The UK has one of the longest tax codes in the world. This is merely an overview of what is a very complex system. It is not possible to give the full details of any of the rules referred to below. Tax reliefs, for example, are always subject to detailed conditions, and various provisions designed to prevent avoidance. Therefore, no transaction should be entered into without taking specific advice (and, indeed, various anti-avoidance penalties apply where independent, individual advice has not been taken).
In the UK, there are three basic types of business entity:
A company can have a single owner or a number of owners; a partnership must have a number of partners; and a sole trader is simply that, an individual in business on his or her own account.
There are a number of different types of company: the most common is a company limited by shares, although non-profit-making companies are often limited by guarantee (so that shareholders only have to pay the amount of their liability if and when the company is wound up; liability can be limited to a nominal amount).
There are three types of partnership: a "standard" partnership, where all partners have unlimited liability; a limited liability partnership, where all partners have limited liability; and a limited partnership, where there has to be at least one partner with unlimited liability who manages the business, but all other partners, provided they do not participate in managing the business, have limited liability.
For tax purposes, a company is taxed separately on its profits; its shareholders are taxed (generally) only on dividends received (although anti-avoidance provisions can charge UK shareholders to tax also on, for example, capital gains made by non-UK-resident companies, or loans made by companies, in both cases only where the company is controlled by five or fewer people). Partnerships are tax transparent, at least where they genuinely carry on business (including non-profit-making activities). Sole traders are taxed as individuals: there is nothing to look through. Apart from tax issues, shareholders in companies, members of limited liability partnerships and limited partners in limited partnerships benefit from limited liability. Finance providers tend to prefer to deal with companies or limited liability partnerships.
The main type of transparent entity is a partnership (of which there are three types, mentioned above). The most frequently used are limited partnerships and limited liability partnerships.
In a limited partnership, the manager alone has unlimited liability, but the importance of this is diminished by having a company be the general partner. In addition, there are limited registration and publicity requirements. For example, a limited partnership need not publish the identity of its ultimate beneficial owners, and it need not publish accounts.
In a limited liability partnership, all partners have limited liability. All of them may participate in managing the partnership’s business, but accounts have to be published. These must show (broadly) the same sort of detail as accounts of companies.
There are very different approaches for determining the residence of incorporated businesses and transparent entities.
For incorporated businesses, they are resident (i) where they are incorporated and also (ii) where their central management and control is exercised. This may give them two tax jurisdictions of residence. Central management and control depends on where the board actually meets and makes high-level management decisions (it does not depend, for example, on where shareholders’ meetings are held, or on the residence or domicile status of shareholders or directors). Where board meetings are conducted by phone, or some of the directors participate by phone, it is therefore important that at least one director is physically present in the jurisdiction in which it is intended that the company should be resident, and to record the location in that jurisdiction where that individual is present and the meeting is administered from. That person should also be the "host" of any conference call.
Partnerships do not have any residence of their own. Because they are tax transparent, it is considered unnecessary for them to have a residence. The taxation of each partner depends on that partner’s own residence (and, indeed, the basis of taxation depends on whether that partner is an individual, and therefore liable to income tax, or a company, and therefore liable to corporation tax). The residence of each partner is determined according to the usual rules applicable to that type of person (in other words, if a partner is an individual, his or her residence is determined according to the usual rules that apply to determine individual residence; where that partner is a company, it is the rules applicable to determine a company’s residence that apply: see above).
Of course, any individual case may also be governed by a double taxation treaty, so that any tie-breaker provisions have to be taken into account.
Currently, the corporation tax rate applicable to companies in the UK is 19%. Any changes take effect normally on April 1st in any year. From 1 April 2023, this will increase to 25% for companies with profits above £250,000; and will increase in a graduated way from 19% to 25% for companies with profits between £50,000 and £250,000. Where a company’s accounting period over which it measures its profits for corporation tax purposes has a different year end, the profits are apportioned between the period before and the period after April 1st, and the applicable rates applied accordingly.
There are different rates for profits of oil extraction activities. These depend on the amount of profits and are from 19% (for profits up to £300,000 per annum) to 30% (for profits of £1.5 million per annum or more), with a gradual increase in between. Unit trusts and open-ended investment companies, when subject to tax, are charged at 20% (the same as the basic rate of income tax).
Tax-transparent entities do not pay any corporation or income tax. Any tax is charged directly on the partners in those entities. Corporate partners are charged at the rates above. Individual partners have a personal allowance for the first £12,570 (this is reduced by £0.50 for every pound of income over £100,000, and so an individual with income over £125,140 has no allowance); thereafter, the rates are 20% for income up to £50,270; 40% for income up to £150,000; and 45% for any income above that.
There are different income tax rates for individuals resident in Scotland, ranging from 19% for income up to £14,550 to 46% for income above £150,000 (the same personal allowance applies). Individuals must also pay National Insurance contributions (NICs) on trading income (but not investment income; there are different rules for employment income). Current rates are a further flat rate of £156 per annum, plus 9% of profits between £8,632 and £50,270, and 2% of profits over £50,270.
