Businesses are increasingly looking to international markets as they grow, particularly with the advent of e-commerce over the past decade. Therefore, international tax issues that may have previously been the preserve of larger multinational businesses are now often in point for other businesses, irrespective of their size. As Brexit nears, businesses may need to consider restructuring their affairs to allow for them to operate in Europe and beyond, post-Brexit.
As a starting point, such businesses need to understand the distinction between ‘doing business with another country’ (eg remotely via internet sales) and ‘doing business in another country’ (eg through having a physical presence there), given there could be materially different tax issues to consider. However, this choice should not be made purely on the basis of tax considerations - commercial and practical issues are usually more important driving factors.
In cases where businesses need to establish a presence in another country, they then need to consider what form it will take. This typically means choosing between having a local branch of a non-resident (eg UK) company or a local subsidiary company.
In choosing between the two options, the following overseas tax issues should generally be taken into account.
Generally speaking, only the trading profits of the local activity undertaken by the branch should be subject to local CIT, although local capital gains tax could also apply on disposals of certain capital assets used by the branch, too.
The initial expectation should be that all profits would be subject local CIT. However, if the only activity carried on locally via the subsidiary is a trade, then any local CIT exposure should generally be similar to that of a branch, but there could be some important differences depending on the activities undertaken, funding of operations, etc.
Attribution of profits
Profits should generally be attributed to a branch as if it were an independent third party acting at ‘arm’s length’. However, this can be a subjective exercise and open to challenge by local tax authorities. By comparison, a subsidiary is a separate legal entity and so usually has to generate income and expenses in its own name, that must be properly documented via invoices etc and which may make it more difficult for local tax authorities to challenge, assuming such transactions are appropriately priced.
If using a branch, local CIT filings would be required in the name of the UK company; if using a local subsidiary, filings should be made in the name of the local entity.
Even if a local entity is set up to operate in another country, care should be taken to not inadvertently trigger local CIT exposures for the UK parent by virtue of its own employees’ activities (eg if UK company’s staff are sent to work on projects relating to the local subsidiary).
In terms of seeking to set up in a country, businesses need to understand that each country will have their own unique CIT rates and rules. It should be noted that countries typically have ‘headline’ tax rates set at a national (or federal) level, but differing regional and local taxes may also then be applied in some countries (eg Germany and the United States amongst others). In contrast, some countries have high headline rates but, in reality, the actual tax exposure is much lower due to reliefs or exemptions being available. Therefore, advice should always be sought prior to implementing or changing any business legal structure so as to properly understand any local tax exposure.
There should always be an appropriate review undertaken of whether the local activities could trigger a requirement to register and account for local VAT or equivalent taxes.
This is usually a priority to consider due to the potential impact on cash flows for the business concerned. This is because such taxes are generally required to be settled in short order and generally on a monthly or quarterly basis within the accounting period.
Obligations for reporting and paying such taxes will generally fall on the UK company. It may also require a local representative to be in place to take responsibility for doing so (which may also be a requirement for local CIT and employment taxes).
Such obligations should fall on the subsidiary, but extra filings could arise if intra-group transactions are entered into (eg to ensure accounting for VAT via the reverse charge mechanism correctly, intrastat filings etc).
As for VAT, employment taxes should also be a priority because if there are people on the ground, the expectation should be that there will be local employment tax obligations, whether in the name of the UK company or the subsidiary. In addition, if employees are seconded or temporarily transferred to work overseas, their own tax affairs may require consideration to ensure they are not taxed in full on the same income in both countries.
Obligations for reporting and paying such taxes will fall on the UK company. It may also require a local representative to be in place to take responsibility for doing so.
Such obligations should fall on the subsidiary.
WHT on dividends should not apply to a local branch as it cannot pay dividends (but see comments below regarding Branch remittance tax), whereas WHT will often apply to dividends paid by a subsidiary company, subject to local domestic laws and any reduced rates under double tax treaties etc.
Currently, the UK benefits from the EU tax directives which, for dividends, generally means that no WHT is suffered on payments by EU subsidiary companies to their EU (UK) parent company. However, Brexit is likely to mean that these directives will no longer apply to UK entities and hence, in the absence of new agreements, double tax treaty reliefs would need to be considered instead, which may not necessarily reduce the domestic rate of WHT to nil. This could therefore lead to tax leakage for clients as dividend income is generally exempt from UK tax in the hands of a UK parent company.
Branch remittance tax
This is basically the equivalent of WHT on dividends, but applicable for branches and does not apply to subsidiaries. Again, the same issues regarding double tax relief will be relevant to minimising tax leakage. Generally speaking, this tax is uncommon in developed countries, but could be a factor for investments in developing countries.
Interest/royalties/management or technical fees
Again, WHT should not apply to such payments by a branch as they cannot pay interest/royalties as if they were a company (eg a company cannot pay such amounts to itself). However, WHT will often apply to interest, royalties and similar payments by a subsidiary company, subject to the same comments above on the use of EU tax directive exemptions and reduced WHT rates under double tax treaties.
In relation to management/technical fees, similar points apply. Generally speaking, it is unusual to encounter such WHT exposure in relation to payments made from developed countries, but it could be a factor for developing countries.
From a UK CIT perspective, the way the UK tax system works should mean that clients may generally be able to end up in the broadly same position in relation to overseas trading activities when ‘repatriating’ profits, due to the possibility of claiming exemptions on such profits.
For example, dividend income should generally be expected to be exempt from UK CIT (hence the importance of minimising WHT on such income) assuming no anti-avoidance provisions apply. Similarly, it is also possible to exempt foreign profits arising in a foreign branch from UK tax, but this can be complicated and ultimately may not always achieve quite the same result as for dividends.
If a local subsidiary is formed then there are certain further aspects that must be considered. For example, if the overseas subsidiary’s place of management is in the UK it may be UK tax resident too, meaning that it may have a foreign branch itself.
Furthermore, in certain circumstances the UK controlled foreign companies anti-avoidance rules may apply, which subject a UK parent company to UK tax on foreign profits earned by its foreign subsidiary. Similar rules apply under the foreign branch exemption regime. These anti-avoidance provisions are more likely to be in point if the overseas CIT rate is lower than the UK rate and/or if there is little commercial substance to the overseas operations.
Other matters to consider could include the following.
- Timing of income - if businesses incorporate a foreign subsidiary to undertake overseas activity, they are more likely to be able to control the timing of income being repatriated to the UK.
- Commitment to local market - some local businesses and customers prefer to engage with a local incorporated subsidiary, as opposed to a branch of a foreign entity; but additional compliance costs may arise when trading through a subsidiary (eg audit of local financial statements).
- Compliance costs - if businesses use a foreign branch, compliance costs do tend to be lower and there is also an ability to access the benefit of local branch tax losses in the UK directly, but branches can be more subjective in terms of profit attribution and therefore more open to challenge by local tax authorities (eg our experience suggests certain tax authorities does not like branches and will target profit attribution for this reason).
The above is not an exhaustive list of factors to consider - each business’s circumstances will be unique and therefore will require appropriate review. Ultimately, however, the decision on how to structure expansion overseas should generally be driven by commercial factors, rather than tax.
For more information, please get in touch with Simon Hart or your usual RSM contact.