by them on the payments) is included in the computation of profits for UK tax purposes.
The prohibition on credit for foreign tax charged on payments for services rendered in the UK may be overruled by the terms of those double-taxation agreements which have a royalties Article which includes technical services in the definition of royalties (see INTM153130) or a separate technical fees Article (see INTM153140) and those agreements deem the source of such payments to be in the country of which the payer is a resident. In such cases, even though the services are rendered in the UK, credit is due for the foreign tax charged on these payments.
If the owner of a right such as a patent, trademark or copyright is not engaged in any trade to which the right relates but derives income by exploiting that right, the source of the income may be regarded for the purpose of credit as located in the country where the right is enforceable.
- Where a franchisor is providing services as well as IP from the United Kingdom, any local tax deducted at source on the service element will not qualify for double-tax relief as a credit unless specifically allowed as technical services under an appropriate double-tax treaty or unless it is merely incidental to the provision of IP. In the absence of a credit relief the foreign tax may be treated as a deduction from income.104
- Where the franchisee has sub-franchisees in a different jurisdiction, then relief may not be available. Unilateral relief for foreign tax in a territory is provided against income 'arising' in the territory. In this case, depending on how the arrangements are structured, the sub-franchise income may not be income of the franchisor but of the franchisee and it may not arise in the 'territory' but in a third country. This position is relaxed in the rare circumstance that a franchisee is in the Isle of Man or the Channel Islands as there is no requirement for income to arise in these territories to allow credit for tax charged there.105 Similarly, tax treaties will also provide double-tax relief for losses in the other treaty state. Care should therefore be taken to avoid this situation or to ensure that the appropriate tax leakage is dealt with correctly in the relevant documentation. To the extent that relief is not available, again the tax may be deductible as an expense of the trade.
- Unilateral relief provides credit for overseas tax calculated by reference to income arising or a gain accruing against UK tax calculated by reference to that income or gain. Similarly, treaty relief is limited to relief against UK tax arising on the same source of income as bears the tax. Therefore, if a company with foreign source income does not have any UK tax to bear (e.g., because there are deductible expenses or trading losses to set against it), the credits cannot be used against other sources of income (e.g., if the double-tax relief is against trading profits, it cannot be used against investment income).
V FRANCHISOR STRUCTURING
Over the past 30 years, as businesses have become increasingly mobile and international, and particularly since the rise of the internet, multinational operations have increasingly used tax planning as a tool to maximise their after-tax returns. There has been a game of cat and mouse between multinational operations and the revenue authorities as more sophisticated structures have grown up to minimise taxes, tax authorities have introduced rules to block such structures and well-advised businesses have introduced even more sophisticated tax structures and mitigation strategies to overcome such rules.
Today, with a difficult worldwide economic situation and the tight budgetary conditions facing many Western economies, politicians, press and public are increasingly scrutinising the tax affairs of multinational companies. This is particularly the case in the sectors of the economy that rely heavily on intangible assets such as brands that are highly mobile and that can, if located in low-tax jurisdictions with minimal substance requirements, have a dramatic downward effect on a group's effective corporate tax rate.
This increasing scrutiny is leading to increased crackdowns on international tax avoidance behaviour and tax arbitrage, with measures such as the BEPS project, which is being run by the OECD and G20 (see Section V.iv). At the same time, however, many governments are seeking to reduce corporate tax rates and provide corporate tax incentives to attract inward investment. In an area such as franchising, where profits substantially derive from IP, there have traditionally been significant opportunities to locate IP in a low-tax jurisdiction to minimise taxes. However, the effect that an overly aggressive tax structure may have on reputation is becoming a key business concern, particularly for consumer-facing businesses.
This section gives a general overview of the tax strategies a franchisor may consider in looking to reduce its effective tax rate and outlines the anti-avoidance rules that have been introduced to limit overly aggressive planning.
A common form of tax planning for franchisors was to take their IP and operations offshore from the United Kingdom to a jurisdiction with a lower tax rate. By doing this they would hope that income could be rolled up in a lower-taxed jurisdiction thus avoiding or at least deferring UK tax.
For tax purposes, a relevant IP holding entity (IP Co) ideally should not be subject to:
- profits tax in that entity;
- withholding taxes on payments by that entity (e.g., dividends or interest); and
- withholding taxes on royalty payments to that entity.
Therefore, tax planning would involve considering which entity would be effective in reducing profits tax and withholding tax, thereby assisting to lower the effective rate.
This entity could either be:
- an entity subject to tax (taxable entity) such as a company incorporated in the United Kingdom; or
- an entity not subject to tax (non-taxable entity) such as a company incorporated in a tax haven.
As tax havens do not have decent tax treaty networks, withholding taxes may dictate having an entity with a low level of taxation in the structure (and therefore access to a tax treaty network). Examples of relevant jurisdictions that may meet these criteria are the United Kingdom, Luxembourg, Belgium, the Netherlands, Cyprus and Ireland. The availability of certain tax advantages in these jurisdictions could, depending on the circumstances, give rise to a competitive effective tax rate. Such advantages to be considered may include:
- a low corporate tax rate on royalty income;
- the availability of relief – the 'taxable' jurisdiction may offer attractive relief for holding IP or undertaking research and development (R&D) activities. For example, 'patent box'-type regimes in the United Kingdom, Netherlands, Belgium and Luxembourg give rise to low tax rates or partial exemption for certain types of IP royalties. The states may also provide taxable amortisation of purchased IP, actual and in certain cases deemed deductions for interest expenses and R&D tax credits; and
- the availability of double-tax treaties or the EU Interest and Royalties Directive to reduce withholding taxes and maximise double-taxation relief, as detailed in Section III.vii.
An increasingly important factor to bear in mind when looking at the location of any vehicle is that the vehicle is likely to require 'substance' to obtain the relevant tax benefits. It is therefore almost always better to locate companies in jurisdictions where there are people with the requisite skills and experience to manage the business carried on by such a company. This requirement for substance has been particularly enhanced following the BEPS project (e.g., the new transfer pricing regime for intangibles).
If IP is held in a taxable structure, tax planning will concentrate around minimising the tax rate (e.g., using special tax regimes applicable in that jurisdiction), maximising reliefs (e.g., amortisation of acquisition cost, R&D reliefs and finance costs) and avoiding withholding taxes.
For an IP Co to be tax-efficient, the licensees would be residents of jurisdictions that do not apply withholding tax on payments to the IP holding vehicle or that have suitable double-tax treaties to reduce or eliminate any withholding tax.
One further way to reduce withholding taxes used to be by using another entity (royalty company) through which the royalties would flow. By flowing the royalties through a royalty company (1) with a suitable tax treaty with the licensee's jurisdiction (eliminating or reducing withholding taxes on royalties); and (2) incorporated in a country that does not levy withholding tax on royalty payments (or has a suitable tax treaty with the jurisdiction in which the IP Co is located), withholding taxes on the royalties could be mitigated (subject to anti-avoidance rules).
However, various tax treaty provisions prevent 'treaty shopping'. Again the BEPS project has made planning through 'conduit' and similar structures more difficult, as it has resulted in the inclusion in tax treaties of various provisions that prevent treaty abuse. Additionally, anti-avoidance rules may apply to deny treaty benefits or the tax authorities may not view the royalty company as being entitled to the royalties for treaty purposes.106
If a UK entity were to set up a structure with an offshore subsidiary IP Co or royalty company, the following hurdles would need to be overcome to achieve its aims:
- Tax charge on transfer of IP: if any of the IP transferred has a value then the transfer is likely to be taxable; if the franchisor is prepared to accept some tax now to enter into the structure what would be the level of taxation?
- Controlled foreign company (CFC) rules: if the IP is in an offshore entity, could its profits in any event be attributed to the United Kingdom under CFC or similar rules?
- Substance: will the offshore company be treated as non-resident or trading in the United Kingdom through a permanent establishment in any event and will it have sufficient substance to be seen as the owner of the IP and to benefit from tax treaties etc.?
- Diverted profits tax: this applies to certain structures that do not have sufficient economic substance or that artificially avoid having a permanent establishment in the United Kingdom.
In addition, all relevant anti-avoidance measures and the offshore receipt rules (see Section III.ix) would need to be considered in detail and overcome. In summary, it is increasingly difficult for a UK business to transfer its IP out of the UK to minimise the business's effective tax rate.
i Tax charges on transferring IP to an offshore licensing entity
A taxable gain may be crystallised when a franchisor disposes of the relevant assets to an offshore company. In seeking to transfer IP to an offshore entity, the franchisor will have to consider the assets to be transferred carefully.
If we consider the nature of the assets to be transferred, each will have a slightly different treatment when seeking to either transfer the asset or simply register new classes of such IP in an offshore jurisdiction. In this respect it should be borne in mind that different IP has different characteristics. Goodwill can be very local to a business or it can be worldwide; patent rights, however, cannot be enforced outside the jurisdiction of registration but may confer priority registration rights overseas. A franchisor looking to transfer IP offshore will therefore have to analyse carefully each asset from both a legal and an economic perspective to determine whether any value is being transferred to the offshore entity and whether such a transfer is therefore taxable (either because the offshore acquirer pays a market price or is deemed to do so under transfer pricing or similar rules).
