US multinationals

It pays to plan

Miles Dean asks how US multinationals must prepare when using the UK as a stepping stone to the wider world.

As Benjamin Franklin once said, “By failing to prepare, you are preparing to fail.” For many US headquartered multinationals, the UK is a natural stepping stone or launchpad to the wider world. Language, culture and a pro-business tax regime all make the UK a natural home. Despite these obvious advantages, however, various aspects of the UK tax regime can create significant problems for US corporates that enter the UK without undertaking proper detailed planning in advance.

1. UK corporate tax residence A US corporation that exercises its central management and control in the UK will become UK tax resident and subject to UK corporation tax at 19% on its worldwide income and gains. Central management and control is determined by reference to UK case law and is the place where decisions about the strategic policy and direction of the corporation are taken. These decisions can generally be distinguished from decisions of a more day to day, operational nature.

Miles Dean Head of International Tax, Andersen Tax

It is not uncommon for US groups to have personnel based in the UK that are involved in the strategic decision making process. UK case law on central management and control is (relatively) taxpayer friendly. With careful adherence to a management framework (in terms of the types of decisions that business managers and senior executives may take in and outside the UK), this risk can be managed. It should be noted, however, that unwinding historic arrangements where central management and control is in the UK can give rise to separate tax risks that need careful consideration (i.e. to ensure a UK exit tax charge does not inadvertently arise).

2. Permanent establishment risk A foreign corporation that does not exercise central management and control in the UK can still be exposed to UK corporation tax where it has a UK permanent establishment. A UK permanent establishment will arise where the foreign corporation:

● has a dependent agent that habitually concludes contracts in the UK on its behalf, even if the formal signing of the contracts takes place outside the UK; or ● has a fixed place in the UK at its disposal (e.g. office premises, client’s premises, home office) through which it carries on profit generating activity by persons taking instructions from the foreign corporation.

18 Author bio Miles Dean is the Head of International Tax at Andersen Tax. He advises privately held multinational companies and high net worth individuals on cross border tax issues.

It is even more common for US groups to have expanded into the UK (or other EU jurisdictions) without formally establishing themselves here. Where a foreign corporation breaches the permanent establishment thresholds, it must register with HMRC and determine what proportion of its profi ts arise from the UK trade, on which it must pay UK corporation tax.

Where a US corporation has a branch in the UK, it is required to disclose its full fi nancial statements to Companies House (a public register), not just the proportion of profi ts attributable to its UK branch.

Where the US corporation has employees working in the UK, it must operate a UK payroll, including the payment of employer’s NICs at 13.1%. Such US companies are often also UK VAT non-compliant, having failed to register or apply the tax correctly to the supply of goods and services.

3. Hybrids and other mismatches The UK introduced the hybrids and other mismatches rules in 2016, applying not only to hybrid instruments or entities, but to multinational companies and permanent establishments that give rise to deduction/ non-inclusion cases (e.g. where a jurisdiction exempts the profits of a foreign branch). Nonetheless, many US headquartered groups have not considered how the rules apply to their UK operations because the focus is more often than not on getting the business started, rather than dealing with the practicalities. The rules are complex and are accompanied by over 300 pages of HMRC guidance. From 1 January 2020, the rest of the EU will have implemented the same rules.

4. Diverted profits tax and the compliance facility The diverted profits tax (DPT) rules were introduced in 2015 and apply only to large organisations. (A group will not be large where it has fewer than 250 employees and its turnover is below €50m or its balance sheet assets are below €43m.) The DPT will apply in two cases: 1. where a UK corporation (or UK branch of a foreign corporation) uses entities or transactions that lack economic substance to exploit tax mismatches (e.g. through payments to low or no tax territories); or

Various aspects of the UK tax regime can create signifi cant problems for US corporates that enter the UK without detailed planning.”

2. where a foreign corporation takes steps to ensure that it is not trading in the UK through a PE.

If cases 1 or 2 apply, the relevant corporation tax deduction is denied and the increase in UK profi ts will be taxable at the punitive DPT rate of 25% (as compared to the UK corporation tax rate of 19%).

Where case 2 applies, the foreign corporation will be deemed to have a UK permanent establishment. The determination of a deemed permanent establishment and allocation of profi ts thereto is determined by HMRC through a rigorous analysis of the facts and commercial drivers behind the structure. Typical arrangements to which the DPT applies include: ● limited risk distributors/service providers; ● toll or contract manufacturing arrangements; ● contract R&D arrangements; and ● the fragmentation within the same UK corporation or different UK entities of valuable integrated functions into standalone functions that are priced individually as low value-adding functions.

Many groups (and tax advisers) consider that if a group has its transfer pricing correct, then a DPT charge can be mitigated. Broadly, this is true; however, the issue is that HMRC considers many groups, using: ● the above listed arrangements; ● price transactions on an incorrect fact pattern (e.g. where the facts in the transfer pricing report differ to what happens on the ground); or ● price transactions which are not consistent with the OECD transfer pricing guidelines (e.g. where there is over reliance on transfer pricing policies predicated on the assumption of risk and legal ownership of assets and insufficient weight to the location of the control functions or the contribution of those control functions in relation to assets and risks).

unveiled a compliance facility giving taxpayers an opportunity to self-report non-DPT compliance. Whilst the facility does not provide an amnesty from penalties or civil or criminal investigation, it demonstrates goodwill on the part of the taxpayer to become compliant, such that any penalties are likely to be at the lower end of the scale.

6. Corporate interest restriction The UK has a number of rules within its armoury to restrict the deductibility of interest expense, including: ● thin capitalisation; ● transfer pricing; ● unallowable purpose; ● corporate interest restriction; and ● hybrid and other mismatches.

The corporate interest restriction regime applies to groups with net interest expense in excess of £2m (including interest on third party debt).

The fixed ratio rule is the basic position and caps the deductible amount of net UK interest expense at 30% of UK taxable earnings before interest, taxes, depreciation and amortisation (EBITDA). A modified debt cap ensures that the net interest deduction does not exceed the total net interest expense of the worldwide group. A higher cap can apply, by election, US MULTINATIONALS

under the group ratio rule and is based instead on the net interest expense to EBITDA ratio for the worldwide group. To determine which ratio is most beneficial, a calculation must be performed. The result is often contrary to the theory!

This new regime has impacted the real estate sector most significantly, where businesses require high amounts of debt resulting in significant disallowances of interest. With this in mind, and considering the numerous other changes to the taxation of UK real estate since 2013, the corporate interest restriction includes an exemption for public infrastructure assets (the public infrastructure benefit exemption (PIBE)).

Broadly, the PIBE allows a number of adjustments or exclusions in calculating net interest of the group, where an election is made. PIBE applies to: ● companies carrying on qualifying infrastructure activities; and ● real estate investment businesses.

Such activities include the provision of tangible assets forming part of the infrastructure of the UK (e.g. utilities, telecoms, transport, health and education), or the provision of rental properties as part of a UK property business to unrelated parties on a short-term basis (i.e. 50 years or less). ●

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