How easy is it to avoid UK corporation tax by registering a company abroad? From time to time the question of corporate residence and the resulting tax implications is raised. Often, it’s in the context of an enquiry about registering the company abroad in a low tax jurisdiction to reduce corporation tax on trading profits. Generally speaking, unless a company is actually and substantially centrally managed and controlled from the proposed low tax jurisdiction then there will be absolutely no UK tax benefit, despite what anyone may say.
So, if the business is transacting in the UK and the real management and control is in the UK, registering the company abroad is really not worth pursuing. Even if, substantially, the central management and control of the company is outside of the UK (not an easy test to satisfy) there is another issue to consider in the light of the Organisation for Economic Co-operation and Development (OECD), and UK in particular, attack on the erosion of taxable profits generated in the UK.
Here is the latest HMRC statement on this:
The general rule is that a company which is not resident in the UK [and remember, it is first necessary to overcome the “central management and control” test – see above] has to pay UK Corporation Tax only if:
it has a permanent establishment in the UK;
the economic activity that generates its profits is carried out in the UK.
What is a permanent establishment?
A permanent establishment is where a company has a presence in a country through which trade is carried out. There are two types of permanent establishment:
- a fixed place of business;
- a dependent agent.
- A fixed place of business is generally a building or a site which the non-resident’s personnel have at their disposal and use to carry out the non-resident’s business. An office, a factory or a shop, for example, can all be a fixed place of business.
A dependent agent is a person who is not independent of the non-resident company and regularly does business for the company, usually by concluding contracts on its behalf.
What determines the location of economic activity?
Many different elements contribute to a multinational’s economic activity, including sales, employees, technology, physical assets and intellectual property. The tax authorities need to work out which of these are developed or take place in a particular country and how much profit is attributable to them.
Simply having customers in the UK does not mean that a company is carrying out its economic activity here. This is because having UK customers is not the same as having a permanent establishment in the UK. There is a difference between a non-resident company that is trading from abroad with customers in the UK, and one that is actually trading in the UK.
Websites and group companies
Having a UK website does not mean that a non-resident company has either a fixed place of business in the UK or a dependent agent in the UK. All of the trading activity could be taking place outside the UK.
Most multinational businesses are not single companies, but a group of companies, only some of which will be operating in the UK.
For example, sometimes a company from outside the UK sells to UK customers via the internet. Another group company in the UK provides warehousing, distribution or other services and support to the selling company. Where this takes place, the UK service company will be taxed only on the profits of its own business, ie. the services it provides to the selling company.
This is not tax avoidance; it is simply the way that Corporation Tax works, ie. it applies to individual companies.
UK companies operating overseas
Most major economies operate Corporation Tax in the same way as the UK, so UK resident companies are treated in a similar way in other countries. In other words, UK companies do not pay Corporation Tax to another country on the profits from sales in that country, unless they trade through a permanent establishment there. Instead, they pay Corporation Tax on those profits in the UK.
So, a UK resident company that is selling its goods overseas via its website will pay Corporation Tax in the UK, and not in the countries where its customers are physically located.
What is happening now?
The concept of a ‘permanent establishment’ and how multinationals are taxed in different countries is not new. As far back as the 1920s, the League of Nations created draft tax treaties to prevent companies from being taxed twice on the same income in different countries. These rules are now part of modern tax treaties, which follow a model developed by the OECD.
What has changed is the way in which businesses operate, not least because of their ability to sell online in many different countries. This has raised questions about whether the tax rules for permanent establishments need to be updated to address these fundamental changes.
The UK has led the way in initiating and implementing the OECD/G20 Base Erosion and Profit Shifting (BEPS) project, which was set up to review and improve the function of international tax rules. The question of what constitutes a permanent establishment was one strand of this work and proposals to amend the international rules were announced in October 2015.
92 countries are working together on an instrument designed to implement the revised definition by amending existing tax treaties.
Further OECD/G20 work on the guidance on the principles for attributing profits to permanent establishments is also in progress.
In the meantme, pending Global reform, in November last year, the Government published a consultation proposing a new Digital Services tax to apply from April 2020. For more information, please see our bulletin of 13 November 2018.
So, you can see that merely registering in another (low tax) country and satisfying the requirements of the law of that country to establish residence there will not be enough alone to secure a UK tax advantage. The central management control test and the generation of profit from trading in the UK are likely to provide significant barriers to legitimate and permissible avoidance of UK tax for businesses run from, and trading in, the UK.