Specifically, different assets will be taxed as follows:
- for trading companies subject to the intangible fixed asset regime, disposals of intangibles will be taxed as trading profit under Part 8 CTA 2009. Rollover relief under Chapter 7 of Part 8 may apply if the proceeds of sale (if any) are reinvested in intangibles; and
- for intangible assets that are not in the above regime, the tax treatment will be as described above, that is:
- goodwill will be taxed as a capital gains asset and will be taxed under Section 21, Section 22(c) or (d) or Section 29(5) of the TCGA with arm's-length pricing substituted if necessary by Section 17 of the TCGA;
- patents will be subject to tax either as a trading profit or under Section 912 of the CTA 2009 with tax being potentially spread over six years. Potentially, if capital allowances have been claimed, an amount may need to be brought into account under the capital allowance rules;
- know-how: Section 177, the ability to elect under Section 178 and Sections 908–910 of the CTA 2009 will not apply to transfers between connected parties. In this event, the transfer will either constitute trading profits, give rise to a chargeable gain or be taxed under the capital allowance rules depending on the circumstances; and
- copyright, trademarks, designs and design rights will similarly be taxed either as trading income or under chargeable gains rules.
Where a company has a solid UK business but is looking to expand internationally through franchising arrangements, it may seek to split its IP between that which relates to the United Kingdom and that which relates to jurisdictions outside the United Kingdom. It may then seek to transfer the non-UK IP to a tax-friendly jurisdiction and argue that the non-UK IP has no or little value at the time of such a transfer. Whether or not this is justifiable is a question of valuation, which will depend on the extent to which the franchisor has already carried on any trade abroad or has any pre-existing enforcement rights in the relevant offshore jurisdictions, including priority registration rights. This will vary between different classes of IP.
Should there be any taxable profit or gain on the transfer, the franchisor will look to see whether it has any tax assets (such as losses) that it can utilise against a gain. Companies looking to migrate their assets offshore may also consider the reorganisation rules outlined above to determine if they could do so without crystallising a tax charge. It should be borne in mind, however, that many of those rules require a bona fide (and not a tax avoidance) intention to fall within the relevant provisions.107 Alternatively, a franchisor may consider licensing the IP in a manner that does not give rise to a disposal of the asset but that gives rise to tax on the licence fees over a number of years. Whether a licence amounts to a disposal depends on its terms and whether the receipt falls into income or capital as set out above. An exclusive licence for a long period is likely to constitute a disposal whereas a non-exclusive licence for a short period is not.
ii Controlled foreign company rules
Under the United Kingdom's CFC rules contained in Part 9A of the TIOPA 2010, if a company resident outside the United Kingdom is controlled by persons resident in the United Kingdom, then the profits of the non-resident company (together with any creditable local tax) can be apportioned to UK tax-resident corporate shareholders and charged to UK tax.
Control by UK persons includes cases where a company is controlled by two shareholders each holding 40 per cent or more of the controlling rights and one of which is resident in the United Kingdom. The rules are designed to target transactions that artificially divert profits from the United Kingdom.
The rules relating to CFCs are highly technical and detailed (and therefore beyond the scope of this chapter). However, there are a number of helpful exemptions that eliminate this charge. The main entity-level exemptions to a CFC apportionment are:
- the exempt period exemption: broadly speaking allowing a period of grace of at least 12 months from coming under UK ownership;
- the excluded territories exemption: this exempts companies resident in certain territories from the CFC rules provided:
- the CFC's 'bad' income (e.g., income that is exempt from tax locally) is not over 10 per cent of its accounting profits or if more, £50,000; and
- the CFC does not have significant IP income that derives from IP transferred from related persons resident in the United Kingdom (or if not so resident, the IP was held for a permanent establishment of such persons in the United Kingdom) or IP that otherwise derives from IP held by such persons;
- the low profits exemption: broadly speaking this applies where the CFC either has:
- profits of less than £50,000; or
- profits of less than £500,000 of which no more than £50,000 are non-trading profits;
- the low profit margin exemption: where the CFC's profits are not more than 10 per cent of its relevant operating expenditure; and
- the tax exemption: where the CFC's tax is at least 75 per cent of what the corresponding UK tax on such profits would have been.
Anti-avoidance rules attach to prevent the exemptions applying in abusive situations.
Even if the CFC is not exempt under the above rules, its profits are only apportioned to relevant UK shareholders and subject to tax under the CFC rules to the extent that those profits fall within one of the 'gateways'. CFC gateways include:
- profits attributable to UK activities;
- non-trading profits;
- trading finance profits;
- captive insurance business; and
- certain subsidiaries of FSA-regulated companies.
Of most relevance for franchising activities will be the first two of these gateways. If a company's profits meet a number of tests as to non-attribution to the United Kingdom, it will not fall within this first gateway. One of these tests is an IP condition that is similar to the above IP test in the excluded territories exemption.
The intention behind these exemptions and gateways is to stop the CFC rules catching commercially driven structures. However, because of the complexity of these rules they may catch what might seem to be commercial structures and therefore need to be considered in all cases where companies are owned directly or indirectly by UK companies.
iii Diverted profits tax
This tax applies where:
- payments are made by a UK resident (or the UK permanent establishment of a foreign company) to another person that lacks economic substance and there is an effective tax mismatch, and it is reasonable to assume that without the tax benefit the income would not have been diverted from the United Kingdom; or
- a foreign company artificially avoids having a permanent establishment in the United Kingdom.
Where the rules apply, a tax charge at 25 per cent applies to the amount of profits that would otherwise have been taxed in the United Kingdom. In the case of the avoided permanent establishment, the DPT rules also charge to tax any royalties that would have been deemed to be payable had there been a UK permanent establishment. The rules do not apply:
- to SMEs (i.e., where, with certain connected persons there are less than 250 employees and either the annual turnover does not exceed €50 million or an annual balance sheet does not exceed €43 million;
- where a permanent establishment is avoided and UK sales do not exceed £10 million and UK-related expenses do not exceed £1 million in a 12-month accounting period; and
- where the 'diverted profits' are taxed by an amount equal to at least 80 per cent of the UK tax that would have been payable.
It is clear that there would, in the absence of rules to the contrary, be significant scope for tax planning as the nature of IP assets means that they are easy to move across borders.
The historic approach to judicial intervention in tax avoidance cases can be seen in IRC v. Duke of Westminster,108 when Lord Tomlin said: 'Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be.' This approach gave rise to a literal interpretation of tax legislation, allowing structures to be easily devised that circumvented the relevant legislation. However, modern jurisprudence, following a line of cases, including Ramsay (WT) Ltd v. IRC,109 Furniss v. Dawson110 and Barclays Mercantile Business Finance v. Mawson,111 has taken a more purposive interpretation of tax legislation. As Lord Nicholls says in Barclays Mercantile Business Finance v. Mawson:
The essence of the new approach was to give the statutory provision a purposive construction to determine the nature of the transaction to which it was intended to apply and then to decide whether the actual transaction (which might involve considering the overall effect of a number of elements intended to operate together) answered to the statutory description.
The courts are therefore no longer prepared to take a blinkered look at each transaction but will consider a tax avoidance scheme as a whole. An example of the current approach in overcoming a tax avoidance scheme can be seen in Astall & Another v. HM Revenue & Customs.112 An example of the limits of such an approach, where it was not possible to interpret the purpose of the legislation, can be seen in the case of Mayes v. HMRC.113
Any tax planning and structuring in respect of franchising arrangements and IP licensing structures should therefore always consider whether what is planned falls within the relevant legislation after taking a purposive interpretation of that legislation.
Further specific anti-avoidance rules have been developed to catch the more obvious schemes that have been devised. In any given situation, all relevant specific anti-avoidance rules, sometimes known as targeted anti-avoidance rules (TAARs), will need to be considered. As this is not a tax textbook, we will not consider all possible TAARs in this chapter. There are also rules whereby certain types of tax avoidance schemes have to be notified to HMRC.114
Additionally, the United Kingdom has a general anti-abuse rule (GAAR) that could apply to any given transaction and would need to be considered seriously by anybody seeking to implement any tax planning. The details of the GAAR are set out in Part 5 Finance Act 2013. The GAAR applies to counteract tax advantages arising from tax arrangements that are abusive.115
'Tax arrangements' for the purposes of the GAAR are arrangements of which it would be reasonable to conclude, having regard to all the circumstances, that the obtaining of a tax advantage was the main purpose or one of the main purposes. Such arrangements are abusive if they are arrangements the entering into or carrying out of which cannot reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions having regard to all the circumstances, including whether:
- the substantive result of the arrangements is consistent with any principles on which the provisions are based and the policy objectives of the provisions;
- there are contrived or abnormal steps; and
- the arrangements are intended to exploit shortcomings in the provisions.
Examples of things that might indicate that tax arrangements are abusive include profits being significantly less than economic profits, deductions significantly greater than economic costs or claims for tax credits relating to taxes that are unlikely to be paid. In contrast, compliance with HMRC practice is indicative that arrangements are not abusive.