Sole traders are charged at the same income tax rates as individuals who are partners in a partnership.
Capital profits made by individuals on any assets other than non-business residential property, whether on their own account as sole traders or as partners in a partnership, are charged normally at 20% (where the person pays income tax at the rate of at least 40%). Individuals who have owned a business (whether shares in a private company, as partners in a partnership, or as a sole trader) for at least two years and (in the case of a company) have been a director for at least that time can pay a reduced rate of tax of 10% on the first £1 million of gains (aggregated over the individual’s lifetime).
The taxation of profits for business entities depends on the form of the entity.
For a company, broadly, revenue profits are calculated for its trading activities, any property-based activities and investment activities. Any capital profits (for example, on the sale of capital assets) are also calculated. Revenue and capital profits are then combined and charged at the tax rates set out above. Revenue profits are based on accounting profits. Essentially, receipts are calculated on an earnings basis (for trade and property businesses).
Expenses incurred wholly and exclusively for the purpose of the business are deducted, again on an earnings basis, from trading and rental receipts. Certain types of expense, such as capital expenditure, are excluded (but can be deducted elsewhere: for example, capital expenditure can be deducted when disposing of the asset acquired). Loan relationships and similar transactions, as well as intangibles, are the subject of specific regimes that are basically aligned with their accounting treatment, with profits and losses taxed as revenue items. There are a variety of reliefs for certain elements of receipts. For example, where a company has a substantial shareholding in another trading company or trading group (generally 10% or more of shares in topco), any gain on a sale of shares is exempt from tax.
A limited liability partnership is a body corporate for the purposes of general law. However, as above, it is tax transparent. Accordingly, its members are taxed by reference to their own status and circumstances. Corporate members are taxed as above. Individual members are taxed as if they were sole traders. Thus, they likewise calculate their profits on an earnings basis, deducting revenue expenses incurred wholly and exclusively for the purpose of the trade.
Capital expenses are excluded from deduction, as are various other specific types of expense, such as entertainment; any bad debt provision (actual bad debts are deductible); and certain salaries paid to employees, unless and until the employees actually receive them. However, rules such as those applicable to loan relationships and intangible assets of companies do not apply to individuals. They are treated broadly as capital assets, and therefore subject to capital gains tax at the rates applicable to individuals (although, for example, debt is generally not an asset for capital gains tax purposes). In addition, certain types of capital expenditure give rise to deductions against trading profits by way of capital allowances. The most important types of expenditure are on plant and machinery, and research and development.
There are a number of special rules for technology investments.
First, research and development expenditure incurred for the purposes of a trade (including a trade that the taxpayer intends to commence, even if, ultimately, it does not) is subject to enhanced deductions from profits. Thus, small and medium-sized enterprises can claim a deduction of 230% of the amount actually incurred on research and development. Alternatively, they can claim a credit against other taxes paid equal to 12% of the amount spent on research and development. The latter is claimable also by large companies. For SMEs, there will be introduced, from 1 April 2021, a cap of £200,000, plus three times the company’s total PAYE and NICs liability, on the amount that may be reclaimed by credit in any one year.
In addition, capital expenditure on research and development for the purposes of a trade (again, including an intended trade) gives rise to writing down allowances of 100% in the accounting period in which the expenditure is incurred. These allowances may be deducted against trading profits (so that relief is obtained as revenue profits are earned, rather than waiting for the sale of the asset). On the sale of any asset that has been created by the expenditure, the disposal proceeds must be brought into account. This has the effect that only net expenditure receives relief, and any profit is taxed.
Other capital expenditure relating to the creation of intangible assets is relieved according to the provisions applying to intangible assets. Tax on this expenditure follows the accounting treatment.
There is currently a patent box system in the UK. Any corporate profits that derive from patents registered in the European Economic Area (whether nationally or with the European Patent Office) are subject to corporation tax at the lower rate of 10%. To qualify, the taxpaying company must either own the patent or have an exclusive licence to exploit it. The income to which the reduced rate applies is income from marketing patented goods or marketing the actual patent. It applies also to profits from using a patented manufacturing process, or providing services using a patented tool.
A variety of special incentives apply to a range of industries, transactions or businesses.
For example, the investment industry receives a variety of beneficial tax regimes. Investment trusts and real estate investment trusts are free of UK corporation tax on profits.
There are special capital allowances for expenditure on renovating business premises; that is, premises that have fallen out of use and are being renovated so as to be used once again for the purposes of a trade or profession.
Commercial woodlands are outside the scope of tax on revenue profits altogether.
On the other hand, for a number of years there has been a focus on disincentives to certain industries and activities. For example, airplane passenger duty is intended to deter people from flying, landfill tax is intended to deter disposal of waste to landfill (and encourage re-use and recycling of material) and soft drinks levy is intended to make drinks that are relatively high in sugar more expensive. A new plastic packaging tax is to be introduced from April 2022: this will apply to packaging that contains less than 30% recycled plastic.
