We are sharing this update from ACCA, our professional body, for the interest of clients and contacts. The content is (c) ACCA
For enterprises intending to start or expand a business in a foreign country it is always advisable to thoroughly investigate a proposed business before investing any money. It is also important to keep plans small and manageable and work within a tight budget before embarking on a grand scheme.
Cost and time of registering and running the business in a foreign country
Incorporating a company might take longer and be more expensive than in the UK. Expert legal advice might be necessary to register the business and also to ensure that the business is legal and tax compliant at all times. It is also important to ensure that contracts are clearly defined before making an investment, because if the business becomes involved in a legal dispute it can take years to resolve it.
Access to grants or tax breaks
A range of grants and incentives is available for new businesses in many countries, particularly in rural and deprived areas. Grants may include European Union subsidies, central government grants, regional development grants, redeployment grants, and grants from provincial authorities and local communities. Grants may include assistance to buy buildings and equipment, research and technological assistance, subsidies for job creation, low-interest loans and tax incentives. The access to grants and tax breaks might be an important factor in deciding in which country to invest.
Local law, government grants and Bribery Act
In seeking tenders for publicly funded contracts, governments often permit or require those tendering for the contract to offer, in addition to the principal tender, some kind of additional investment in the local economy or benefit to the local community. Such arrangements could in certain circumstances amount to a financial or other ‘advantage’ to a public official and be subject to the Bribery Act. To avoid being caught by the Bribery Act the business has to ensure that relevant ‘written law’ permits or requires the official to be influenced by such arrangements.
Employment, local law and employment taxes
The cost of hiring employees abroad must be taken into account before starting a business. In addition to salaries, the business may need to consider the cost of social security contributions, bonuses, paid annual leave and public holiday, sickness and maternity leave etc.
Businesses that create jobs are usually welcomed, particularly in areas with high unemployment, but a business licence may be conditional on the employment of a number of local citizens. The business might need to take into account any local labour laws and employees’ rights.
Company residency for tax purposes
A company is UK resident for tax purposes if it is registered in the UK or is registered offshore but has its central management and control exercised in the UK.
A UK resident company is subject to UK tax on its worldwide income and gains (unless otherwise provided in a particular double tax treaty) whilst a non-resident company is only liable on its UK source income.
There is no legislation defining central management and control and it has therefore been left to the courts to decide what it means. In De Beers Consolidated Mines Ltd v Howe (1906) it was decided that ‘a company resides where its real business is carried on and this can be determined from where its central management and control abides’.
It must be noted that shareholders have the collective power to ensure the affairs of the company are conducted in accordance with their wishes, but the board of directors approve and implement decisions. HMRC Statement of Practice SP1/90 explains that case law attaches importance to the place where the company’s board of directors meets, but the location of central management and control is wholly a question of fact so there cannot be a single conclusive test.
Double taxation treaty
Double taxation treaties are designed to protect against the risk of double taxation where the same income is taxable in two states. UK has the largest network of treaties covering over 100 countries. The UK seeks to encourage and maintain an international consensus on cross-border economic activity and to promote international trade. Copies of double taxation conventions can be found on the HMRC website.
Withholding, unilateral and underlying tax
Relief for foreign tax may still be given against the UK tax on the same income, even though there is no double taxation agreement between that territory and the UK. Relief may also be given where there is an agreement between the UK and the foreign territory, but the agreement does not include a particular tax or source of income.
This is known as ‘unilateral relief’.
If credit is available (‘may be allowed’) under any applicable double taxation agreement but has not been claimed, unilateral relief is not allowed. Also, where a double taxation agreement explicitly precludes relief in specified cases or circumstances, unilateral relief is not allowed in such specified cases or circumstances either.
Subject to all these rules, the UK tax system also allows unilateral tax relief under which the foreign tax suffered is allowed as a credit against the UK corporation tax liability on the foreign income.
The maximum relief that a company may deduct is limited to the UK tax on the foreign income.
To ensure that the tax is paid, many countries impose a tax charge on certain payments which is withheld at source. This is called withholding tax and unilateral relief is always available for this.
Also, if the UK company controls at least 10% of the voting power of a foreign company and if foreign tax was paid on the profits out of which a distribution of dividend has been made then the underlying tax relief and unilateral relief are available.
Unilateral relief for underlying tax may still be available where the control of voting power as above is below 10%. This is so where:
- the held percentage: (i) has been reduced below 10% (and such reduction occurred on or after 1 April 1972), or (ii) was acquired after that date in exchange for voting power in another company in respect of which relief was previously available due to the percentage of voting power held prior to exchange
- the recipient of the dividend shows that the reduction in the held percentage in (i) above (and any further reduction), or the exchange in (ii) above (and any reduction after the exchange), could not have been prevented by any reasonable endeavours on the part of the recipient (or a parent or associate), and was due to a cause or causes not reasonably foreseeable by it (or them) when control of the relevant voting power was acquired
- the recipient shows that no reasonable endeavours on the part of the recipient (or a parent or associate) could have restored/increased the held percentage to at least 10%.
Transfer pricing issues
Transactions between connected parties should be carried out at an arm’s length. The arm’s length principle is endorsed by the OECD and enjoys general international agreement.
But the business should not underestimate the complexities of applying the arm’s length principle in practice. Because of the closeness of the relationship between the parties there can be genuine difficulties in determining what arm’s length terms would have been – especially where it is not possible to find wholly comparable transactions between unconnected parties.
The idea of developing business outside the UK can seem like a natural progression in growing an existing business; others might make global expansion a part of their business plan. Whatever the reason, it makes sense to fully explore the risks and benefits and the decision to invest or expand in a foreign country should not be taken lightly.