A number of taxpayer safeguards are built into the GAAR, including:
- requiring HMRC to establish that the arrangements are abusive;116
- applying a 'double reasonableness' test. This requires HMRC to show that the arrangements 'cannot reasonably be regarded as a reasonable course of action';117
- allowing the court or tribunal to take into account any relevant material as to the purpose of the legislation that it is suggested the taxpayer has abused, or as to the sort of transactions that had become established practice at the time when the arrangements were entered into;118 and
- requiring HMRC to obtain the opinion of an independent advisory panel as to whether an arrangement constituted a reasonable course of action, before they can apply the GAAR.119
The legislation is also supported by detailed guidance rules issued by HMRC. In respect of international tax planning the guidance notes state:120
B5.1 There is a network of treaties between States setting out rules that govern the taxation of investment and business activities involving more than one State. These treaties (which are typically based on an OECD Model Treaty) are usually referred to as 'double-tax treaties', and their purpose is to avoid subjecting such investments or activities to tax in more than one State and to prevent tax evasion. The United Kingdom has entered into over 100 such treaties, and they are given effect in domestic tax law.
B5.2 Many of the established rules of international taxation are set out in double-taxation treaties. These cover, for example, the attribution of profits to branches or between group companies of multinational enterprises, and the allocation of taxing rights to the different States where such enterprises operate. The fact that arrangements benefit from these rules does not mean that the arrangements amount to abuse, and so the GAAR cannot be applied to them. Accordingly, many cases of the sort which have generated a great deal of media and Parliamentary debate in the months leading up to the enactment of the GAAR cannot be dealt with by the GAAR
B5.3 However, where there are abusive arrangements which try to exploit particular provisions in a double-tax treaty, or the way in which such provisions interact with other provisions of UK tax law, then the GAAR can be applied to counteract the abusive arrangements.
The BEPS project has also changed the global approach to international tax planning and the MLI (see Section III.viii) has significantly reduced the scope for treaty shopping.121
In addition, the EU has adopted the Anti-Tax Avoidance Directive (ATAD), which has been applied by Member States since 1 January 2019. The ATAD imposes a minimum standard for a number of the matters set out in this chapter, to be applicable at EU level, including exit taxation (i.e., tax on assets transferred across borders); an EU-wide GAAR; and minimum standards of CFC rules. Furthermore, the EU is looking to impose a common corporate tax base under which corporate tax is calculated in each Member State on the same set of rules; followed by a common consolidated corporate tax base under which tax will be payable on an EU-wide basis and then apportioned to relevant Member States. Given the uncertainty of the UK position post Brexit, we have not analysed these proposals in detail.
v Company residence
As stated, where an entity is established in any jurisdiction to hold IP rights or carry out any other function, it is likely to require the requisite 'substance' commensurate with its functions. Such substance requirements may arise as a result of a number of factors:
- local laws may require specific substance requirements to fall within favourable tax regimes or to benefit from tax treaties or EU directives;
- transfer pricing analysis will be undertaken on the basis of a functional analysis that in turn will require continued substance commensurate with such analysis;
- residence under local law and tax treaties will usually depend on where the company is managed; and
- if the company does not carry out its functions in the local jurisdiction, there is a risk that it may be taxable elsewhere through a permanent establishment.
HMRC will apply these tests to determine whether an entity established offshore is actually resident in the United Kingdom. It is usually best practice to ensure that an entity is appropriately managed in its home jurisdiction to ensure that it meets any required substance tests locally and to ensure that it is not resident in the United Kingdom (or another taxable jurisdiction).
As stated above, a company that is not incorporated in the United Kingdom could be treated as resident in the United Kingdom under UK domestic law if it is centrally managed and controlled in the United Kingdom. The meaning of central management and control is not defined in UK statute and has instead been determined according to UK case law principles. Broadly, the central management and control test is a question of fact that looks at where the highest level of control (i.e., the overall strategic management structure, as opposed to the day-to-day management) of an overseas company is physically conducted. As stated in UK case law,122 the question depends on where the 'real business is carried on' and this is 'where the central management and control actually abides'. It is also stated that 'it is the actual place of management, not that place in which it ought to be managed, which fixes the residence of a company'.123 If this is in the United Kingdom, the company is UK tax-resident (in the absence of any tax treaty provision to the contrary). Cases have attached importance to the place where the company's board of directors meet, although this is not necessarily conclusive. HMRC sets out detailed guidance in its manuals as to the meaning of central management and control, including a reproduction of the Statement of Practice,124 which sets out its view of the factors relevant to determining residence under the common law test.
In some cases, central management and control may be exercised by a single individual. This may happen when a chairman or managing director exercises powers formally conferred by the company's articles and the other board members are little more than ciphers, or by reason of a dominant shareholding or for some other reason. In those cases, the residence of the company is where the controlling individual exercises those powers.
In general, the place of directors' meetings is significant only insofar as those meetings constitute the medium through which central management and control is exercised. In the case of Wood and another v. Holden125 the Court of Appeal held that an overseas incorporated company, managed by an overseas trust company, which received advice from professional advisers in the United Kingdom, could not be considered to be UK-resident for tax purposes purely because the trust company acted on the recommendations of the professional advisers. This case showed that there must be clear evidence that the central management and control of a non-UK incorporated company is carried out by its directors, and that the authority of the directors has not been usurped by anybody (such as UK-based directors or advisers) in the United Kingdom.
Where a treaty tiebreaker applies, residence is where the company is 'effectively managed', although, following implementation of the MLI, this is likely to change in many treaties to the jurisdiction agreed by the relevant tax authorities under a mutual agreement procedure. It is usually very difficult to see how the place of the 'central management and control' of a company's business for the purposes of determining its residence under UK domestic law will not be the same as the location of its 'place of effective management' for the purposes of the double-tax treaty. A useful case, which considered in detail a company's residence, was that of Laerstate BV v. HM Revenue & Customs.126
As well as residence issues, a company will be keen not to have taxable permanent establishments in a jurisdiction outside its place of residence. As well as ensuring that the company does not have an overseas office or other fixed place of business, it should not have dependent agents concluding or substantially negotiating contracts on its behalf outside its jurisdiction of residence. Ideally the company should also not have any employees outside such a jurisdiction.
As a practical matter, companies should follow clear guidelines to ensure their decision-making processes do not inadvertently mean they are resident in a different jurisdiction from that intended – or for that matter trade through a permanent establishment in such a jurisdiction. Examples of matters that could be contained in such guidelines might include:
- having a majority of local directors with the necessary requisite skill and knowledge;
- holding a minimum number of board meetings each year in the relevant jurisdiction;
- making all strategic and other decisions of effective management at those board meetings;
- not holding board meetings in any other jurisdiction;
- ensuring that there is no or limited participation in board meetings by telephone and no written resolutions;
- approval of key contracts should be at board meetings and all contracts should be approved and entered into by local directors;
- not substantially negotiating contracts without input from the board. The board should not simply 'rubber stamp' contracts;
- having a local company secretary, or similar officer, from which all key documents emanate; and
- holding all necessary books and records at the local registered office.
vi Tax issues arising from corporate structuring
As well as the above issues that arise from tax-driven structuring, many tax issues for franchisors can arise from more commercially driven corporate structuring. For example, franchisors may seek equity participation in their franchisees for economic benefits but also to provide the franchisors with a degree of corporate control. The tax implications of such joint-venture arrangements will depend on the precise circumstances but may involve:
- the effect of any control arrangements on the tax residence status of the franchisee;
- whether the control arrangements make the parties connected for any tax purposes (e.g., transfer pricing);
- the ability to claim consortium relief for tax losses and the need to deal with surrenders of tax losses under the relevant documentation;
- whether the interest acquired by the transferor is sufficient to obtain any tax relief (e.g., exemption from chargeable gains in the United Kingdom under the substantial shareholdings exemption); and
- the tax treatment of any financing arrangements.
VI FRANCHISEE TAX POSITION
While franchisors will generally be companies (and we have therefore concentrated on the corporation tax rules for companies), franchisees may be much smaller businesses and could be run as companies, partnerships or unincorporated small traders. It is beyond the scope of this book to discuss the general tax environment for all such traders. We set out below, however, the tax treatment of the likely payments by corporate franchisees under franchising arrangements. This is generally the reverse of the franchisor treatment. Specifically, a franchisee will want to know:
- whether payments are deductible for tax purposes; and
- whether it will be required to deduct tax at source from payments under any franchise agreements.
For the franchisee, a greater degree of analysis will generally be required as the nature of the payments will vary more dramatically.
i Initial fee
The crucial question for the franchisee will be whether the initial fee (or fees) payable by it are income or capital in nature. As the fees will be incurred wholly and exclusively for the franchisee's trade, then if income in nature the fees should be deductible as part of the franchisee's trading profits. If capital in nature, the fees would not be so deductible. The tax treatment will depend on the nature of the fee and the circumstances of the franchisee. Specifically, for corporate franchisees:
- If the payment is an acquisition of intangible assets (including goodwill), this will for UK corporate franchisees fall within the intangible fixed asset rules (unless the intangible assets are pre-April 2002 IP, which will be the case if it is pre-April 2002 IP for the franchisor and the franchisor and franchisee are connected). If the intangible fixed assets rules apply, the franchisee should, other than in the case of acquired goodwill (or similar IP), obtain a tax deduction for the accounting amortisation of the IP or, if it elects, a fixed writing-down deduction of 4 per cent per annum. For goodwill, customer-related intangible assets and unregistered trademarks, the franchisee will be treated as having made an election for a fixed writing-down deduction of 6.5 per cent per annum. The franchisee may also qualify for rollover relief in respect of past gains under Chapter 7 of Part 8 or Section 898 of the CTA 2009.
