Businesses generally take the form of a limited company or a limited liability partnership (LLP) but individuals may carry on business as a sole trader/self-employed individual, or in partnership with other self-employed individuals. For tax purposes, a partnership is transparent and the members are chargeable to income tax or corporation tax on their share of the partnership profits.

A limited company is chargeable to corporation tax, whereas an LLP which carries on business on a commercial basis with a view to making a profit, although it is a corporate body as a matter of the general law, is treated for tax purposes as a partnership, so that it is not chargeable to income or corporation tax in its own right, rather, the members of the LLP are chargeable to income or corporation tax on their share of the profits of the LLP.

In all instances, in order to be deductible from profits chargeable to tax, expenses must be incurred “wholly and exclusively for the purposes of the trade”. For a recent case on that test, see CHR Travel & Anor v HMRC.

Capital gains tax may be chargeable on the partners when assets used in the partnership or LLP are disposed of, or when there is a change in the partners’ capital profit sharing ratios. 

If an individual works for a client through a personal service company, and the individual would be an employee of the client if engaged directly, then the company will be treated as the individual’s employer and liable to pay income tax and NIC on the fees paid by the client. Many cases have been heard in the tribunals and courts in recent years on the question of whether the individual would indeed be an employee (or rather self-employed) if engaged directly by the client.

Private equity funds may be structured using a limited partnership structure, whereby the manager of the fund (which may itself be a partnership) is the general partner, and the investors of the fund are the limited partners. Therefore, the investors are not liable for the debts of the limited partnership beyond their own capital contributions. For tax purposes, the limited partnership is transparent so that the partners are taxable on their profit shares. Usually, once the investors have received a certain return on their investment, the managing partner is entitled to an additional profit share (called a “carried interest”). The partnership will generally be carrying on an investment activity rather than a trade, so that gains made from the disposal of investments will in principle be taxable as capital gains and not income. However, in 2015 the UK enacted “disguised investment management fee income” rules which in certain circumstances deem receipts from the “carried interest” to be income and taxable accordingly. 

Corporation tax is chargeable on income and gains arising to a company in a financial year wherever they arise if the company is resident in the UK (as to which see below). If a company is a non-UK resident, it is nevertheless chargeable to corporation tax on income if:

• it carries on a trade in the UK of dealing in or developing land (and if so, then it is chargeable on all its profits wherever arising);
• it carries on a trade through a permanent establishment in the UK;
• it carries on a UK property business; or
• it has other UK property income.

A company is resident in the UK if it is incorporated in the UK, or if the “central management and control” of its business (usually, control at board level) is exercised in the UK. This is the test of residence originally applied by the House of Lords in De Beers Consolidated Mines Ltd v Howe [1906] AC 455 and more recently applied in Wood v Holden.

However, a company whose central management and control is exercised in the UK may be treated as not UK resident by virtue of a double tax treaty. The OECD model treaty test to be applied is usually where the place of effective management (POEM) of the company is. This was considered by the Court of Appeal in Wood v Holden (and more recently was considered in relation to the residence of trustees in the context of a particular tax avoidance scheme, known as the “round the world” scheme, by the Court of Appeal in the case of Smallwood v HMRC [2010] EWCA Civ 778).

The corporation tax rate for companies with profits over GBP250,000, known as the “main rate”, is 25%. For companies with profits under that amount but over GBP50,000, marginal relief applies to give an effective rate between 19% and 25%, and companies with profits under GBP50,000 are chargeable at a rate of 19%.

Between 1 April 2015 and 31 March 2023, a single rate of corporation tax of 19% applied.

Partnerships and LLPs are usually transparent for tax purposes, so a corporate partner in a partnership or LLP would pay corporation tax on its share of the profits. There are certain anti-avoidance rules that may apply to charge income tax on such profits.

Individuals are chargeable to income tax on their profits, including their share of partnership or limited liability partnership profits, at the following rates of income tax:

• 0% on income of up to GBP12,570 (unless total income exceeds GBP100,000);
• basic rate of 20% on income between GBP12,571 and GBP50,270;
• higher rate of 40% on income between GBP50,271 and GBP125,140; and
• additional rate of 45% on income over GBP125,140.

National Insurance contributions are also payable by self-employed individuals and employees.

