The UK is the fifth largest economy in the world, and its stated goal is to be business friendly from a tax perspective. Join two international tax experts to learn about some of the tax implications of expanding to the UK, including VAT, employment taxes, transfer pricing, R&D incentives and more.
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Expanding to the UK: Understanding the Landscape Transcript
This transcript was assembled by hand and may contain some errors.
It has been edited for readability.
Adelle: Welcome to untangling the technical, Frazier & Deeter’s podcast series in which we take a look at complex business issues and break them down for business executives navigating today’s complicated and ever-changing regulatory environment. I’m Adelle Erdman, and I am delighted to welcome two of the key partners in Frazier & Deeter’s international practice as we discuss expanding your business from the US into the UK. Today, we’re talking to Malcolm Joy, the leader of Frazier & Deeter’s London office. Malcolm is an expert in international tax planning, including areas such as value chain analysis and transfer pricing. Malcolm, welcome.
Malcolm: Thanks, Adelle.
Adelle: We are also happy to be joined by Mike Whitacre, one of our US based partners and a leader in our international tax practice. Mike frequently speaks at events across Europe about business considerations surrounding expanding into the US. Mike, welcome.
Mike: Hi, Adelle, thank you.
Adelle: For many years, the UK has been a major outbound destination for US businesses that are looking to expand internationally. As the world’s fifth largest economy, there’s every reason to believe that US businesses will continue to seek out opportunities in the UK, notwithstanding the prospect of Brexit.
Today, we’re going to talk about aspects of the business landscape that need to be considered when expanding into different markets in Europe. For purposes of today’s conversation, let’s assume this is the first expansion outside of the US.
Malcolm, just how easy is it to setup in the UK?
Malcolm: From a legal perspective, it should be relatively straightforward. We operate under a common law system in the UK, which should be familiar to a lot of US businesses. The government in the UK tries wherever possible to be business friendly. And in the main, businesses choose to set up in the UK either as a branch, a limited liability company or they could even choose a partnership. There are other forms of entity available as well.
In theory, a limited liability company can be set up in a matter of days, but in practice it does take a little bit longer as lawyers, bankers and accountants are required to undertake checks in the UK these days on their client’s identity to confirm the identity and the owners of the business under the anti-money laundering provisions.
Adelle: Mike, based on your experience, what are the key tax issues that US businesses need to think about in advance of setting up in the UK?
Mike: There’s a great treaty between the UK and the US, so you get a lot of zero percent withholding rates on different things, so that’s a nice benefit. Malcolm will probably get into more of the details later, but I think a lot of the benefits are really more non-tax-related.
I think because the UK is an easy place for Americans to do business, and obviously there’s a sharing of a common or somewhat common language. Culturally, it’s very similar. It’s a big economy, so there’s a lot going on. In today’s environment, you also need to balance that with what’s going on with Brexit and, you know, does that impact or potentially impact your company if you put it in the UK?
Adelle: One of the things that American companies might find interesting is differences in the tax structure. Presumably, there are a variety of tax registrations that need to be made.
Malcolm: The main registrations you need to make are corporate income tax, VAT and payroll taxes. So, VAT is probably the one that for most Americans stands out as the most unusual. You do need to register for VAT pretty much as soon as you start doing business over there, as you will need to have the VAT registration number to quote on the invoices that you raise, and you definitely need to get your head around your VAT position as you enter into the UK market. Corporate income tax and payroll tax registrations are pretty straightforward, but the payroll tax, again, you do need to make that registration before you can start paying employees in the UK.
Mike: And Malcolm, even with the US corporate tax rate dropped substantially about a year ago to 21%, but it’s still even lower than that, right, In the UK, now?
Malcolm: Yes, so, you’ve got, obviously, the corporate tax rate in the US, just over 20%, but you’ve also got the states and local tax rates on top of that. So, typically, I guess you’re getting up to around 25% in the US, whereas the UK has a stated objective, actually, of being the lowest or the most competitive tax system in the G20. The rate there at the moment is 19% for the main corporate income tax rate. And that’s coming down to 17% in April of 2020, and that’s the only corporate income tax. There are no further local state charges or anything like that.