- Payments not covered by the intangible fixed asset rules will need to be analysed on a case-by-case basis and analysed as income or capital depending on the facts (see above for a review of what constitutes income or capital expenditure). Generally, franchisors' initial costs are likely to be capital in treatment on the guidelines set out. HMRC confirms this in its manuals on the basis of S Ltd v. O'Sullivan127 and Atherton v. British Insulated and Helsby Cables Ltd.128 The costs are to be split as follows:
- Capital payment for goodwill or franchise rights – for individuals and companies not within the intangible fixed asset rules, goodwill will be an asset for capital gains tax purposes and therefore the acquisition cost will form part of the base cost of the asset but will not give rise to any income tax relief on acquisition. It may be possible to roll over a gain into the expenditure under the rules in Section 152 of the TCGA. However, HMRC takes the view that the amount paid by a franchisee is not for goodwill but for franchise rights, which while being assets for capital gains tax purposes are not assets to which rollover relief applies, and if the licence agreement is less than 50 years, the asset acquired will be a wasting asset for capital gains purposes129 the effect of which will be to not only prevent rolling any gains into the asset but also to depreciate its base cost for chargeable gains purposes. Nevertheless, a franchisee can subsequently generate its own goodwill130 such that it is able to apply rollover relief on a subsequent sale of its franchised purchase. This was the case in Balloon Promotions and HMRC's view of this is set out in Tax Bulletin 83. However, in this case the Special Commissioners accepted that there was substantial goodwill in the actual business as run by the franchisee and not in the franchisor's brand (Pizza Express) at that time. It was also a pertinent fact that the franchise agreement had a six-month termination right for either party such that the court held that there were not substantial valuable rights in the agreement.
- Capital payment for know-how or patents – to the extent that any of the initial fee could be attributed to patents or know-how then capital allowances should be available under Parts 7 or 8 Capital Allowances Act 2001.
- Deferred revenue expenditure – just because an initial lump-sum payment is made, it does not mean that this is necessarily capital and general principles should apply to determine if expenditure is income or capital in nature. For example, a prepayment for ongoing staff training may be income in nature albeit paid up front (c.f., an initial one-off training, which is likely to be capital in nature). Such payments for deferred revenue expenditure could be written off in the accounts up front or over a period of years. The accounting treatment will be important in this respect131 but not conclusive.132
- Acquisition of trademarks and copyright – these rights would be capital gains assets – possibly wasting assets – and there are no capital allowance rules for such rights.
- Costs of premises are likely to be capital in nature and fit out costs may qualify for relief under the capital allowances code.
HMRC states in its published guidance133 that:
Whether an apportionment between capital and revenue expenditure is appropriate depends on the facts. The facts may show that no part of the initial lump sum fees can be attributed to services of a revenue nature provided by the franchiser because such services are separately charged for in the annual fees.
In practice, franchisees may put forward an apportionment without reference to the franchisor. An apportionment of this type may be difficult to justify in relation to the services provided. For instance, some franchisors are unwilling to negotiate special terms with individual franchisees and the same lump sum is payable irrespective of the actual services required from the franchisor; for example, the number of staff needing training may be irrelevant.
If the agreement terms are such that no part of the initial fee is specifically attributed to revenue items, then the claim for apportionment may need to be critically examined.
ii Capital allowances
A deduction for capital expenditure is available under the capital allowances regime to reduce profits for corporation tax (under the pre-April 2002 regime) and for income tax purposes. Generally, expenditure must be classified as capital and must be incurred on specified assets. Specific rules provide for expenditure on R&D, know-how and patents to be relieved.
The quantum of capital allowance that can be claimed by a taxpayer is provided at a specified rate for each tax year and depends on the type of capital asset and the type of entity incurring the expenditure.
Acquisition of know-how
Where a taxpayer incurs expenditure for the purpose of acquiring know-how from an unconnected person, a capital allowance deduction may be available if the know-how is used in a trade.134
'Know-how' is defined as 'any industrial information or techniques likely to assist in manufacturing or processing goods or material; working a source of mineral deposits; or carrying out any agricultural, forestry or fishing operations'.135
HMRC takes the view that this definition does not extend to commercial know-how (such as market research, customer lists and sales techniques) because this is not 'industrial information or techniques likely to assist in the manufacture of goods or materials'.136 As such, know-how allowances are unlikely to be of relevance in many franchising situations.
The rate of allowance depends on the tax year in which the relief is sought. Where relief is sought, the allowance is:
- all years (except the year in which (b) applies) – 25 per cent of the excess of available qualifying expenditure (AQE) for the pool of assets subject to capital allowance deduction over total disposal value (TDV); and
- final tax year (e.g., when trade discontinued) – amount by which the AQE exceeds the TDV.137 If the TDV exceeds AQE then an assessable balancing charge will arise to the taxpayer.138
Broadly speaking, AQE is capital expenditure on know-how that is incurred for the purposes of the trade and TDV is the net proceeds of sale (which consists of capital sums).
Acquisition of patent rights
A capital allowance deduction is available for capital expenditure incurred to acquire patent rights for the purpose of a trade within the charge to UK tax139 (or for patent rights that give rise to UK taxable income).140
Patent rights are defined as rights to do or authorise the doing of anything that would, but for that right, be an infringement of a patent.141
There is a separate pool of expenditure for each trade and a pool for non-trading expenditure. The writing down allowance available is 25 per cent of the excess of the AQE over total disposal receipts142 each tax year with similar rules for balancing charges or allowances as know-how. Where the patent rights are not used for a trade, any allowance is given against patent income only.
iii Ongoing fees
Ongoing payments will almost always constitute deductible expenses for the purposes of calculating the franchisee's trading profits as they should be income in nature and wholly and exclusively incurred for the purposes of the trade. The key question for such expenses will be whether they are subject to deduction of tax at source – which may also be a question for some capital expenditure included in the initial fee (e.g., if patents have been acquired). Whether or not this is an issue for the franchisee will depend on whether or not the agreement includes a gross-up clause, pursuant to which the fees are increased such that the franchisor stays in the same after-tax position.
As well as the above issues that are specific to the agreement, franchisees will have to contend with all the same tax issues as many other small businesses would have to contend with. For example, it would have to consider:
- If it is a start-up, should the franchisee establish itself as a sole trader, a partnership or a company?
- How are its real estate costs treated? Can it make sure its rental payments are deductible?
- Will it obtain tax deductions for depreciating capital items (e.g., under the capital allowances rules)?
- Are interest expenses tax deductible for the franchisee? Will it have to deduct tax at source?
- Can the franchisee attract investors by offering tax-incentivised equity (e.g., under the UK enterprise investment scheme rules or the seed enterprise investment scheme)?
- Can it minimise VAT in respect of its supplies to the public?
VII TRANSFER PRICING
Where transactions take place between related, associated or connected companies, there is an incentive for profits to be 'moved' from a company with a relatively high tax rate to another company with a relatively low tax rate. This could be achieved, for example, in the context of a trademark licence, by an inflated royalty being charged by a licensor in a low-tax jurisdiction to a licensee resident in a high-tax jurisdiction (thus stripping taxable profits out of the high-tax jurisdiction).
The transfer pricing regime seeks to prevent this type of practice by requiring an arm's-length price to be paid (in the above case, an arm's-length royalty to be paid by the licensee). This is a general rule, which is similar to the specific rules, which impose market value prices on transactions between connected persons (e.g., for capital gains tax, TCGA 1992, Section 17 and for chargeable intangible assets, CTA 2009, Section 845).
Many countries have a transfer pricing regime and, although the precise mechanics vary from country to country, many are based on the OECD's transfer pricing guidelines, which were most recently updated in 2017 to bring them into line with the BEPS action points. The United Kingdom's transfer pricing rules are in TIOPA 2010, Part 4. Broadly speaking, the provisions seek to adjust the tax return of a person who obtains a potential UK tax advantage from its non-arm's length dealing with another person. The tax return is adjusted as though the transaction had been at arm's length. SMEs may be exempt from transfer pricing rules under Section 166 TIOPA unless the transaction is with a party in a non-qualifying territory (broadly speaking, a tax haven), although HMRC may by notice, in the case of medium-sized enterprises (and where the UK Patent Box applies, small enterprises), disapply the exemption. The definition of an SME follows the general EU definition.143
The regime applies where provision has been made or imposed between two 'affected persons' by a transaction or series of transactions, the participation condition is met, and the actual provision differs from what would have been the actual provision between independent enterprises dealing on arm's-length terms (the 'arm's-length provision'). The UK rules apply even where the transactions are between two UK parties.
To meet the participation condition, one person must control the other or they must be under the control of the same person. 'Control' means voting control or control by virtue of powers conferred by the articles of association or other document regulating the powers of a company whereby the company's affairs are conducted in accordance with the wishes of the controller.144 In the context of a partnership, control means the right to a share of more than one half of its assets or income. The definition is extended in certain circumstances (e.g., to include rights held by connected persons, rights that will be acquired in the future or persons who own 40 per cent or more of the controlling shares in a company where there is another such 40 per cent or more shareholder).
Where the provisions apply, penalties may be assessed to the extent of tax lost because of fraud or negligent conduct. However, HMRC indicates that where the taxpayer makes an honest and reasonable attempt to comply with the legislation, HMRC will not impose a penalty.145
In practice, determining the arm's-length value, particularly one that is acceptable to the revenue authorities of two countries, is a difficult exercise. This is particularly the case for intangible assets such as IP, which are often unique to the company or group concerned.
