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DOING BUSINESS IN UK

TYPES OF ORGANISATION

Principal forms of doing business

Business organisations in the UK usually take one of four forms: partnership, branch, private limited company or public limited company. Private limited companies may not invite the public to subscribe for shares or bonds; public limited companies may. Public companies may choose to be quoted on the stock exchange or to be unlisted. A listing on an exchange in the EU entitles a company to be listed on any other EU exchange. Other organisational forms exist (such as limited partnerships) but are not widely used.

Most foreign-owned companies organise their affiliates as private limited companies. Those that do not, establish branches. Particular tax considerations can influence the choice. For example, operating as a subsidiary in the UK may mean that the profits of the subsidiary are subject only to UK corporation tax; operating as a branch of a non-UK company may mean that these profits (or losses) may also be taxable (or deductible) where the company resides. The tax treatment for a non-UK company varies from country to country.

Requirements of public and private limited companies
Capital. Public: Companies must have capital of at least £50,000, 25% of which must be paid up on each share. Capital may be supplied in non-cash forms (eg machinery, patents or know-how), but non-cash contributions must be independently valued. No legal reserves are required. Private: Same requirements, except there is no minimum for private limited companies and non-cash contributions do not need to be independently valued.

Founders, shareholders. Public: Public limited companies must have at least two shareholders. There are no nationality or residence requirements. Private: Same requirements, except they may have only one shareholder.

Board of directors. Public: There must be only one board with at least two directors. There are no nationality or residence requirements. A director may be chairman. Any changes to the board must be reported to Companies House within 14 days. Private: Same requirements, except that the minimum number of directors is one.

Management. Public: Managers need not be shareholders or directors. Every company must have a company secretary, who may be a director as long as there is more than one director. There are some qualification requirements. Private: Same requirements, except there are no qualification requirements.

Disclosure. Public: An outside auditor is appointed at the annual general meeting. Annual accounts, together with many additional details, must be filed with Companies House, where they are publicly available. Unless the company is small or medium-sized, the accounts will include a profit and loss account, a balance sheet signed by a director, an auditors’ report signed by the auditor, a directors’ report signed by a director or the company secretary, and notes to the accounts. Alternatively, a company may prepare its accounts in accordance with international accounting standards. No public company, regardless of its size, can qualify as a small- or medium-sized enterprise (SME) for these purposes. Private: Same requirements, except for special provisions applicable to SMEs. Small companies (those meeting two of the three following requirements: annual turnover of no more than £5.6m, balance sheet total of less than £2.8m and a workforce not exceeding 50 employees) may submit a shortened balance sheet and notes, and a special auditors’ report (unless claiming audit exemption—see below). Medium-sized companies (those meeting two of the three following requirements: turnover of no more than £22.8m, balance sheet total of no more than £11.4m and 250 employees or less) may submit as a minimum an abbreviated profit and loss account, a full balance sheet, special auditors’ report, directors’ report and notes to the accounts. Shareholders, however, must continue to receive a full set of accounts. Small companies (as defined above) need not be audited.

Taxes and fees. Public and private: Fees for registering a company are low. Standard registration fee: £20 (£50 for same-day service), reduced to £15 for electronic incorporation (£30 for same-day electronic incorporation); re-registration fee: £20 (£50 for same day service); change of name fee: £10 (£50 for same day service); annual returns filing fee: £30 if sent on paper, £15 if filed electronically. Stamp duty of 0.5% is payable when registered securities change hands, but there are numerous exemptions.

Types of shares. Public: Ordinary, preference and cumulative preference shares, and straight and convertible bonds are the common forms in which corporate securities are issued. Multiple classes of ordinary share with differing voting rights or no voting rights are prevalent in many large companies, particularly those in which families with minority equity holdings control public firms. A company must maintain a register of its shareholders. Although UK companies cannot issue bearer shares as such, they can issue warrants entitling the bearer to the shares specified in the warrant. Private: It is a criminal offence for private companies to offer their shares or debentures to the public.