The ability to obtain corporation tax relief for (income) losses is dependent on both the type of loss (ie, its source) and (in relation to carry-forward relief) when it originally arose. The main loss relief categories are trading losses and non-trading deficits (non-trading deficits are basically losses from a company’s debt and derivative financial instruments, excluding those held on trading account). Relief can also be available for other types of losses (including losses arising in a property business and, for companies that carry on an investment business, management expenses).
Corporate Income Loss Restriction
Major reforms of the UK’s corporation tax rules relating to carry-forward relief took effect in 2017. Under those reforms, carry-forward relief for income losses is subject to a cap under the UK’s corporate loss restriction (CILR). In broad terms, CILR limits loss carry-forward relief to no more than 50% of future profits (subject to a (group) annual allowance of £5 million a year, which is only available if certain administrative requirements are met). From 1 April 2020, the (group) annual allowance – the deductions allowance – applies to both CILR and the corporate capital loss restriction (CCLR), which imposes a similar restriction on the use of carry-forward capital losses (see 2.7 Capital Gains Taxation).
A company can obtain relief for its trading losses in one of three ways: carry back, same year or carry forward.
Carry-back relief generally allows a company to offset trading losses arising in a particular accounting period against any profits of the preceding 12 months (subject to special rules on cessation of a trade that can extend that period to three years). However, as part of its response to COVID-19, the UK government announced in March 2021 that for losses arising in an accounting period ending between 1 April 2020 and 31 March 2022, a temporary three-year carry-back will apply (subject to a £2 million cap). Same-year relief allows a trading loss to be offset against any other profits of the same period. Both carry-back and same-year relief must be claimed.
The nature of carry-forward relief depends on when the trading loss arose. Trading losses that arose up to 31 March 2017 carry forward automatically to offset against profits of the same trade (subject to the company claiming not to use them). However, for trading losses that arise on or after 1 April 2017, carry-forward relief is available against any type of profit (subject to a claim being made). In both cases, carry-forward relief is subject to the cap under CILR.
The rules for non-trading deficits are similar: here, although same-year relief allows offset against any profits, carry-back relief is more limited (to offset against profits under the UK’s loan relationship rules only).
In relation to carry-forward relief, non-trading deficits that arose up to 31 March 2017 carry forward to offset any non-trading profits of the same company (basically, any profits other than trading profits) whereas for non-trading deficits that arise on or after 1 April 2017, carry-forward relief allows offset against any profits (subject to a claim being made). Again, in both cases, the cap under CILR applies to limit carry-forward relief.
In addition, the UK has rules that allow losses to be surrendered between companies that are members of a group. Originally, group relief only allowed a company to surrender current-year losses to another group company (in the same accounting period). But, for losses that arise on or after 1 April 2017, group relief is now available on a carried-forward basis, although again subject to the cap under CILR. See 2.6 Basic Rules on Consolidated Tax Grouping for further information on the UK grouping rules.
Non-resident Companies and Property Losses
From 6 April 2020, a non-UK-resident company that carries on a UK property business becomes subject to corporation tax (having previously been subject to income tax on rental income). If that non-resident has any carry-forward (income tax) property losses at that time, transitional rules allow those income tax losses to be offset against future (corporation tax) profits of the property business.
Relief for interest and equivalent financing costs is generally provided for under the UK’s loan relationship regime, with interest generally being a deductible expense (and relief given broadly in accordance with accounting treatment). For trading companies, relief for interest costs on trade debts will generally be given as a trading expense; in other cases, relief will be given in the form of a non-trading deficit (for further information, see 2.4 Basic Rules on Loss Relief).
UK tax legislation contains a number of rules that restrict or deny relief for interest expense. These include provisions that can deny deductibility where the relevant debt is quasi-equity in nature as well as transfer pricing rules that limit interest deductions to the arm’s-length amount, and various targeted anti-avoidance rules.
Corporate Interest Restriction
In response to the OECD BEPS Action 4 recommendation, the UK introduced a corporate interest restriction (CIR) in April 2017. The rules are complex, and, in addition to reducing the amount of tax relief given for interest, impose significant compliance obligations on groups.
Under CIR, relief for (net) interest and equivalent financing costs is limited to a percentage of a group’s taxable earnings before interest, taxes, depreciation and amortisation (EBITDA). That percentage will generally be 30% under the fixed ratio but groups can elect for the “group ratio” instead. The group ratio (in broad terms) is calculated using accounts numbers and is basically the ratio that the group’s third-party (net) interest expense bears to its EBITDA. Whichever ratio applies, the CIR rules also apply a debt cap, which can further limit interest relief by reference to the group’s overall external (ie, third-party) interest costs. As a result, groups with a high level of related-party debt are likely to find their ability to get tax relief for interest costs restricted under CIR.
The UK CIR rules include an annual de minimis of £2 million (so groups with no more than £2 million net interest expense should not, in practice, find their interest costs restricted). Plus, there is a (limited) exemption available for certain infrastructure and UK property businesses that meet a “public benefit” test: to benefit from this exemption, a company must meet certain detailed conditions as to its activities and elect in.
From 6 April 2020, non-UK-resident companies that own UK land and carry on a property business will become subject to corporation tax and, as a result, CIR.