The OECD Transfer Pricing Guidelines146 describe valuation methods that are generally acceptable to tax authorities around the globe and that have been accepted by HMRC. These are divided into traditional transaction methods and transactional profit methods.
i Traditional transaction methods
Comparable uncontrolled price
The comparable uncontrolled price (CUP) method simply compares the price charged between the connected parties (the 'controlled transaction') with the price in a comparable uncontrolled transaction (i.e., a comparable transaction between unconnected third parties – an 'uncontrolled transaction'). The price in the uncontrolled transaction may need to be substituted for the price in the controlled transaction if the two are comparable. The two transactions should be comparable if:
- there are no differences between the transactions being compared or between the enterprises entering into the transactions, which could materially affect the price charged in the open market; and
- where there are differences, reasonably accurate adjustments can be made to eliminate their effect.
While the CUP method is the most reliable method for transfer pricing, identifying good, reliable comparable uncontrolled transactions can be difficult in practice, as was demonstrated in the case of DSG Retail Ltd and others v. HMRC.147
Resale minus (resale price)
This method is most useful where a company purchases goods for distribution from a connected party (the minus effectively corresponds to a commission and represents the amount out of which the reseller would seek to cover its expenses and, in the light of its functions (taking into account assets used and risks assumed), make an appropriate profit).
This method is most useful for services or where semi-finished goods are transferred between related parties (e.g., a manufacturing company selling to a distribution affiliate), or where joint facility agreements have been concluded. It is in effect the opposite of resale minus, looking at costs incurred and stating that an independent third party would expect to make a fixed profit in addition to such costs. The starting point is therefore the costs incurred by the supplier of the goods or services. A percentage is then added to this to give the supplier a profit appropriate to the functions carried out and the market conditions. The profit element is determined by looking at comparable uncontrolled transactions carried out by the supplier with independent third parties (an 'internal comparable'). If the supplier does not enter into comparable uncontrolled transactions, the mark-up that would have been earned in comparable transactions by an independent enterprise (an 'external comparable') should be considered. As cost-plus generally gives rise to a low fixed profit, it is more suitable to low-risk, low-value functions and is likely to be challenged where the functions or risk involved should give rise to a variable and potentially high level of profits. A risk and functional analysis of what the supplier actually provides is therefore key as to the application of this (and all transfer pricing methodologies). In looking at comparables, it is therefore important to demonstrate similar risk allocations in comparable circumstances. Cost plus can also be used for R&D services, provided that the functional analysis and allocation of risk justify this methodology and any realistically available options or alternative structures in pricing the transaction. In this sense it is sometimes necessary to consider not just who contractually takes the entrepreneurial risk but who would take the entrepreneurial risk were the parties independent.
ii Transactional profit methods
There are two further methods supported by the OECD guidelines that do not look so much at each transaction undertaken by a party but at what level of profit should be allocated to the party. These two methods are the profit split method and the transactional net margin method.
This method seeks to determine the division of profits that independent enterprises would have expected to realise from the relevant transactions. It is a 'two-sided' method as it looks at both (or all the) parties to the transaction. The other methods are 'one-sided' in that they only test the appropriate return for a single party without considering the effect on the return of the other party. The method is useful for complex trading relationships where it can be difficult to evaluate transactions separately. The most recent OECD Guidelines make clear that application of a profit split methodology should split the profits on an economically valid basis, which approximates the division of profits that would have been anticipated and reflected in an agreement made at arm's length. This part of the OECD Guidelines was updated as a result of the BEPS project to provide more guidance and examples on when this might be the most appropriate method to use and how it should be applied.
Transactional net margin method
The transactional net margin method looks at the net profit relative to a particular base (e.g., costs, sales, assets) that a taxpayer realises from a controlled transaction. In this sense it is similar to cost plus or resale minus. So in this sense internal comparable should be considered in the first instance followed by external comparables. The OECD Guidelines emphasise finding comparable transactions based on functional analysis.
Applying transfer pricing principles to transactions involving intangible assets, including disposals of such assets and royalty payments, is a particularly difficult area because of the uniqueness of most IP and therefore the lack of comparables. There is a specific chapter of the OECD Guidelines dedicated to intangible property. Similarly, there are special chapters dedicated to intra-group services, cost contribution arrangements and business restructurings – all of which may need to be considered in the context of franchising arrangements. The chapter relating to intangible assets was rewritten as part of the BEPS project.148 This provides new guidance on defining intangibles, identifying transactions involving intangibles and for determining arm's-length terms for transactions involving intangibles. In a key change resulting from this project, it has been highlighted that IP income should accrue to entities that perform value-creating functions relating to the development, enhancement, maintenance, protection and exploitation of the intangible asset (known as the 'DEMPE functions'). The net effect of this is that it will be more difficult for multinational enterprises to argue that a company in a low-tax jurisdiction that simply funds IP development (e.g., R&D or marketing expenses) can accrue the income from the resulting IP, as it will not have sufficient substance in terms of people functions.
Whichever valuation method is chosen, evidence will be needed to justify the value given. Documentation should be kept to prove the relevant relationship, nature, terms and prices of the relevant transactions, the valuation method used (particularly how the arm's-length price was determined, including any functional analysis or comparable study). The basis for any computational adjustment required to reach an arm's-length value should be retained, and the terms of relevant commercial arrangements with both third-party and affiliated customers. Such documentation should be kept for at least six years from the end of the chargeable period to which it relates.
The extent of documentation should be such 'as is reasonable given the nature, size and complexity (or otherwise) of their business or of the relevant transaction (or series of transactions) but which adequately demonstrates that their transfer pricing meets the arm's-length standard'.149
It should also be borne in mind that where transfer pricing is relevant to any transaction, a taxpayer may apply pursuant to Section 223 of the TIOPA for an advance pricing agreement to seek clarity on the terms of a transaction for transfer pricing purposes. Such agreements can be unilateral (i.e., only agreements with HMRC) or bilateral (i.e., where the agreement relates to a cross-border transaction seeking agreement with HMRC and the tax authority in the other jurisdiction).
VIII VALUE ADDED TAX
Broadly speaking, VAT is an indirect tax, chargeable on consumer expenditure. In the EU, it is based on the EU VAT Directive.150 VAT is implemented under the VAT Directive and various other EU regulations thereunder as well as local implementing laws in each jurisdiction. In the United Kingdom, the main implementing law is the Value Added Tax Act 1994 (VATA).
Under the UK rules, VAT applies to any supply where:
- there is a supply of goods or services (including anything related to that supply);
- the supply is made in the United Kingdom;
- the supply is a taxable supply;
- the supply is made by a taxable person for (monetary or non-monetary) consideration (albeit certain supplies can be deemed to arise even without consideration); and
- the supply must be made in the course or furtherance of a business carried on by the taxpayer.151
There are in addition separate VAT charges where goods are 'imported' into the United Kingdom from outside the EU and also where there is an 'acquisition' of goods in the United Kingdom from another EU Member State.152
VAT is collected and payable by the supplier or by the person making the importation or acquisition. The 'cost' of VAT is intended to be borne by the end user, but the tax is collected at different stages in the supply chain.
A VAT-registered person must charge VAT (output tax) on its VATable supplies and can recover the VAT it pays (input tax) on supplies received by it to the extent that this can be attributed to taxable (i.e., VATable or zero-rated) supplies. It pays to the UK tax authority, HMRC, (generally on a monthly or quarterly basis) the difference between its output and input tax (or receives a repayment where input tax exceeds output tax).
Input tax is generally only recoverable to the extent it is attributable to taxable supplies. Therefore, where a VAT-registered person makes both taxable and non-taxable (i.e., exempt, non-business, or certain other outside the scope of VAT) supplies, only a proportion of his or her input tax will be recoverable.
Businesses that make taxable and exempt supplies are generally referred to as 'partially exempt traders', typical examples of which are banks and insurance companies. The recovery of input tax attributable to 'outside the scope' supplies varies. However, recovery is not blocked in the case of exports of services that would be taxable if made in the United Kingdom.
There are no specific VAT laws for franchising in the United Kingdom, or in the EU VAT Directive, so general VAT principles apply to franchising arrangements. The United Kingdom's Brexit withdrawal terms also broadly propose that UK VAT laws should continue to be aligned with EU VAT laws during any transitional period and for a five-year extended period in respect of certain transactions involving a cross-border element. However, after these periods, Great Britain would not be part of the EU's customs union and VAT system, so it could then unilaterally introduce specific UK VAT laws for franchising arrangements. Northern Ireland may remain aligned with the rules of the EU's customs union and thus would not be able to introduce specific rules. It is therefore unlikely that the rest of the United Kingdom would deviate substantially from the EU's approach in the medium term.
i Taxable person
VAT applies to supplies made by a taxable person. Therefore, a person who is a taxable person must charge VAT on taxable supplies made by him or her at the appropriate rate and a person who is not a taxable person must not charge VAT in respect of any supply.