Mike: So, even though we think our corporate rates are pretty low, it’s like you said, let’s say, assume 25% including state, it’s going to compare to 17% in the future, which is pretty substantially lower than the US rate.
Malcolm: Exactly. And that still gives us small arbitrage opportunity. So, things like our cross-border financing, if you’ve got interest deductions in the US coming into the UK, there will still be a group benefit in that rate arbitrage.
Adelle: All right, so you’ve covered the basic corporate income tax. What about VAT and any other taxes?
Malcolm: VAT is an EU-wide tax, and then common with other EU countries, VAT is chargeable on most sales, but the VAT cost can be recovered by the majority of businesses. In most cases the cost of VAT is ultimately borne by the end customers. So, it’s a slightly odd kind of sales tax system, but once you get your head around it, there’s a good degree of logic. Payroll taxes in Europe generally can be quite significant and sometimes there are contributions that need to be made by employers as well as withholding amounts from the pay that’s paid to the employees.
So, for example in the UK we have something called National Insurance and typically an employer would need to be paying 12% National Insurance contributions for any earnings between about six thousand pounds and fifty thousand pounds per year for each employee, and then on top of that if the earnings go above fifty thousand pounds a year, we’ve got an extra two percent national insurance charge.
Adelle: Switching gears a bit, does that make the UK an attractive place for a European holding company?
Malcolm: Over the last 10 years or so, we’ve seen a lot of US groups set up with the UK as an intermediate holding company in their group. But concerns around Brexit, I think, are causing people to re-evaluate this position. I think there are still a number of factors that make the UK a very attractive intermediate holding company location. For example, we don’t have any tax charge, any dividends coming into the UK from other group companies. We can also sell a trading subsidiary out from underneath the UK with no tax charge. And again, there’s no domestic withholding tax on dividends going out.
So, all of those things, together with a reasonable allowance for deducting financing costs for financing the UK operation, still make the UK quite an attractive location for an intermediate holding company in their group. But having said that, if the UK does leave the EU, then it may not make the most sense to have the UK as some kind of Central European Distribution company with goods coming into the UK and then going out again, as there may be some issues around customs duty and VAT if we have that structure.
Mike: I would just also say that, from a non-tax standpoint, from operational issues, a lot of US companies like to put their controller or C-level people in the UK and let them more closely manage the continental European team. That’s not a tax issue, but you’ll see a lot of US companies do that from an operational issue and use the UK as kind of controller function for the rest of Europe.
Adelle: Can you tell us a bit more about the VAT regime and what US groups need to understand about that if they’re selling into the UK?
Malcolm: Sure. So, we touched on this earlier. Obviously, this is an unusual regime from a US perspective; it’s one that most U.S. groups are not familiar with. But, if you are selling into the UK, then you need to think about whether VAT needs to be charged on the sales in the UK. And you need to think about registrations, you need to understand where and when you need to register for VAT. The rules here are different depending on whether or not you’re selling goods or services.
For goods, it’s generally the importer who has to account for the VAT, but for sales of services, you need to think about where the supply is deemed to be taking place and the VAT place of supply rules, and the fact is that you need to consider here, include things like the type of service you’re supplying, is it covered by the general rule in the UK, or is it covered by one of the special rules, and you also need to think about the place of supply and whether or not it could be affected by the type of customers you have. So, for example, are you supplying to business customers in the UK or are you supplying to individual end customers? So the VAT regime is generally quite alien for most American businesses, and certainly worth getting good advice early on in the process in this area.
Mike: And Malcolm just one point on that, so, VAT is applicable to essentially everything. Services, products.
Malcolm: So, there are a number of things that are outside the scope of VAT, and there also are some items in the UK that are what we call zero range, and so in theory VAT is applicable, but it’s only applicable at the rate of normal percent, so things like food that’s bought in supermarkets or children’s clothes or books, they’re all zero rated. Most other things, though, are fully VAT-able, and VAT is charging the rate of 20%.
Mike: So, that’s a big difference from what people in the US are used to, where sales tax in the US is only charged against tangible personal property, and generally it’s not applicable to sales tax, that’s just something that people need to be aware of, that VAT is much more broadly applied than sales tax in the US.