The UK does not offer a fiscal consolidation regime. Instead, individual companies file and pay corporation tax on a standalone basis.
However, under CIR, CILR and CCLR, a company may have to have regard to the tax profile of other companies within its group when working out its own taxable profits. This is because, under CIR, the interest restriction is worked out at group level (“group” for these purposes means an International Accounting Standards consolidated group); for CILR and CCLR this is because the £5 million annual allowance is a group allowance and so shared between group companies.
In addition, the UK has a number of distinct “grouping” provisions for different taxes that go some way to alleviating some of the tax/economic mismatches that could otherwise arise for groups under a pure “solus” tax system.
As each type of “group” has its own rules, care is needed as it is possible for two companies to be grouped for one particular purpose, but not for others.
Group Relief Group
One of the most important UK tax “groups” is the group relief group.
Companies that are members of a group relief group can surrender (income) losses between each other, both on a same-year and (for losses arising on or after 1 April 2017) carry-forward basis (see 2.4 Basic Rules on Loss Relief). For group relief purposes, companies are members of the same group if one is a 75% subsidiary of the other or both are 75% subsidiaries of a third company. In determining whether a company is a 75% subsidiary of another company, account is taken of both ownership of ordinary share capital and effective economic ownership (which takes account of rights a person has as a creditor under loans that have equity-like features). The group relief rules also include specific anti-avoidance provisions; for example, group relief is not available if there are arrangements for one of the companies concerned to leave the group.
Capital Gains Group
Another important UK tax grouping is the capital gains group.
If a company that is a member of a capital gains group transfers an asset to another group member, that transfer should normally be capital gains tax-free (it is treated as taking place on a no gain/no loss basis). However, if the transferee subsequently leaves that group within six years, there could be a degrouping charge. Members of a capital gains group can effectively offset capital losses of one against gains of another – this is done by the relevant group companies jointly electing that the gain (or loss) is transferred by one to the other. Where, as a result of an election, a group company is looking to offset carry-forward capital losses against gains, CCLR applies (see 2.7 Capital Gains Taxation).
The capital gains group definition, like group relief, requires ownership of 75% of ordinary share capital, but in testing effective economic ownership, a lower threshold of 51% applies.
Stamp Duty Group
Specific grouping rules apply for the purposes of certain UK transfer taxes, including stamp duty (in relation to shares and securities) and stamp duty land tax (SDLT) (in relation to land in England and Wales). Under these grouping rules, assets can be transferred between group companies without stamp duty/SDLT being chargeable (as applicable). The group definition here is very similar to that which applies for group relief (namely, the 75% subsidiary test), but is subject both to specific anti-avoidance provisions (and, in relation to SDLT, degrouping provisions).
The UK distinguishes between income and capital gains for tax purposes. For companies, capital gains and losses arising on sales or other disposals of assets are calculated separately, with net chargeable gains included in the company’s total profits and taxed at normal corporation tax rates.
Capital losses can only be offset against capital gains, and then only against capital gains that arise in the same or a future accounting period. The CCLR applies to carry-forward capital losses from 1 April 2020. Under CCLR, carry-forward capital losses can only be used to offset no more than 50% of future capital gains (subject to the £5 million (group) annual allowance that, as mentioned in 2.4 Basic Rules on Loss Relief, now applies to both income and capital losses).
The UK capital gains rules include a number of capital gains exemptions and reliefs, many of which are relevant for trading businesses only. For example, the substantial shareholding exemption (SSE) provides an exemption from capital gains tax for gains arising on the sale of a “substantial shareholding” in a trading company (in broad terms, a holding of at least 10% held for a continuous period of at least 12 months can qualify as a substantial holding).
In addition, where a trader sells an asset used in its business, it may be able to “roll over” (and so defer) any gain on that sale if it reinvests in a replacement business asset within a specified period (basically, one year before the disposal to three years after). This only applies to certain specified categories of asset (including land used for business purposes), and any “rolled-over” gain is realised when the replacement asset is sold.
There are also specific deferral reliefs that apply to certain types of share reorganisation and/or corporate reconstruction provided the relevant transaction is carried out for bona fide commercial purposes (and not tax avoidance).
Until December 2017, companies could benefit from indexation allowance when computing their capital gains to allow for the effects of inflation. Indexation allowance ceased to be available from 1 January 2018, as a result of which, for assets owned prior to that date, indexation is now calculated up to December 2017.
Other taxes that an incorporated business may have to pay include value added tax (paid as part of the price of goods or services purchased but sometimes capable of being recovered from HMRC through a VAT return); income tax (which may have to be withheld from interest payments, or payments of patent royalties, and paid over to HMRC); and other indirect taxes, payable as part of the price to a supplier, can also be charged, such as landfill tax, airplane passenger duty and insurance premium tax. The import of goods attracts customs duty, and the manufacture of certain goods (mainly alcohol, tobacco and petroleum-based products) attracts excise duty.