A 'taxable person' is essentially a person (including a company or a partnership) who makes taxable supplies in the United Kingdom in the course or furtherance of a business carried on by him or her and the aggregate value of the supplies that have been made by him or her in the previous 12 months or less, or are expected to be made in the forthcoming 12 months (or in the next 30 days alone), exceeds the prevailing registration limit (this is currently £85,000 in the United Kingdom). This threshold has, however, been removed with effect from 1 December 2012 for all non-UK traders without a UK establishment who make taxable supplies for VAT purposes of any value in the United Kingdom (such as supplies relating to UK land or supplies of stock stored in the UK). Businesses may also register voluntarily for VAT (thus becoming taxable persons).
ii Supply of goods and services
A 'supply of goods' means the supply of the whole property in goods but the transfer of an undivided share in property or of the possession of goods is a supply of services (unless possession is transferred under a sale agreement or in certain other circumstances (e.g., hire purchase agreements). Additionally, certain other supplies are specifically treated as supplies of goods (e.g., supplies of power or certain supplies of land).153
A 'supply of services' is defined as anything that is not a supply of goods but is done for a consideration (including, if so done, the granting, assignment or surrender of any right).154 Granting IP rights will generally be supplies of services for VAT purposes.
iii Time of supply
For goods, the time of supply is when they are removed or otherwise made available. If the goods are removed before it is known whether they are to be supplied, the time of supply is when the supply becomes certain or, if sooner, 12 months after removal.155
The 'time of supply of services' is when the services are performed.156 An exception to this general rule is where there is a continuous supply of services, in which case the time of supply is the earlier of when the payment is received by the supplier and when the supplier issues the invoice.157 In the case of royalties, the time of supply is the earlier of when the royalties are received and a VAT invoice is issued.158
For both goods and services, it is possible to accelerate the time of supply by the issue of a VAT invoice or receipt of payment.159 Further special time-of-supply rules apply in respect of reverse charge services received by UK businesses from outside the United Kingdom160 and in respect of intra-EU acquisitions of goods to the United Kingdom.
iv Taxable supply
A taxable supply is a supply of goods or services made in the United Kingdom other than an exempt supply.161 There are three rates of VAT on taxable supplies, 20 per cent, 5 per cent (on a limited class of supplies) and nil (on zero-rated supplies). Supplies of certain services or types of stock may be exempt or subject to a reduced (for example, zero) rate of VAT, but this will depend on the nature of the services or goods in question and whether they form part of a mixed or composite supply with other goods or services.
An exempt supply is a supply specified in Schedule 9 of the VATA. Exempt supplies include financial and insurance services, but supplies of IP are not generally exempt. Zero-rated supplies are set out in Schedule 8 of the VATA and include, subject to detailed conditions, food, children's clothing, and medicines prescribed by pharmacists.
There are two other categories of supply, which are important for VAT purposes: 'outside-the-scope' supplies and other supplies treated as not involving a supply of goods or services with the result that VAT is not chargeable. Examples of such supplies include non-business supplies, the supply of certain international services (e.g., a transfer of IP to a customer outside the United Kingdom) and a transfer of a business as a going concern (TOGC). UK TOGC rules can cover IP supplies or licensing, or both. The expression 'going concern' generally refers to a business that is still in existence, live or operating and has all parts and features necessary to keep it in operation, as distinct from being only an inert aggregation of assets. A business scaled down because of financial difficulties or in anticipation of a sale, or even in liquidation, receivership or bankruptcy, can still be a going concern.
TOGC rules are not implemented in a harmonised way across Europe, and different local considerations will apply. In the United Kingdom, TOGC treatment for transfers of franchise businesses can be available provided several conditions are met, including that the same kind of business is transferred from a franchisor to a franchisee and that the new franchisee intends to carry on the same kind of business, without a significant break in trading after the transfer, and the transfer will not be followed by other immediately consecutive transfers of the business (e.g., to another new franchisee). Where only part of a business is sold, it must be capable of separate operation. HMRC guidance notes the importance of establishing whether a franchisor has actually operated the business being transferred. If so, it is capable of being a TOGC. Otherwise, merely granting a franchise is not a TOGC, as such a grant is not the same kind of business as making supplies of goods and services under a franchise agreement. TOGC for VAT purposes may also be available in circumstances where a franchisee gives up a franchise and the franchisor 'installs' another franchisee in the premises. In those circumstances, one would have to examine whether the new franchisee was buying the premises, stock or fixtures and fittings from the old franchisee and that what was being transferred was the possession of a business as a going concern that could be carried on by the new franchisee on a lasting basis. The fact that the permission of the franchisor may be necessary for the assets to be sold should not prevent the transaction from being a TOGC. In addition, where the transferor is a taxable person (i.e., UK VAT registered), the transferee must be a taxable person (VAT registered) already or immediately become one as the result of the transfer (with the VAT registration usually being in place by and with effect from completion).
Where land is transferred as part of a TOGC, there are certain extra conditions that have to be met for the transfer of the land or lease, etc. to be given TOGC (non-VAT) treatment. One such condition is that the transferee may have to make an election (called an 'option to tax') before completion to waive any VAT exemption relating to a transfer of the property in question, and also notify that this option will not be revoked under certain anti-avoidance rules.
v Place of supply
The complex 'place-of-supply' rules determine in which Member State, if any, a supply of goods or services should be taxed. The result is that UK VAT is only chargeable where the place of supply under these rules is the United Kingdom. UK VAT is not chargeable if the place of supply is outside the United Kingdom, even if made by a taxable person. If the place of supply is another Member State of the EU, that Member State has the jurisdiction to charge its local equivalent of VAT on the supply. If the place of supply is outside the EU, no Member State has the jurisdiction to charge VAT on the supply although VAT or sales tax may be chargeable outside the EU.
There are detailed rules for both goods and services and the rules vary depending on whether supplies are to 'taxable persons' (broadly speaking, businesses) or not. In the context of franchising we would assume that all supplies by franchisor to franchisee are business-to-business supplies.
The Place of Supply of Services Directive (Council Directive 2008/8/EC of 12 February 2008 amending Directive 2006/112/EC as regards the place of supply of services) has applied in the EU since 2010. Changes came into effect in 2011 (certain services supplied where performed) and in 2015 (relating to broadcasting, telecommunications and electronically supplied services) (BTE)) providing that such BTE supplies are subject to VAT where the customer resides. As a result of more changes, a Mini One-Stop Shop (MOSS), an electronic registration and payment system, was introduced to facilitate suppliers' VAT administration for their BTE supplies to non-business consumers in the EU. This MOSS concept is now planned to be extended for supplies of tangible goods ordered online both within and outside the EU (see below), and potentially in the future, for all (cross-border) supplies of services.
The place of supply of services ultimately depends on various factors, such as the nature of the services, whether or not the recipient is a taxable person, and where the service is carried out. Nonetheless, subject to future changes, in summary, the present position is that the general place-of-supply rule for services is as follows:
- for business-to-consumer (B2C) supplies, the general rule is that the supply is made where the supplier belongs; and
- for business-to-business (B2B) supplies, the general rule is that the supply is made where the recipient belongs.
However, this general rule is subject to so many exceptions that it should not be looked upon as the normal position; it is the position should no exception apply. For example, as noted above, for BTE supplies, the supply is treated as made where the recipient belongs, irrespective of whether the recipient is in business or not. For IP royalty income – either the general B2B rule applies for UK VAT place-of-supply purposes (so VAT is chargeable where the business customer belongs) or, where applicable, a special rule applies for UK-outbound IP supplies to non-business consumers outside the EU whereby such supplies are not subject to UK VAT.
A crucial question to determine place of supply in respect of services is normally where the supplier or recipient 'belongs'. For a relevant business person, it is broadly the place where that person has its business establishment or some other 'fixed establishment' or (in the United Kingdom at least), if it has more than one business establishment, the establishment that is most directly concerned with the supply of services in question. How these provisions should be interpreted, as well as the meaning of terms such as 'fixed establishment', has been subject to a substantial body of UK and EU case law. Non-business persons are treated as belonging in the country of such a person's usual place of residence.162
Business-to-business supplies of services
Supplies of services by a supplier to a relevant business person are treated as supplied in the country in which the recipient belongs. For this purpose, a relevant business person is a person registered for VAT in the United Kingdom, Isle of Man or EU or any person who independently carries out in any place any economic activity.163
Again this can be overridden; for example, for telecommunications, broadcasting and electronically supplied services where 'use-and-enjoyment' provisions may apply in the context of international supplies to the United Kingdom from a non-EU jurisdiction and vice versa (the use-and-enjoyment provisions do not apply in respect of intra-EU transactions, albeit this could have more relevance in other European jurisdictions post-Brexit when the UK becomes a non-EU jurisdiction).
Business-to-business supplies of goods
These rules are more complicated than the rules for services and we do not go into them in detail here on the assumption that the heart of a typical franchising arrangement is the licensing of IP and the supporting services. Nevertheless there can be associated agreements for the supply of goods, so the rules would then have to be considered, including in light of the EU Commission's proposals derived from its Action Plan on VAT (see below).164
Section 7 VATA sets out a priority for the place of supply of goods. If a supply does not involve the removal of the goods to or from the United Kingdom, they shall be treated as supplied in the United Kingdom if they are in the United Kingdom. There is then a complicated hierarchy of rules that follow this to determine place of supply. In any event, if goods are supplied in the United Kingdom, supplies of goods to EU registered businesses are zero-rated provided the goods are removed from the United Kingdom within three months of the supply. Similarly, supplies involving the exporting of goods outside the EU are also zero-rated. However, intra UK-EU trade in goods post-Brexit will be subject to VAT rules on imports and exports and customs supervision and UK businesses may require local fiscal representation to provide trade (including providing services) within the EU.