Individuals and companies carrying on a trade or other business are chargeable to tax on the accounting profits, subject to statutory adjustments for certain items (for example depreciation of assets debited to the profit and loss account is disallowed, but capital allowances may be available as a deduction instead).

For corporation tax purposes, the accounting period may be the same as the period for which the accounts are made up, if that is 12 months or less, and otherwise there will be two accounting periods, one of 12 months and one for the remaining period. For example, if accounts are made up for 18 months from 1 January 2023 to 30 June 2024, the accounting periods will be the 12 months to 31 December 2023 and six months to 30 June 2024.

Tax is charged on the accounting profits, which are generally calculated on an accruals basis rather than a receipts basis.

Research and Development Tax Credits

Different types of research and development reliefs are available for different sized companies which incur expenditure on part of a specific project to make an advance in science or technology. The project must relate to the company’s existing trade, or a trade that the company intends to commence based on the results of the R&D.

In order to claim it is necessary to explain how a project:

• looked for an advance in the field;
• had to overcome the scientific or technological uncertainty;
• tried to overcome the scientific or technological uncertainty; and
• could not be easily worked out by a professional in the field.

The project may research or develop a new process, product or service or improve on an existing one. Additional detailed criteria must be met and the relief varies depending on the size of the business. For small to medium-sized businesses, relief allows companies to:

• deduct an extra 86% of their qualifying costs from their yearly profit, as well as the normal 100% deduction, to make a total of 186% deduction; and
• claim a payable tax credit if the company has claimed relief and made a loss, in which case the payable credit is worth up to 10% of the surrenderable loss.

For large companies, and small to medium-sized companies that are unable to claim relief, expenditure credit is available, calculated as a percentage of qualifying R&D expenditure. The rates are:

• 11% on expenditure incurred from 1 April 2015 up to and including 31 December 2017;
• 12% on expenditure incurred from 1 January 2018 up to and including 31 March 2020;
• 13% on expenditure incurred from 1 April 2020 up to and including 31 March 2023; and
• 20% on expenditure incurred from 1 April 2023.

UK Patent Box

The UK patent box enables companies to apply a lower rate of corporation tax to profits earned after 1 April 2013 from qualifying patent inventions and equivalent forms of intellectual property. The lower rate of corporation tax under the regime is 10% (compared with 19-25% depending on the company’s profits.

There are several reliefs available for the creative industries, namely:

• film tax relief;
• animation tax relief;
• high-end television tax relief;
• children’s television tax relief;
• video games tax relief;
• theatre tax relief;
• orchestra tax relief; and
• museums and galleries exhibition tax relief.

The reliefs allow qualifying companies to increase the amount of their allowable expenditure, and reduce the amount of corporation tax payable.

There are also “audio-visual expenditure credits” and “video games expenditure credits” which give a credit based on the amount of qualifying expenditure and can be used to pay off corporation tax liability and to set against other tax liabilities, and may also be paid to the company.

In order to qualify, the company must be directly involved in the production and development of the relevant production (ie, the film, animation, etc, as listed above), must have responsibility throughout the production from the start of pre-production until completion, and for theatre, concerts or exhibitions must be responsible for producing, running and closing it. There is also a “cultural test” to be met to ensure the production is British.

A company carrying on a trade may make trading losses in a particular period, which can be carried forward and set against profits arising in a future year.  Generally trading losses cannot be carried back to set against profits of earlier years, unless the trade ceases, in which case they can be carried back for up to three years in the prescribed order.

Group relief may be available for trading losses.

Capital losses cannot be set against trading profits. They can be carried forward and set against capital gains that arise in the future. Capital losses may be utilised by another member of the same group.

Detailed anti-avoidance rules apply in relation to groups.

There are several restrictions imposed on the deductibility of interest against profits chargeable to corporation tax.

The corporate interest restriction, or CIR, rules apply to periods of account starting on or after 1 April 2017. Periods of account straddling 1 April 2017 are treated as two notional periods. A notional period ending 31 March 2017 is subject to Part 7 of TIOPA 2010, commonly known as the World-Wide Debt Cap (WWDC). Only the notional period commencing 1 April 2017 is subject to the CIR.

The CIR applies to restrict the UK net interest deductions (expense less income) to the higher of three amounts:

• the de minimis amount of GBP2,000,000 per annum;
• the Fixed Ratio amount; or
• the Group Ratio amount.

