Hamilton Pratt

Questions and Answers

How are branches and companies taxed?

A UK branch of an overseas company and a UK subsidiary will both be subject to UK corporation tax. Income profits and capital profits are charged at the same rate. The section entitled 'Your Options – Setting up on Your Own' explains the nature and tax status of a branch.

Are there any special rules for small companies?

There are two special rates of corporation tax for small companies, the starting rate of corporation tax (which is currently nil) and the small companies' rate.  Both rates apply to companies with profits below certain figures.  If a UK company is a member of a group, this threshold is divided by the number of associated companies, including any companies not resident in the UK.   Marginal relief is available for companies with profits between certain limits.  These thresholds are similarly divided by the number of associated companies. The special rates are not available to some companies which exist wholly or mainly for the purposes of holding investments.

These special rates only apply to UK resident companies.  However, a branch of an overseas company may be able to rely on a non-discrimination clause in any double tax treaty to argue it is entitled to the small companies rate or the starting rate.

How are profits calculated for corporation tax purposes?

For tax purposes, trading profits are calculated by deducting from the trading receipts specified deductions together with any expenses incurred wholly and exclusively for the purposes of the trade. Trading profits are taxed on an accruals basis, generally in accordance with the accounting treatment.  Capital gains are generally taxed on realisation.

Depreciation: Depreciation on fixed assets is disallowed for corporation tax purposes.  Companies are instead allowed a fixed writing down allowance on certain capital expenditure.  Writing down allowances of 25% on a reducing balance basis are allowed on most expenditure on plant and machinery.  Small or medium sized enterprises are entitled to a 40% first year allowance and thereafter allowances at 25%.  A small or medium sized enterprise will fulfil at least two of the following conditions:

  • turnover not exceeding £11.2 million
  • assets not exceeding £5.6 million
  • no more than 250 employees.

Where the enterprise is a member of a group the test must be satisfied on a group-wide basis, including any overseas companies.

From time to time higher allowances are made available on a temporary basis. New industrial buildings (such as factories) also qualify for allowances at the rate of 4% per annum of the initial expenditure over a 25-year period.

Losses:  Trading losses can be:-

  • set off against other profits and gains, including capital gains, arising in the same period;
  • carried back and set off against other profits and gains, including capital gains, in the previous accounting period;
  • carried forward indefinitely and set off against profits arising in the same trade; or
  • surrendered by way of "group relief" to other members of the UK group who can use them to set off against trading profits arising in the same accounting period.

If your business in the UK is initially likely to be loss making, there may be advantages to establishing a branch rather than a subsidiary as it may be possible to obtain relief for the losses both in the UK and (subject to local tax advice) in your own country.  It may also be possible subsequently to incorporate the business and carry forward the losses which have not been relieved in the UK into the new subsidiary.

Capital losses (losses arising on the disposal of a capital asset) can only be set off against capital gains arising in the same period or in subsequent periods.  They cannot be carried back or surrendered to other members of the group.

Interest:  Interest paid by a UK company is, subject to certain anti-avoidance provisions, deductible in calculating its profits.  Deductions are available broadly on an accruals basis.

On making a payment of yearly interest to a non-resident, a UK company must usually deduct tax.  "Yearly interest" is interest payable on borrowings which last more than a year or are capable of lasting more than a year, in contrast to "short interest", which would be payable on a temporary loan which is intended to last for less than a year. The withholding may be eliminated or reduced under any relevant double tax treaty.  To enable a UK subsidiary to pay interest gross or subject to a reduced rate of withholding tax, you must obtain confirmation from the Inland Revenue Financial Intermediaries and Claims Office (FICO) that the provisions of the relevant double tax treaty will apply.  The provisions of the double tax treaty will not normally apply when interest is paid to a permanent establishment of an overseas company in the UK or where the parties have a special relationship and the amount of interest paid exceeds that which would be paid in the absence of the special relationship.

Thin capitalisation rules apply in certain situations to re-categorise certain interest payments as dividends.  These apply where interest is paid by a UK company to its 75% parent or subsidiary or another member of the 75% group and the amount of interest paid exceeds that which would have been paid in the absence of the special relationship.  To determine what interest would have been paid in the absence of the special relationship the following factors are taken into account:-

  • the amount of the company's overall indebtedness;
  • whether in the absence of the special relationship the loan would have been made at all;
  • the rate of interest and other terms of the loan.

Although the UK does not specify what is acceptable by way of debt:equity ratio or interest rate cover, the Inland Revenue has indicated that, in general, it considers a debt:equity ratio of 1:1 and interest rate cover of 3:1 as acceptable.

If, on the other hand, you operate a branch in the UK and provide it with funds and it pays "interest" to you, the branch will not usually be entitled to relief for the interest.  Where you borrow from a third party to fund the activities of the branch, the branch should be able to obtain relief for the interest against UK tax.

Transfer pricing:  UK transfer pricing legislation enables the UK Inland Revenue to adjust a UK subsidiary's profits for corporation tax purposes if it pays more than the market rate for goods or services provided by its overseas associates or charges less than a market rate for goods or services provided to them.

Goodwill:  No tax relief is currently available in relation to amortisation of goodwill. However the Government is considering a reform of this aspect of the UK tax system so that goodwill and intellectual property rights will be taxed in accordance with their accounting treatment.

Are there special rules for groups of companies?

Special tax reliefs apply to some transactions between group companies.  For example:

  • assets can be transferred between group companies free of corporation tax on chargeable gains and stamp duty;
  • trading losses can be surrendered between group companies by way of "group relief"

The group rules have recently changed.  Groups can now be traced through non-resident companies.  Two UK companies both owned separately by a non resident company will now form a group as will a UK branch of a non-resident company and a UK subsidiary of the non-resident company.

When does tax have to be paid?

For large companies (ie with profits in an accounting period of more than £1.5 million), corporation tax will be payable at three monthly intervals in four equal instalments.  The first instalment is payable on the date six months from the start of the accounting period.  The amount payable is calculated by reference to the actual profits for the year and therefore the first two instalments will have to be based on an estimate of the profits. Where a company is a member of a group, the £1.5 million threshold is divided between the number of associated companies, including any companies not resident in the UK.  Interest will be payable on underpayments and will be paid by the Inland Revenue on overpayments of instalments.

Companies outside this system pay corporation tax nine months after the end of the accounting period. For accounting periods ending before 1 July 2002, only a percentage of the corporation tax is paid by instalments.