Irrespective of Brexit, further changes proposed by the EU could affect all suppliers trading within the EU, building upon the 2015 place-of-supply changes introduced for digital services. The proposals include new rules for intra-EU B2C online sales of goods from January 2021 and substantially changing the VAT treatment of intra-EU B2B transactions in goods from July 2022, and subsequently making changes to cross-border services (with certain exceptions), the proposals for which have yet to be determined. The expected changes form part of the EU's VAT Action Plan proposals to overhaul its existing VAT regime and create a single destination-based VAT system for all cross-border transactions, under which supplies would be taxed in the destination Member State at the VAT rate applicable in that Member State.
vi Importation of services from other countries
Where a supplier belonging outside the United Kingdom makes a supply to a taxable person in the United Kingdom and such a supply is treated under the above rules as taking place in the United Kingdom, the 'reverse charge' rules apply. Under the reverse charge, the recipient of the services (rather than the supplier of the services) is required to account for VAT at the rate applicable in the Member State in which he or she belongs to the relevant tax authority. The rules also allow the recipient an input tax deduction in respect of purchases related to taxable outputs. The effect of the reverse charge in the United Kingdom, therefore, is to treat services brought in from outside the United Kingdom in the same way as services that are actually supplied in the United Kingdom if the recipient of the services is VAT registered but with the recipient applying the relevant VAT formalities. The reverse charge procedure may also be used on intra-EU acquisitions of goods and by business recipients in the EU in respect of supplies from a UK supplier. However, as noted (and irrespective of Brexit), the EU's proposed changes would end the current practice of allowing an EU supplier to zero-rate intra-EU B2B sales and for the EU purchaser to self-assess and account for (acquisition) VAT on intra-EU purchases using the reverse-charge mechanism. Instead, the practice would be replaced by making suppliers (both within and outside the EU) responsible for charging, collecting and forwarding the EU VAT due on their intra-EU supplies of goods (i.e., supplies involving a transport of goods within the EU) to business customers in other Member States at the rate applicable in the customers' Member States. Eventually this VAT treatment may be extended to all imported, cross-border services, the proposals for which will be implemented at a later date. To mitigate the administrative impact of these changes on suppliers, the EU Commission has simultaneously proposed to expand the use of MOSS as an evolving EU-wide IT solution or scheme (i.e., a one-stop shop) that will allow suppliers to report and pay in a single Member State the EU VAT due on their intra-EU sales in other Member States. This system will also be available in respect of other B2C supplies of services and to distance sales, and to companies outside the EU who want to sell to businesses within the EU and who would otherwise be required to register for VAT in every Member State. However, we understand that non-EU businesses (so UK businesses post-Brexit) could be required to appoint an EU-based intermediary to use this scheme, with the intermediary fulfilling the obligations laid down in the scheme in the name, and on behalf, of the non-EU business.
The significance of these proposals will obviously depend on the transitional arrangements agreed upon the United Kingdom leaving the EU.
Generally, reverse charges have no effect on recipients who are not taxable persons.
vii Effect of the above rules on franchising arrangements
The net effect of the above rules on franchising arrangements is that generally:
- UK franchisors will charge VAT to UK franchisees in respect of all services and goods (assuming the goods are in the United Kingdom) save where the supply satisfies TOGC rules such that TOGC treatment applies;
- UK franchisors (assuming they are not VAT registered elsewhere) will not charge VAT to non-UK franchisees in respect of services (which includes IP licences). VAT on the services should be accounted for by EU franchisees under the reverse-charge procedure. The VAT treatment of any goods supplied will depend on the nature of the supply chain;
- non-UK franchisors will not need to charge VAT on services supplied (including on the IP licences) to UK-based business recipients. EU-based VAT registered franchisees would account for VAT under the reverse charge procedure. Again, the VAT treatment of any goods supplied will depend in more detail on the nature of the supply chain;
- if there is a disagreement over the VAT treatment of any of the supplies under a franchising agreement then the question would then need to be asked as to whether one apportions the fees between supplies with different VAT treatments or whether there is a single composite supply with VAT determined on the principle element of the supply under the principles established in Card Protection Plan v. C & E Comrs;165 and
- to the extent a franchisee is VAT registered and carrying out fully VATable services, it should be able to recover the VAT incurred on the franchising fees.
For example, under (a) above, in a franchising context, where a franchisor charges royalties under a standard franchise agreement to a franchisee (i.e., the royalties represent the franchisor's licensing of the franchisor's IP), this would be a B2B supply of IP or services for UK VAT purposes (assuming this licence were not part of a qualifying TOGC transfer of the franchise) and this supply would be inside the scope of UK VAT where supplied between two UK-established businesses. UK VAT would be chargeable, accountable by the franchisor. In the case of inbound IP supplies from a non-UK franchisor to a UK franchisee or licensee, then, as under (c) above, UK VAT would not be charged by the overseas franchisor, but it would be accountable by the UK VAT registered franchisee or licensee under the United Kingdom's reverse-charge mechanism, although, as this is a reporting or simplification mechanism, there should be no net VAT payable by the UK franchisee on the supply (i.e., then the supply should be cash-flow or VAT neutral for the franchisee or licensee) unless it was a partially or wholly exempt business that cannot fully recover UK VAT. Internal licensing of IP between sister franchisor entities would be subject to UK VAT on the same principles, assuming the entities were not part of a formal UK VAT group (which would need to be specially registered as such) to disregard such supplies. UK VAT grouping rules presently require group members to have a UK fixed establishment.
There have been some UK VAT cases involving franchising arrangements. One such case is Kumon Educational Company Limited v. HMRC,166 which looked at rewards provided to a franchisee by the franchisor. It was held that these rewards were not for a separate VATable supply but were linked to the franchise fee and in effect amounted to a contingent discount. The franchise fee could therefore be reduced for VAT purposes and VAT previously accounted for repaid.
In Reeds School of Motoring (Sheffield) Ltd v. C & E Comrs,167 driving tuition supplied to pupils was held to be made by the (franchisee) instructors as principals and not by the motoring school, the latter's role being to provide a supporting organisation by which the instructors were provided with the means to give tuition, such as the tuition cars. It was held that the tight control maintained by the school over the instructors was a common feature of franchise agreements, where the franchisor does not carry on the business in question (say for example, one of a chain of restaurants), but instead licenses another (for reward) to do so under a name and method of operation that are, or are intended to be, distinctive and well known. This control was held not to be determinative of the type of relationship between the parties, and it was concluded that the business in question was that of the franchisee while the franchise agreement was in force.
Tumble Tots UK Ltd v. Revenue and Customs Comrs168 involved a franchisor of a chain of play centres for children. To take part in a play session, the child would need to be a member of the National Tumble Tots Club. An annual fee was payable, and this was the subject of the appeal. In return for the annual fee, a member received various benefits including a T-shirt and various newsletters and booklets. HMRC argued that there was one main supply of membership (standard rated), entitling the children to take part in activity sessions at Tumble Tots premises. All other supplies were considered to be incidental to this main supply. Tumble Tots argued that the main supplies were the zero-rated supplies of printed material and children's clothing (T-shirt), so overall it was making a zero-rated supply. The tribunal concluded that the membership was the main benefit, and all other supplies were incidental apart from the T-shirt that had some monetary benefit and importance to the child. However, HMRC appealed169 to the High Court, which ruled that the aim of the payment made by the customer was to secure attendance at the classes. Other benefits such as the T-shirt were incidental to this main supply. The entire payment made by the customer was therefore subject to VAT.
In the joined cases of Air France-KLM and Hop!-Brit Air SAS v. Ministère des Finances et des Comptes publics,170 (KLM), Hop!-Brit Air SAS (Hop) provided air passenger transport services under a franchise agreement with Air-France-KLM, with Air-France being responsible for marketing and ticket management on the franchised routes. In the context of the franchise agreement, Air-France received the ticket price direct from passengers and paid this on to Hop in relation to each transported passenger. Where there were 'no-shows' or tickets had expired, Air-France paid Hop compensation at an annual flat rate calculated at 2 per cent of the annual turnover (including VAT) received from the routes operated as a franchise. Hop did not account for VAT on these sums and the French authority issued assessments for VAT on these amounts. The question for the Court of Justice of the European Union (CJEU) was whether or not a non-refundable payment for unused tickets was a taxable supply. The taxpayer argued that payments in such circumstances should be treated as compensation and therefore outside the scope of VAT. However, the CJEU held that, looked at objectively, the payments were subject to VAT as they represented consideration for a right to benefit from the airline's obligations under a transport contract, even if they were not actually used by no-show passengers. It also held that the sums paid by Air France-KLM to Hop could not be regarded as compensation for harm suffered. Instead the sums corresponded to the value attributed by the parties to the unused tickets issued for a transport service and were therefore subject to VAT.