The CIR is designed to target large corporations where the risk of BEPs is considered higher. Companies with financing costs of under GBP2,000,000 do not have to submit a CIR return, but those with financing costs over that amount have to calculate their interest allowance using the Fixed Ratio or Group Ratio method.

The former produces an interest allowance of the lower of:

• 30% of the company’s or group’s UK taxable profits before interest, capital allowances, taxes and other reliefs; or
• the company’s or group’s worldwide interest expense owed to unrelated third parties.

The latter involves appointing a reporting company and making an election. The interest allowance is the lower of:

• the ratio of the company’s or group’s worldwide net interest expense owed to unrelated parties, to the company’s or group’s overall profits before interest, capital allowances, taxes and other reliefs, multiplied by the company’s or group’s taxable UK profits before interest and capital allowances; or
• the company’s or group’s worldwide interest expense owed to unrelated parties

Transfer pricing and “thin cap” rules also apply to interest.

Note that for transfer pricing purposes, the potential tax advantage is calculated without taking into account any CIR disallowances or reactivations (TIOPA10/S155(6)).

TIOPA10/382(1) defines a tax-interest expense amount as an amount that meets certain conditions and is (or apart from TIOPA10/PT10 would be) brought into account for the purposes of corporation tax in a relevant accounting period of a company. S385(1) takes a similar approach as regards tax-interest income amounts. These tax-interest amounts form the starting point for determining the aggregate net tax-interest expense of the group and it is this amount that may be subject to restriction by the CIR (S373). It follows that other provisions must first be applied to reach the starting point for application of the CIR.

It may be possible for profitable companies to claim group relief if the company is part of a group (broadly, 75% common ownership), or a joint venture or consortium, and set the losses against their profits for the same accounting period or an overlapping period. For consortium companies or joint venture companies, only the relevant percentage of the profits corresponding to the shareholding can be offset. Detailed rules apply in relation to the nature of the shareholdings and rights attaching to the shares.

Companies are chargeable to corporation tax on profits arising on the disposal of assets wherever they are situated (and in some other instances).

If the asset disposed of is shares, the substantial shareholdings exemption may apply, in which case the gain would not be chargeable. Detailed conditions must be met in order for the relief to be available.

If the assets disposed of are shares that are exchanged for shares in another company, then relief may be available (unless there is a main purpose of avoiding tax) so that no gain accrues on the disposal; instead, the asset acquired is treated as having the same base cost as the asset disposed of.

Loans made by a company to its directors may give rise to a charge to tax if the loan is not repaid within nine months of the end of the accounting period in question. Anti-avoidance rules apply to prevent “bed and breakfasting”.

Stamp duty may be payable on the acquisition of shares by a company. Stamp duty land tax is payable on the acquisition of land or an interest in land.

Withholding tax may be payable on certain payments made by a company.

Diverted Profits Tax

Large multinational enterprises with business activities in the UK who enter into contrived arrangements to divert profits from the UK by avoiding a UK taxable presence and/or by other contrived arrangements between connected entities may be caught by the diverted profits tax rules.

Most small businesses that have a choice of operating as an individual or a company would prefer to have limited liability and therefore to operate through a company. 

In order to ascertain whether a company is more beneficial for tax purposes, a comparison would have to be done between the rates of income tax/NIC and corporation tax for small businesses. The level of profits may not be predictable and income tax and national insurance rates change quickly, therefore it may not be possible to say which is more beneficial for tax purposes over time.

Income could be extracted by way of dividends (currently chargeable at the basic rate of 8.75%, higher rate of 33.75% and additional rate of 39.35%), paid out as salary (currently chargeable at 20%, 40% and 45%, and subject to employers and employees national insurance contributions), or reinvested. A sole trader may incorporate, take an annual salary or dividends at the lowest tax (and NIC) rates available and reinvest profits realised by the company in the company.

Anti-avoidance rules operate to prevent individuals seeking to avoid income tax on what would otherwise be earnings from an employment with a client, from operating through a company and therefore paying corporation tax at a lower rate instead. These are known as IR35 and have given rise to extensive litigation, mainly because the test involves asking the question of whether a person would be an employee of the client if engaged directly by them, but this is a common law multi-factor test that cannot be consistently applied from case to case. The recent case of Atholl House Productions limited v HMRC [2024] UKFTT 37, involving a BBC presenter who eventually won her case on the basis that she was self-employed under the test, demonstrates the difficulties in this area.