Control. Public and private: A majority (more than 50%) is required for ordinary resolutions (unless byelaws stipulate otherwise); for changing articles and liquidation, 75% of shareholders’ votes are required. If a bid is made for the entire equity of a company (and the bidder obtains 90% of equity), the bidder can compel the remaining shareholders to sell. If the bidder owned shares before the bid, compulsory acquisition can take place only if the bidder acquires 90% of the shares that were not previously held.

Establishing a branch

If a foreign limited liability company establishes a branch in Great Britain (England, Scotland or Wales) and the company is required under the law of the country in which it is incorporated to prepare, have audited and disclose financial statements, the company must file for public inspection in Great Britain all accounting documents that are disclosed under that foreign law. If the foreign company is not a limited liability company or is not required to prepare such accounts, then accounts must be prepared as though it were a UK company (with various modifications) and filed for public inspection. Similar rules apply in Northern Ireland.

Within a month of establishing a branch, a foreign limited liability company must file various particulars and documents that can be viewed by the public, such as the names and addresses in the UK of persons authorised to accept legal notices served by the authorities; the name of the company, its legal form, its country of registration, company number, details of its directors and secretary; and address of the branch, when it was opened and its business. Additional disclosures are required for non-EU companies. Slightly less disclosure is required from unlimited liability companies. In all cases, it must also file copies of its constitution (translated into English). At every place of business, and on every letter and invoice, the branch must provide details of the company of which it is a branch, such as its registered name, the country of incorporation and whether its members have limited liability.

Setting up a company

Every company must be registered with the Registrar of Companies. The registration application should set out the scope of the intended corporate activities and must be submitted with a memorandum. If the company’s activities diverge from the goals stated in the memorandum, the transaction can be judged to be outside of the company’s authority. The company must also submit the articles of association, which detail the rights of the shareholders, borrowing powers and the duties of directors. The procedure usually takes several weeks.

Public companies must include the words “public limited company” or the abbreviation “plc” as an integral part of the company name, to be used on all official documents, general stationery and nameplates. Private limited companies use the word “Limited” or the abbreviation “Ltd”.

The Company Law Bill was published in November 2005 and brought forward to the House of Commons in May 2006. The legislation will substantially change company law, making it easier to understand and more flexible, especially for small businesses. The plans will help to keep the regulatory burden to a minimum, and promote shareholder engagement and a long-term investment culture.

The legislation has the following objectives:

* Enhancing shareholder engagement and a long-term investment culture;
* Ensuring better regulation and a “think small first” approach;
* Making it easier to set up and run a company; and
* Providing flexibility for the future.

It is possible to set up a European Company (Societas Europea—SE) in the UK. An SE is subject to the laws of the country where it is registered.

BUSINESS TAXATION

Overview

The UK has a low-tax, low-allowance system of taxation. The main tax rate on corporate profits is 30%. With effect from April 1st 2006, UK-tax-resident companies with profits up to £300,000 are taxed at a 19% rate, and those with profits between £300,000 and £1.5m are taxed at a rate between 19% and 30%. Where companies are associated, the thresholds are reduced pro-rata. Similar rates apply to UK permanent establishments (PEs) of non-UK-resident companies provided the company is resident in a territory that has an appropriate double-taxation treaty with the UK.

A UK-resident company is subject to corporation tax on its worldwide profits with credit given for most overseas taxes. Profits include chargeable gains. A non-UK-resident company is subject to corporation tax only in respect of the profits of its PE in the UK and chargeable gains on assets used or held for the purpose of the trade or PE. If a non-resident company carries on an investment activity in respect of UK sources of income, it will be subject to income tax. The rate of income tax for income from UK real estate (held as an investment) is 22%, and that on UK-source interest income is 20%.