Malcolm: Yeah, and I think particularly the area of services is an area which catches a lot of people out, just understanding what kind of services you’re supplying, are they subject to VAT, and then working out where they’re supplied. So, things like, if you’re supplying services digitally, then you may well be caught by VAT rules in the UK and in the rest of Europe.
Adelle: Having dug into the VAT a bit more, are there any special considerations regarding employment taxes that we should discuss?
Malcolm: Yeah, there are a couple of things to think about. On employment taxes, I think for US businesses coming into the UK or operating in the UK, it’s well worth being aware of the fact that we have a number of tax favored stock option plans which can be used, and these can offer significant advantages, particularly to the employees around their personal tax treatment and therefore well worth considering. They’re relatively straightforward to implement, and they’re quite commonly used.
The issue we sometimes see, though, with US businesses operating in the UK is where we have very senior employees in scenarios where the US parent has granted stock options, but the finance team in the UK are unaware of those stock options, and that can sometimes cause us to trip over the compliance requirements, as there are annual filing requirements in the UK. And if the finance team in the UK are unaware of the stock option situation for those senior employees who are based in the UK, then it makes it very difficult for them to comply with those annual filing requirements.
Adelle: Are there any other taxes that US companies may find unusual?
Malcolm: Yes, there’s a couple of unusual taxes that people may have heard of. First of all, the diverted profits tax that was introduced a few years ago, sometimes referred to in the UK as the Google tax. And this is an anti-avoidance measure, which imposes a punitively high rate of tax on businesses that undertake certain types of transactions that are deemed to be artificially eroding the tax base in the UK. The rules don’t apply very often in practice, and in many situations you can make sure they don’t apply simply by ensuring that your transfer pricing arrangements are robust and appropriately documented. But it’s something that certainly companies coming into the UK need to be aware of.
Another new tax which is yet to be introduced but which has been announced and has been in the news quite a lot recently is the digital services tax. This is intended to apply in situations where there are digital sales, and a significant part of the value is effectively being created by the user of the service. It is still uncertain when this tax will eventually ever come in, as the government has said that it will withdraw the proposals if the OECD manages to achieve consensus on its proposals for taxation on the digital economy.
Adelle: Well, why don’t we talk a bit about the more pleasant side. Are there any special tax incentives or reliefs?
Malcolm: There are a number of incentives in the UK, probably the most common ones that we would come across are similar to US incentives around research and development. So, for small and medium sized companies, there is a very attractive deduction available for every hundred pounds that is spent on qualifying research and development. A tax deduction in the corporate tax return of two hundred and thirty pound is available, so that’s obviously a very significant saving that can be made. And, if the company isn’t tax-paying, it can surrender that enhanced deduction in exchange for a cash payment, so well worth looking into that.
The range of activities that qualify for this research and development relief is also actually quite broad. Often we see claims including things like internally developed software. So, well worth looking at if you are setting up in the UK, even if you don’t consider yourself to be a highly inventive or creative business, there is still a good chance that you may qualify for some research and development tax deduction.
Mike: This is an important point, because the US has, as you know, its own R&D tax credit as Malcolm mentioned, and the US also has a new regime under the tax reform that came in about a year ago called FDII (Foreign Derived Intangible Income), which is a benefit if you house your R&D in the US and derive foreign revenue off of that. So, my point here is that companies should, if they have the ability to move that around, they should probably do an analysis of, “Does it make more sense to house that in the UK or in the US,” because there’s benefits in both places, and the question would be based on how your company operates and its business model, which location is more beneficial for the company.
Malcolm: That’s absolutely right. I think more and more we are starting to see R&D-type activities that are carried out by virtual teams across both the UK and the US, as well as other jurisdictions as well, and just getting a head around what tax incentives there are available in each jurisdiction where you operate, as well as doing it in a structured and coordinated way.
Adelle: Excellent. Well, you’ve certainly given our listeners an awful lot of things to think about as they consider going across the pond. I want to thank both of you for being on the podcast, and for our audience. Thank you for listening to Frazier & Deeter’s Untangling the Technical podcast. Please join us for our next episode, as we continue to discuss complex topics in terms that help you navigate your way forward.