Close investment holding companies (CICs) are chargeable to corporation tax at the rate of 25% regardless of the level of profits or the number of associated companies.

A close company (broadly, one owned by five or fewer shareholders) is a CIC unless it exists for a prescribed purpose listed in the legislation (such as trading).

Individuals are charged to capital gains tax on the disposal of shares in a company at the applicable rate of capital gains tax (18% or 28%), unless a specific relief is available.

For example, if they exchange the shares for shares in another company within the share exchange rules then no gain arises at that point and instead they will be treated as acquiring the new shares for the same base cost as the shares disposed of.

Shares in a CIC are unlikely to qualify for Business Asset Disposal Relief as the company would likely not be carrying on a qualifying activity.

Dividends from a CIC would be taxed at the rates mentioned above.

Dividends received from a plc are chargeable to income tax at the dividend rates mentioned in 3.1 Closely Held Local Businesses.

Business asset disposal relief from capital gains tax, if it applies, reduces the rate of capital gains tax to 10%, but it is only available in relation to gains on disposals of shares in an individual’s personal company and a plc is unlikely to be such, as the individual must be an employee or office holder and hold at least 5% of the shares and voting rights.

There is no withholding tax on the payment of dividends by a UK company, except in the case of property income dividends payable by a UK REITs, which are (subject to certain exceptions) subject to withholding tax at the rate of 20%. 

A company making a payment of UK source interest must deduct income tax at the basic rate, again 20%. This is subject to exceptions, the main ones being:

• where the recipient is a UK resident company;
• interest payable on quoted Eurobonds; and
• interest paid by or to a UK bank.

Royalties and annual payments are also subject to withholding tax at the rate of 20%.

Tax deductions at source are also required in respect of:

• certain schemes, such as the Construction Industry Scheme;
• sportspeople and entertainers doing work in the UK; and
• non-resident landlords, who are required to have 20% income tax deducted from their UK source rental payments by their UK agent.

There is no need for investors to rely on a treaty for exemption from withholding tax on dividends since there is no withholding tax on dividends. 

In relation to interest, treaty relief can be claimed, but the claim can take months to be processed. A double treaty passport scheme may be available to the payer.

A list of treaties under which relief can be claimed is available on HMRC’s website.

The Upper Tribunal recently heard an appeal in relation to the requirement to deduct withholding tax from interest (Hargreaves v HMRC [2023] UKUT).

The taxpayer had not claimed treaty relief under the UK/Guernsey treaty but sought to rely upon treaty relief, in circumstances in which it was not entitled to.

Regarding CIR rules, see 2.5 Imposed Limits on Deduction of Interest. The CIR applies after most other tax rules that may impact the calculation of tax-interest amounts, such as transfer pricing rules, and hybrid and other mismatch rules, but before the loss restriction rules.

“Thin cap” rules for transfer pricing adjustments also present a challenge to inbound investors to the UK that are subject to transfer pricing rules. 

Broadly speaking, a company is thinly capitalised if it has more debt than it either could or would borrow without the support of the rest of the group, either because it is borrowing from a group company, or it is borrowing from a third party but with support from elsewhere in the group (for example, by way of a financial guarantee).

The thin cap rules require an adjustment to the finance cost deductions of the company in order that it only claims a deduction for an amount of finance which it could obtain if acting on its own.

Transfer pricing rules may restrict deductions for payments by companies chargeable to corporation tax which are not “arm’s length”.

The UK broadly follows the OECD transfer pricing standards. Indeed,the UK transfer pricing legislation is required, where possible, to be interpreted consistently with the OECD standards and guidelines. However, there are some differences; for example, in determining the terms on which associated entities would lend to one another, guarantees cannot be taken into account.

HMRC is nowadays more willing to litigate transfer pricing disputes. In the past, HMRC would settle transfer pricing cases, so that they hardly ever came to court. Now, however, perhaps because HMRC’s litigation and settlement strategy does not permit it to “do a deal”, litigation is more likely.

International transfer pricing disputes are sometimes resolved through mutual agreement procedures.