The main other taxes to which incorporated businesses may be liable are local taxes on property. Thus, occupation of commercial property attracts non-domestic rates. These are a form of levy that is charged by local government. It is charged by reference to the value of the property in question. The rate is fixed annually by the relevant local authority, at a percentage of the value of the property.
In the UK, most closely held local businesses operate in non-corporate form. Thus, the majority of small businesses are sole traders. According to the Federation of Small Businesses (a UK trade organisation representing small businesses), there were approximately 5.8 million small businesses in the UK at the start of 2019, out of a total number of private sector businesses of about 5.9 million. Of the 5.8 million small businesses, approximately 3.5 million were sole traders, 2 million were companies, and 400,000 were partnerships.
In general, if corporate rates are lower than individual rates, there are no tax rules to prevent "genuine" professionals taking advantage of the lower corporate rates. Certain professions (for example, the Bar) have a code of conduct that prevents members from operating through the medium of a company. However, as a generality, professionals are free to carry on business in any form they choose, including corporate form.
However, there is a wide range of anti-avoidance rules aimed at preventing individuals who would otherwise count as employees from incorporating and seeking to provide their services through companies in order to reduce their tax rates. In particular, individuals who provide services personally to a client via a company, and over whom the client is entitled to exercise the control normally associated with an employer, are taxed in effect as if they were employees (although any expenses that would be deductible by an employee can be deducted from profits). Where the client of such an individual is either a public body or a medium-sized or large enterprise, the client must operate a payroll deduction system in the same way as for direct employees.
There are no specific rules preventing closely held corporations from accumulating earnings for investment purposes.
However, beneficial treatment is often given to holders of shares in trading companies that is not available to holders of shares in investment companies. For example, business asset disposal relief on the disposal of shares in a company is limited to shares in companies whose sole or main purpose is trading. Rollover relief from capital gains tax is available where shares in a private trading company are sold and the proceeds used to invest in shares of another private trading company. Inheritance tax relief is available on the value of shares held by a deceased in a company whose sole or main purpose was not making or holding investments.
Individuals are taxed on dividends from closely held companies in the same way as from any other company. Thus, the first £2,000 of dividend income attracts no income tax. Thereafter, the rate is 7.5%, 32.5% or 38.1%, depending on the amount of the individual’s total income.
The sale of shares is taxed as a chargeable gain, at the rate of 20% on the profit on sale (deducting, for example, the costs of acquisition; the costs of establishing and defending title to the shares; the costs of marketing the shares; and the costs of sale, including, for example, professional fees such as lawyers, accountants and so on). Where an individual owns at least 5% of the ordinary share capital in a trading company that is not publicly traded, and has done so, and has also been a director, for at least two years, business assets disposal relief (previously entrepreneurs’ relief) may be available. This relief reduces the tax rate to 10% of the gain on disposal. Any individual may claim entrepreneurs' relief on up to £1million of gain in the course of his or her lifetime.
Anti-avoidance provisions apply. These are the so-called transactions in securities provisions. Thus, where shares are disposed of in circumstances where the sale has a sole or main purpose of avoiding income tax, an individual may be obliged to pay the difference between the capital gains tax actually due and the income tax that would have been due on a dividend up to the amount of the company’s distributable profits at the time of the sale. The purpose of these provisions is to prevent the building up of a cash reserve that is sold rather than distributed, and to prevent the sale of shares to be paid from future revenue profits.
Individuals are taxed on dividends from publicly traded companies in the same way as from any other company. Thus, the first £2,000 of dividend income attracts no income tax. Thereafter, the rate is 7.5%, 32.5% or 38.1%, depending on the amount of the individual’s total income. Relief is available for dividends paid by certain collective investment vehicles, such as venture capital trusts. Dividends from those types of company are free of income tax.
The sale of shares is taxed as a chargeable gain, at the rate of 20% on the profit on sale (deducting, for example, the costs of acquisition; the costs of establishing and defending title to the shares; the costs of marketing the shares; and the costs of sale, including, for example, professional fees such as lawyers, accountants and so on).
Anti-avoidance provisions apply. These are the so-called transactions in securities provisions. Thus, where shares are disposed of in circumstances where the sale has a sole or main purpose of avoiding income tax, an individual may be obliged to pay the difference between the capital gains tax actually due and the income tax that would have been due on a dividend up to the amount of the company’s distributable profits at the time of the sale. The purpose of these provisions is to prevent the building up of a cash reserve that is sold rather than distributed, and to prevent the sale of shares to be paid from future revenue profits. However, it is only in exceptional circumstances that these provisions could apply where the shares are in a company listed on any stock exchange.
UK withholding tax generally applies to payments of interest to non-UK residents, subject to the availability of an exception. The rate of withholding tax on interest is currently 20% (the basic rate of income tax).
There are a number of possible exceptions, including where the non-resident is eligible for relief from UK tax under the terms of an applicable double tax treaty. Where a non-resident wishes to rely on the terms of an applicable double tax treaty to receive interest gross, it must submit a claim to HMRC. If HMRC accepts that relief is available, it will authorise the payer to pay that interest gross, but until that authorisation is received, UK withholding will apply.