1 Zoe Feller is a partner at Bird & Bird LLP.
2 Corporation Tax Act 2010 (CTA 2010), Section 1121.
3 Corporation Tax Act 2009 (CTA 2009), Section 5(1).
4 CTA 2009, Sections 5(2) and (3).
5 TCGA, Section 10B(1).
6 CTA 2009, Section 14.
7 De Beers Consolidated Mines Ltd v. Howe 5 TC 198.
8 CTA 2010, Section 1143.
9 CTA 2009, Section 2.
10 CTA 2009, Section 19.
11 TCGA, Section 8(1); CTA 2009, Section 4.
12 CTA 2009, Section 46.
13 Income Tax (Trading and Other Income) Act 2005 (ITTOIA), Section 33; CTA 2009, Section 53.
14 ITTOIA, Section 96(1); CTA 2009, Section 93; and Business Income Manual BIM14060.
15 Marson (Inspector of Taxes) v. Morton 59 TC 381 at 393.
16  3 All ER 949.
17 ITTOIA, Section 34(1); CTA 2009, Section 54(1).
18 CTA 2009, Section 906.
19 CTA 2009, Section 882.
20 CTA 2009, Section 883, Corporate Intangibles Research and Development Manual (CIRD) 11670.
21 CTA 2009, Section 883(5) to (7).
22 CTA 2009, Section 884.
23 CTA 2009, Section 713(1).
24 CTA 2009, Section 712; CTA 2010, Section 1127.
25 CTA 2009, Section 715.
26 CTA 2009, Section 803.
27 CTA 2009, Sections 721–722.
28 CTA 2009, Section 723.
29 CTA 2009, Section 724.
30 CTA 2009, Section 725.
31 CTA 2009, Sections 733–741.
32 CTA 2009, Section 728.
33 CTA 2009, Section 729.
34 CTA 2009, Section 735.
35 CTA 2009, Section 732.
36 CTA 2009, Section 730.
37 CTA 2009, Section 753.
38  STC 117.
39 Jeffrey v. Rolls-Royce (1962) 40TC443.
40 Rustproof Metal Window Co Ltd v. IRC  2 All ER 454.
41 Coalite & Chemical Products v. Treeby (HM Inspector of Taxes) 48 TC 171.
42 British Salmson Aero Engines v. IRC (1938) 3 All ER 283.
43 Murray (HM Inspector of Taxes) v. Imperial Chemical Industries Ltd (1967) 44 TC 175.
44 Margerison v. Tyresoles Ltd (1942) 25 TC 59.
45 British Insulated and Helsby Cables v. Atherton  AC 205, HL.
46 Triage Services Ltd v. HMRC Sp C 519  SCD 85.
47  STC 353.
48 See also Strick v. Regent Oil Ltd (1965) 43 TC1; Vallambrosa Rubber Co Ltd v. Farmer (1910) 5 TC; Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337.
49 Business Income Manual BIM35505.
50 Business Income Manual BIM35510.
51 Business Income Manual BIM35525.
52 Business Income Manual BIM35545.
53 Business Income Manual BIM35540.
54 CTA 2009, Sections 882(7) and 896.
55 CTA 2009, Sections 176–179.
56 CTA 2009, Section 178.
57 CTA 2009, Section 909.
58 CTA 2009, Section 912.
59 CTA 2009, Section 912(3).
60 CTA 2009, Section 913(1).
61 CTA 2009, Section 913(2).
62 CTA 2009, Sections 914–915.
63 ITTOIA, Section 591; CTA 2009, Sections 916–917.
64 CAA 2001, Section 468(1).
65 CAA 2001, Section 469.
66 TCGA, Section 10B.
67 TCGA, Section 275.
68 TCGA, Section 1.
69 TCGA, Section 21.
70 TCGA, Section 22.
71 TCGA, Section 29(5).
72 TCGA, Sections 37–38.
73 TCGA, Sections 17–18.
74 TCGA, Section 37.
75 TCGA, Section 171; CTA 2009, Section 775.
76 TCGA, Section 179; CTA 2009, Section 780.
77 TCGA, Section 171(1A); CTA 2009, Section 775(1)(c).
78 TCGA, Section 185; CTA 2009, Section 859.
79 TCGA, Section 186; CTA 2009, Section 860.
80 National Grid Indus BV v. Inspecteur van de Belastingdienst Rijnmond C-371/10 (NGI).
81 Council Directive 2005/56/EC and Council Directive 2009/133/EC.
82 Moss Empires Ltd v. IRC (1937) 21 TC 264.
83 Earl Howe v. CIR (7 TC 289).
84 The Income Tax Act 2007 (ITA), Section 900.
85 ITA, Section 910.
86 Section 917A ITA.
87  STC 1195.
88 2009 DTC 5053 (FCA).
89 2012 TCC 57.
90 Countess Shrewsbury v. Earl of Shrewsbury (1907) 23 TLR 224, CA; Turvey v. Dentons (1923) Ltd  1 QB 218,  2 All ER 1025.
91 CTA 2009, Section 747.
92 CTA 2009, Section 754.
93 CTA 2009, Section 734.
94 See Patterson Engineering Co Limited v. Duff (1943) 25 TC 43 under which the court is not bound to follow contractual allocations if these do not reflect the real nature of payments.
95 Business Income Manual BIM57610.
96  40TC443.
97 Business Income Manual BIM57610.
98 British Dyestuffs Corporation (Blakeley) Ltd v. IRC (1924) 12 TC 586.
99 Chapter 7 Part 8 of the CTA 2009.
100 CTA 2009, Section 898.
101 For example, Johnston v. Britannia Airways Ltd  67TC99.
102 TIOPA, Section 9(6).
103 HMRC manuals, International Manual INTM161130.
104 TIOPA, Section 112.
105 TIOPA, Section 9(7).
106 See Indofood International Finance Ltd v. JP Morgan Chase Bank NA London Branch; see also the revised commentary on the meaning of 'beneficial ownership' as set out in the 2014 update to the OECD Model Convention.
107 For example, Section 140C, Section 140E(8), 140F(9) TCGA.
108 (1936) 19 TC 490.
109  AC 300.
110  STC 153.
111  STC 1.
112  EWCA Civ 1010.
113  EWHC 2443 (Ch) (8 October 2009).
114 The primary legislation is to be found in Part 7 and Schedule 2 Finance Act 2004.
115 Section 206 FA 2013, Section 206.
116 FA 2013, Section 211(1).
117 FA 2013, Section 207(2).
118 FA 2013, Section 211(3).
119 Schedule 43 FA 2013 and Section 211(2)(b) FA 2013.
120 HMRC'S GAAR Guidance (Approved by the Advisory Panel with effect from 28 March 2018).
121 OECD (2013), 'Action Plan on Base Erosion and Profit Shifting', OECD Publishing. See http://dx.doi.org/10.1787/9789264202719-en.
122 De Beers Consolidated Mines Ltd v. Howe 5 TC 213.
123 Unit Construction Co Ltd v. Bullock  AC 351.
124 SP1/90 (9 January 1990) now published at INTM120200.
125  STC 443 (Court of Appeal).
126  UKFTT 209 (TC).
127 Irish Tax Cases 108.
128 (1925) 10TC155; Business Income Manual BIM57620.
129 Capital Gains Manual CG68270 and CG76724.
130 Balloon Promotions Limited v. Wilson SpC 524/06  STC (SCD) 167.
131 For example, Strick v. Regent Oil Limited (1965) 43 TC 1; Johnson v. Brittania Airways Ltd (1994) STC 763.
132 EEC Quarries Limited v. Watkis (1975) STC 175.
133 Business Income Manual BIM57620.
134 CAA 2001, Section 454(1).
135 CAA 2001, Section 452(2).
136 Capital Allowances Manual CA70030.
137 CAA 2001, Sections 458(1), (6); 457(4), (5).
138 CAA 2001, Sections 457(3); 458(5).
139 CAA 2001, Section 468(1).
140 CAA 2001, Section 469.
141 CAA 2001, Section 464(2).
142 CAA 2001, Section 472.
143 As set out in the Annex to Commission Recommendation 2003/361/EC of 6 May 2003 (concerning the definition of micro, small and medium-sized businesses).
144 CTA 2010, Section 1124.
145 International Tax Manual, INTM 483120.
146 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, July 2017.
148 Guidance on Transfer Pricing Aspects of Intangibles, BEPS Action 8: final report dated 5 October.
149 INTM 483030.
150 Council Directive 2006/112/EC on the common system of value added tax.
151 VATA, Sections 1(2), 4.
152 VATA, Section 1(1)(b) and (c).
153 VATA, Schedule 4 paragraphs 1–3.
154 VATA, Section 5(2)(b).
155 VATA, Section 6(2).
156 VATA, Section 6(3).
157 SI 1995/2518, Regulation 90(1).
158 SI 1995/2518, Regulation 91.
159 VATA, Section 6(4).
160 SI 1995/2518, Regulation 82.
161 VATA, Section 4(2).
162 VATA, Section 9.
163 VATA, Section 7A(4).
164 See, e.g., COM(2016) 148 final: 'Towards a single VAT area – Time to decide', and a follow-up Communication, COM(2017) 566 final.
165 Case C–349/96  STC 270, ECJ (Part V11), applied by the House of Lords  UKHL/4 STC 174.
166  UKFTT 84.
167 Reeds School of Motoring (Sheffield) Ltd v. C & E Comrs (1995) VAT Decision 13404.
168 Tumble Tots UK Ltd v. Revenue and Customs Comrs  EWHC 103 (Ch),  STC 1171.
169  EWHC 103 (Ch),  SWTI 293,  All ER (D) 274 (Jan).
170 Air France-KLM and Hop!-Brit Air SAS v. Ministère des Finances et des Comptes publics (Cases C-250/14 and C-289/14) (KLM).