HMRC views the MAP process as a potential means of resolving international transfer pricing disputes, and as an alternative to litigation through the UK courts.

However, MAPs are still not a common way of resolving disputes.

Compensating adjustments can be made when a transfer pricing dispute is resolved.

A UK branch of an overseas subsidiary is chargeable to corporation tax on the profits from its UK activities. By contrast, a UK resident subsidiary of a non-UK resident parent company is taxable on its worldwide profits.

A non-UK resident company that holds shares in a UK-incorporated subsidiary would not be chargeable to capital gains tax on the disposal of the shares in the subsidiary, unless 75% or more of the subsidiary’s gross asset value is UK land (a “UK property rich company”).

In principle, a double tax treaty may apply to eliminate the charge, although many treaties exclude relief where the value of the shares in the subsidiary consists, to a specified extent, of land in the UK.

The UK legislation includes “value shifting” provisions, whereby if value passes out of shares in a company, into other shares, that could be treated as a disposal of the shares. However, this would only be relevant to a non-UK resident company if the shares which are deemed to be disposed of are in a UK property rich company (see 5.3 Capital Gains of Non-residents). 

Formulas are only ever used to determine the income or expenses of a UK subsidiary of an overseas company selling goods or services if the transfer pricing rules apply to the company and the arm’s length price of goods or services must be ascertained. 

OECD guidelines are applied in the UK to ascertain the arm’s length price of goods and services.

See 5.6 Deductions for Payments by Local Affiliates.

A company that is UK resident is chargeable to corporation tax in the UK on its worldwide income unless a treaty exemption or credit is available in relation to particular non-UK source income, for example income of an overseas permanent establishment in a “full treaty territory”.  An election must be made in order for the income of an overseas permanent establishment to be exempt. Certain income is excluded from the exemption, such as income from a trade of dealing in or developing UK land and gains on assets that are not used in the overseas trade. Profits of an overseas branch are calculated by reference to the double tax treaty, or OECD principles.

Where no election is made, profits from overseas branches are computed and taxed in the normal way. UK corporation tax would usually be reduced by way of a credit for local tax paid, under the relevant treaty or by way of unilateral relief.

No response has been provided in this jurisdiction.

Dividends and other distributions from UK and overseas companies are generally exempt if received on or after 1 July 2009. However, distributions within Section 1000(1) E and F of CTA 2009 are not exempt, such as non-dividend distributions comprising interest and other distributions out of assets in respect of non-commercial and special securities.

If a UK company owns intellectual property and allows overseas subsidiaries to use it, the corporation tax treatment in the UK depends on the precise circumstances of the transactions. If the UK company licenses intellectual property to its overseas subsidiaries, there may be royalty income payable to the UK company, which is chargeable to corporation tax, and may be subject to transfer pricing adjustments. It may be that receipts are of a capital nature instead of income, because a capital asset is disposed of by the UK company to its overseas subsidiaries: see, for example, Murray v Imperial Chemical Industries Limited [1967] 44 TC 175, and Wolf Electric Tools Limited v Wilson [1968] 45 TC 326.

The UK has “diverted profits tax” and “controlled foreign companies” (CFC) rules which are intended to prevent the artificial diversion of profits out of the UK, rather than to tax the profits from overseas commercial trading activities. If the CFC rules apply, the profits of overseas subsidiaries are chargeable to corporation tax in the UK. Diverted profits tax is chargeable at the rate of 25%.

There are a number of entity-level exemptions in the CFC rules to reflect the fact that most overseas subsidiaries are set up for genuine commercial reasons and the CFC rules are not intended to apply. For example, if the rate of tax in the jurisdiction of the subsidiary is at least 75% of the UK corporation tax rate. There are also time-based and profit-based exclusions.

UK companies are chargeable to corporation tax on the sale of shares in an offshore subsidiary, unless an exemption is available, such as the substantial shareholdings exemption.

The UK has a General Anti-Abuse Rule, which was enacted in the Finance Act 2013 and is applicable to almost all taxes. Broadly, the rule applies where there are arrangements with the main purpose of obtaining a tax advantage, which no reasonable person would consider a reasonable course of action having regard to the relevant legislation and all the circumstances, including a list of factors. The list includes whether the substantive results of the arrangements are consistent with any principles on which the relevant provisions are based, whether the means of achieving the results involve one or more contrived or abnormal steps, and whether the arrangements are intended to exploit any shortcomings in the statutory provisions.