Other exemptions under domestic UK law include the quoted Eurobond exemption (which applies to listed debt securities and is intended to facilitate capital raising through the capital markets) and an exemption for (third-party) private placements that meet various conditions. In addition, the UK has a treaty “passport” scheme that allows (registered) treaty-eligible non-residents to fast-track treaty clearance – this is commonly used by participants in the syndicated loan market.
UK withholding tax does not apply to payments of dividends by UK companies (save where the dividend is a “property income dividend” paid by a UK REIT).
UK withholding tax can apply to patent, copyright and design royalties, again subject to relief under an applicable double tax treaty. Following the UK’s departure from the EU, the UK government has announced that, from June 2021, UK companies will no longer be able to benefit from a specific withholding exemption that applied to payment of interest or royalties to an EU company, with relief only then being available under an applicable double tax treaty.
UK withholding tax can also apply to rent from UK land payable to a non-resident, although if the non-resident undertakes to HMRC that it will meet all its UK tax obligations, it should be able to receive gross payment of rents under the UK’s Non-Resident Landlord Scheme.
The UK has an extensive network of double tax treaties: details of the UK’s treaties are published by HMRC (see www.gov.uk/government/collections/tax-treaties, accessed 1 March 2021).
Figures from the UK’s Office for National Statistics indicate that, in 2018, the four jurisdictions with the highest levels of foreign direct investment into the UK were the USA, the Netherlands, Jersey and Luxembourg (with the same report noting that, looking at indirect (or ultimate) investment, the highest levels came from the USA, Japan and Germany).
The UK is a signatory to the Multilateral Instrument (MLI) that implements a number of the OECD’s BEPS recommendations, including the adoption of a principal purpose test in affected treaties that is intended to give countries the ability to deny treaty benefits in cases of treaty shopping.
The MLI came into force in the UK on 1 October 2018, and already applies to a number of the UK’s double tax treaties (and will apply to others as and when the MLI is ratified by other countries). Given the complexities involved in determining both how and when the MLI takes effect in relation to a particular treaty, HMRC is publishing synthesised texts of individual “updated” treaties online as and when MLI-related changes are to take effect.
In addition, if HMRC considers that a non-resident is treaty shopping, it may use the Indofood principle and apply an “international fiscal meaning” of beneficial ownership to deny treaty relief.
The UK has recently introduced measures that extend the territorial scope of UK tax, particularly in relation to non-residents that own UK land. These measures generally include a specific treaty-related anti-forestalling rule, intended to discourage non-residents from treaty shopping in advance of these new measures coming into force.
The biggest transfer pricing issue for inbound investors is not so much the amount of tax that may be required to be paid, but the energy that may have to be devoted to a lengthy enquiry from HMRC (which may not result in any significant amount of tax being payable).
The authors are not aware of any systematic challenge by HMRC of limited risk distribution agreements (in other words, there is always a risk of challenge by HMRC to a corporation’s tax return and assessment, but no specific risk arises in relation to related-party limited risk distribution agreements).
UK transfer pricing rules apply not only in an international context but also in a domestic context; that is, the rules apply also to transactions between UK-resident companies in the same group. Where the potentially advantaged corporation is a small or medium-sized entity, transfer pricing provisions do not apply, except on an opt-in basis. Advance pricing agreements can be a useful way of minimising risk and uncertainty.
The authors are not aware of any data as regards the frequency with which international transfer pricing disputes are resolved through double tax treaties and mutual agreement procedures. In general, HMRC tends to look favourably upon the resolution of disputes by means other than litigation. The authors expect that this attitude prevails in relation to mutual agreement procedures covering transfer pricing disputes.
When transfer pricing claims are settled, compensating adjustments are allowed to the other party.
Broadly, the basis of taxation of local permanent establishments of non-resident companies is limited to taxation of profits of any trade carried on through the permanent establishment, and UK-sited capital assets used for the purposes of the establishment’s trade. By contrast, local subsidiaries of non-resident companies are subject to worldwide taxation.
Prior to 6 April 2019, the general rule was that a non-resident company was outside the scope of UK capital gains tax (other than in relation to certain disposals of residential property).
Since 6 April 2019, gains and losses realised by a non-resident that makes a direct or an indirect disposal of UK land is within the scope of capital gains tax (for individuals) or corporation tax (for companies). In working out any gain, the base cost is generally taken as the market value of the relevant asset as at 6 April 2019 market value, subject to the company being able to elect to use actual base cost instead (for certain residential property, the default is April 2015 market value).
A non-resident makes a direct disposal where it sells UK land directly.
A non-resident makes an indirect disposal of UK land where it makes a disposal of (all or part) of its holding in a company that is “UK property-rich” where, at the date of the disposal, the non-resident holds (or has in the previous two years held) a minimum 25% interest in that company. In determining if this minimum ownership test is met, account can be taken of interests held by connected persons in that two-year period.
A company will be “UK property-rich” if 75% or more of the gross value of its assets derives from UK land, taking account of both directly and indirectly held assets.