A company has to prepare audited financial statements unless it is exempt (micro and small entities which have filed their two preceding annual returns on time), and would usually prepare them annually unless it changes its accounting date.

PLCs and PUCs have to file audited financial statements regardless of the size of the company.

The Organisation for Economic Cooperation and development (OECD) produced an “Inclusive Framework on BEPS” which is designed to reduce tax avoidance and work towards more coherent international tax rules and greater transparency, and to address challenges with the digital economy. The UK has begun implementing BEPS 2.0 in two phases: Pillar One and Pillar Two.

Pillar One prescribes how the consolidated profits of a multinational enterprise are allocated and taxed, based on the jurisdiction in which the activities are carried out (where the goods or services are used). There is a minimum global revenue threshold of EUR20 billion for Pillar One to apply.

Pillar Two has a minimum threshold of EUR750 million in global consolidated group revenues (for at least two of the previous four accounting periods). It sets an effective global minimum rate of corporation tax of 15%. It was approved by c140 participating jurisdictions in 2021. Draft legislation was published in the UK on 18 July 2023 to amend Finance (No 2) Act 2023, which introduced the multinational top-up tax and domestic top-up tax as part of Pillar Two. The multinational top-up tax will apply to the responsible member of the group for financial periods commencing after 31 December 2023 where the criteria mentioned above are met, and at least one of the group members is not in the same territory as the others.

Certain persons are exempt, such as not-for-profit organisations, charities, government organisations and pension funds. Real Estate Investment Trusts are also exempt.

See 9.1 Recommended Changes.

International tax has a high profile in the UK and the OECD considers the UK to be a committed partner. The UK played a vital role in persuading the G20 group of countries to launch the work on BEPS.

The UK government had come under considerable pressure from the consumer population in relation to large corporations obtaining revenue from consumers in the UK but not paying corporation tax on profits earned from those revenue streams. BEPS is a welcome response to the growing pressure on governments worldwide to implement a fairer tax system.

The UK is no longer a member of the EU and therefore the rules on EU subsidies no longer apply (limited application continues in the context of trade between Northern Ireland and the EU and in certain other circumstances, for example, the distribution of residual EU state aid).

A new regime, “subsidy control”, operates in the UK, which overlays the EU and WTO rules on subsidies, and which takes a principles-based approach to the delivery of subsidies by public authorities. The rules are there to protect the UK’s internal market and its international trade relationships.

The Finance Act 2018 introduced changes to the CTA 2009, the policy behind which was to enable a deduction for coupons on certain types of hybrid instruments which are in essence genuine debt instruments. This was an important measure and a necessary reaction to changes in regulation, which required banks (Basel III) and insurance companies (Solvency II) to issue instruments enabling loss absorption in the event of financial strain and depleted levels of capital. In order for the rules to apply, the instrument must be a loan relationship on which the debtor is allowed to defer or cancel interest payments. In addition, it must have no other significant equity features, and the debtor must have made an election into the new rules within six months of issue of the instrument.

See 9.6 Proposals for Dealing with Hybrid Instruments.

The general drift of the CFC regime is to prevent profits from being taxed at a lower rate overseas and repatriated by way of dividends at a time when the company had been brought onshore so that the dividends were exempt as being from a UK resident company. They have been applied in wider circumstances than intended and were arguably not compliant with EU rules, as they were discriminatory.

See 9.8 Controlled Foreign Corporation Proposals.

It remains to be seen how BEPS will affect tax revenues in the UK as it is early days.

Country-by-country reporting enables tax authorities to assess transfer pricing and other risks and determine where resource is required.

The UK introduced a diverted profits tax aimed at charging profits earned from UK activities which are diverted outside the UK.

See 9.12 Taxation of Digital Economy Businesses.

The UK has a number of sets of rules to tax exploitation of intellectual property which is held offshore. Royalty payments by a UK resident company are subject to withholding tax, transfer pricing rules seek to ensure payments are made at an arm’s length rate, there are “diverted profits tax” rules, and there are also rules which catch offshore receipts in respect of intangibles intellectual property on “UK derived amounts” exceeding GBP10 million arising to residents of a territory with which the UK does not have a full double tax treaty.