Normal capital gains rules apply in working out any gain on a direct or indirect disposal, including reliefs (like SSE; see 2.7 Capital Gains Taxation). Indirect disposals also benefit from a specific exemption where the company being sold is a trading company and the vast majority of the land it owns is used for the purposes of its trade.
A limited number of the UK’s double tax treaties restrict the UK’s taxing rights in relation to capital gains for eligible non-residents. Given these treaties, the indirect disposal provisions include a treaty override to counter treaty shopping.
There are special rules that apply where the company being sold is, or is part of, a collective investment vehicle.
Changes in ownership amounting to a change in control can lead to a company’s ability to access loss relief (both on a carry-forward and carry-back basis) being restricted where the profits against which the loss is to be offset arise under different corporate ownership.
There are also restrictions on the use of capital losses where a company with capital losses joins a new group.
Change of control rules also apply under CIR, where they can limit carry forward of interest allowance under the CIR regime (interest allowance being the amount of interest a group is entitled to get relief for in a particular period).
The authors are not aware of formulas being used to determine the income of foreign-owned local affiliates selling goods or providing services.
The standard applied is that of an arm’s-length transaction; that is, a deduction will be allowed if the amount would reasonably have been incurred between parties at arm’s length.
As mentioned in 2.5 Imposed Limits on Deduction of Interest, UK tax legislation contains a number of rules that restrict or deny relief for interest expense. These rules generally apply whether or not a borrowing is a related-party borrowing: however, for related-party borrowings, particular issues may arise under the transfer pricing rules and/or as a result of the exclusion of related-party debt if using the group ratio under CIR.
Foreign income of UK-resident companies is liable to tax on the same basis as profits from UK activities. Relief may be available pursuant to double tax treaties, and a credit may be available for foreign taxation.
UK-incurred expenses are deductible in general only in so far as they are incurred "wholly and exclusively" for the purposes of earning taxable income. Accordingly, on general principle, expenses that are incurred for the purpose of earning exempt income of any sort, including exempt income that arises abroad, are not deductible against other income.
The general rule is that dividends received from foreign companies, including subsidiaries, are taxable. This is subject to a number of exceptions.
Where the receiving company is a small company, the distribution is exempt if all of four conditions are satisfied:
Otherwise, to be exempt, a distribution must also meet one of five criteria:
Thus, in short, dividends from controlled subsidiaries are exempt provided the subsidiary is in a jurisdiction with an acceptable corporation tax rate, the security is not a non-commercial security, and there is no deduction for any person outside the UK for the dividend from taxable profits of some form.
Assuming intangibles developed by a UK-resident company remain owned by it, the use of the intangible by a non-UK resident subsidiary will be subject to transfer pricing rules.
UK-resident companies are taxed on the income of foreign companies they control where such foreign companies are located in territories listed in secondary legislation. Relevant foreign territories are, broadly, those with an insufficiently high rate of corporation tax. There are a variety of exemptions; for example, where the foreign entity’s profits are less than £50,000, or its profit margin is less than 10% by reference to operating expenditure. Profits of non-UK branches of UK-resident companies are fully included in the UK corporation tax calculation, subject to credit for foreign tax actually paid.
No information has been provided in this jurisdiction.
UK-resident companies pay corporation tax at the normal rate on gains from the sale of shares in non-UK subsidiaries or associated companies. However, the substantial shareholdings exemption applies on the same conditions as it applies to UK-resident subsidiaries or associated companies. Key points are whether the shares held in the foreign subsidiary count as ordinary share capital on the UK definition of that term, and whether the foreign entity is classified as a company for UK tax purposes.
There is a general anti-abuse rule in place in the UK. This allows HMRC to adjust a company’s tax return where the company has entered into arrangements designed, in short, to take advantage of any shortcomings or loopholes in the UK tax system. The legislation gives, by way of example of the criteria to be considered:
There are significant procedural steps to be completed before any adjustments can be made, including reference to an independent panel. Significant penalties apply if a taxpayer enters transactions within these provisions.
The frequency of tax investigations depends on a variety of factors, including size of the taxpayer. Large corporates can expect to have ongoing dialogue with specific individuals in HMRC who are responsible for considering their tax affairs.
The UK is an active supporter of the OECD BEPS project and has implemented many of its recommendations. The UK has enacted legislation to implement BEPS Action 2 (hybrid instruments) and BEPS Action 4 (interest restriction), and has also modified its patent box rules (BEPS Action 5).
The UK government has also introduced country-by-country reporting (BEPS Action 13) using the OECD template; this came into effect in January 2016.
The UK is a signatory to, and has ratified, the MLI (BEPS Action 6 and BEPS Action 15), and has adopted some (but not all) of the recommended changes to “permanent establishment” (BEPS Action 7).
There have been no changes to the UK’s CFC rules as the UK considers them to be compliant with BEPS Action 3. Similarly, the UK has not introduced specific measures in relation to BEPS Actions 8–10 and 13 (transfer pricing) as its rules already follow OECD guidelines. On BEPS Action 14 (dispute resolution), the UK is committed to mandatory binding arbitration.
In relation to BEPS Action 12 (disclosure), in January 2020 the UK enacted the EU’s DAC 6 Directive (Mandatory Disclosure) into domestic law, under which details of certain cross-border arrangements need to be reported to HMRC (supplementing the UK’s existing disclosure of tax avoidance schemes regime). However, following the end of the EU transitional period on 31 December 2020, the UK announced that it would no longer be implementing DAC 6 but would instead be adopting disclosure rules based on the OECD’s model Mandatory Disclosure Rules (MDR).
On the digital economy (BEPS Action 1), see 9.12 Taxation of Digital Economy Businesses.
As above, the UK has been actively involved at the OECD in relation to the BEPS project. It is also keen to see reform to the taxation of digital companies – and has recently introduced unilateral measures in advance of an OECD solution (see 9.13 Digital Taxation).
International tax has a high profile in the UK, particularly following the Paradise Papers investigation of 2017 and the recent introduction of a digital services tax (DST).
The UK participated heavily in the BEPS project, and either was already compliant with or has so far implemented a significant number of BEPS measures. It is likely that, politically, tax competition will be restricted in the future, not only because of BEPS but also other, more general political pressures.
No response has been provided in this jurisdiction.
The UK was one of the first countries to implement anti-hybrid measures compliant with BEPS Action 2, replacing more limited rules that had been originally introduced in 2010. The rules are very detailed and complex and are very wide in scope. As well as double-deduction mismatches and deduction/non-inclusion mismatches, the rules cover “imported mismatches” (meaning that they can apply where the UK borrower is party to a “vanilla” loan if somewhere else in the funding chain there is a mismatch).
The rules have been subject to various technical amendments since 2017. In 2020, the UK government announced a number of detailed changes to the hybrids rules, with legislation to implement them expected in 2021.
Extensive guidance and commentary has been published by HMRC to assist taxpayers and their advisers with making sense of the rules. Even with the help of the guidance, the rules are challenging to apply in practice, and concerns have been expressed that the rules can apply in unexpected circumstances.
The UK has a mixed system, in that companies resident in the UK, whether because that is the place of their incorporation or because central management and control is exercised there, are taxed on worldwide profits; whereas permanent establishments of non-UK resident companies are taxed on the profits of their UK activities. It is difficult to foresee how interest deductibility changes will affect people investing in and from the UK.
The UK does not have a territorial tax regime for UK-resident companies.
Certainly, the UK is now seeking to have limitation of benefit and/or anti-avoidance rules in double taxation conventions (DTCs) it negotiates. However, the effect is difficult to foresee, other than a reduction in the abuse of UK DTCs.
The transfer pricing changes are unlikely to give rise to any radical changes in the UK transfer pricing rules. Taxation of profits is a source of controversy because certain well-known companies are notorious for locating their intellectual property in related companies in low-tax jurisdictions in order remove profits from the UK tax net, while, on the other hand, the UK has adopted a patent box regime that is regarded by a number of other countries, including member states of the EU, as overly competitive.
The UK has already implemented the proposals for transparency and country-by-country reporting. It is not easy to identify any disadvantages resulting from them.
The UK introduced the diverted profits tax (DPT) in 2015, which was (in part) directed at digital businesses that structured their activities to avoid a permanent establishment. The tax, currently charged at 25%, is charged by reference to the “diverted” profits, with companies under an obligation to notify HMRC if they are potentially within its scope. The rate was deliberately set higher than the rate of corporation tax to encourage companies to restructure their operations (to fall within corporation tax instead). With corporation tax rates set to increase in April 2023, the UK government has announced that DPT will also then increase – to 31%.
In 2019, HMRC launched a Profit Diversion Compliance Facility to encourage businesses effectively to self-report non-compliance with DPT and agree arrangements for paying any additional tax (and applicable interest/penalties).
The UK introduced a digital services tax in 2020 that is intended to tax the value attributable to UK-based users of the relevant digital services, rather than by reference to whether the business has a presence in the UK. The DST is a 2% tax on revenues from UK-based users of digital services businesses that provide an online marketplace, a social media platform and/or an internet search engine. DST is worked out at group level and is chargeable whether or not the group has a physical presence in the UK. However, it only applies to groups receiving worldwide revenues of at least £500 million from relevant activities, of which £25 million or more derives from UK users – and where DST applies, only UK user revenues in excess of the £25 million threshold are subject to the tax. It applies from 1 April 2020. The DST also contains standalone compliance and reporting rules.
The UK has committed to review the DST before the end of 2025: this reflects the UK’s stated commitment to support the ongoing work at the OECD to agree a multi-country approach to taxing such businesses.
The UK introduced income tax on offshore receipts in respect of intangible property in April 2019. The tax, in broad terms, applies to certain non-residents who receive amounts in respect of IP that is referable to UK sales of goods and services. Where it applies, tax is charged at a rate of 20% on the gross receipts from the IP (whether income or capital in nature).
A non-resident is in the scope of the tax if it is based in a low-tax jurisdiction (being a jurisdiction that does not have a “full” tax treaty with the UK). There are also a number of exemptions to the tax, including a £10 million de minimis UK sales threshold.