A company is UK tax resident if it is incorporated in the UK or, if not incorporated in the UK, if its place of central management and control is in the UK. In practice, this often means determining whether the directors exercise central management and control and, if so, where they exercise that control.

The government believes it is important to maintain a competitive tax system. Recent measures cited by the government in support of this include a new regime for the taxation of intellectual property, goodwill and other intangibles; an exemption for capital gains and losses on the sale of a substantial shareholding; a volume-based enhanced tax deduction (150%) for small and medium-sized enterprises (SMEs) for certain revenue expenditure on research and development (R&D) that, for loss-making SMEs, can also be surrendered for cash; a volume-based enhanced tax deduction (125%) for non-SMEs for certain revenue expenditure on R&D; and a comprehensive system for taxing loan relationships, derivative contracts, and foreign-exchange gains and losses.

Like many EU governments, the UK government must carefully monitor developments in EU jurisprudence to ensure that UK corporation tax provisions accord with EU law. As a result of recent decisions by the European Court of Justice (ECJ), there is significant litigation in progress and pending that challenges many provisions in UK tax law. These include the taxation of foreign dividends, the controlled foreign companies’ legislation, the taxation of capital assets transferred to a foreign group company and the restriction on claiming relief for interest paid by a thinly capitalised company.

The ECJ decision in the Marks & Spencer case has caused the UK government to amend the group loss surrender rules. It is now possible, in certain limited circumstances, to offset losses of a non-UK trade incurred by a non-UK company against UK taxable profits, even if that non-UK company had made profits they could not be taxed in the UK.

Compliance with and enforcement of tax law is high in the UK. HM Revenue & Customs (formerly the Inland Revenue), the tax collector, has intensified enforcement procedures in recent years. The chancellor of the exchequer, currently Gordon Brown, takes a tough line on tax avoidance and the government recently introduced significant measures to monitor and counter some lawful tax avoidance. For example, the Finance Act 2004 introduced anti-avoidance rules that give HM Revenue & Customs early notification of certain tax-avoidance schemes. Where this applies, a promoter is required to disclose certain tax-planning proposals (on a no-names basis) shortly after they are made, setting out the nature of the proposed transactions and the expected tax consequences. If the transaction is implemented, it must be reported in the user’s tax return. The regime is to be extended in 2006. The recent Finance Acts included many anti-avoidance measures to address some of the disclosed proposals.

Taxable income and rates

Only the central government levies corporate income tax in the UK. The highest rate of company tax is 30%, and companies with taxable profits of £1.5m or above pay this rate. These companies pay taxes in quarterly instalments starting in the seventh month of their financial year.

For periods to March 31st 2006, companies with profits of up to £10,000 do not pay tax, but there is a 19% minimum tax on distributed profits that might apply, as described below. The small companies’ rate of 19% applies to profits of £50,000–300,000. Marginal relief eases the transition from the zero rate to the 19% rate for profits between £10,000 and £50,000, and the transition from the 19% rate to the 30% rate for profits between £300,000 and £1.5m.

For periods to March 31st 2006, profit distributions made to non-corporate shareholders by companies that are liable for the starting (0%) or lower marginal rates attract additional corporation tax. The broad effect of this measure is to impose a 19% minimum rate of corporation tax on distributed profits.

From April 1st 2006, the 0% starting rate and the 19% minimum rate on distributed profits were abolished; the 19% lower rate of tax applies to all profits from up to £300,000.

Where companies are associated, all the thresholds are reduced pro-rata.

The tax year begins on April 1st. For company accounting periods that straddle the start of the tax year, the taxable income is time-apportioned and taxed in accordance with the rates prevailing in the two tax years that the accounting year overlaps.

There is no tax on corporate capital, and there is no excess-profits or alternative minimum tax.

Shipping companies may elect to be subject to the tonnage tax. Under this regime, the profits from shipping activities subject to corporation tax are based on the tonnage of the ships operated by the company concerned rather than on the actual profits.

Legislation introducing Real Estate Investment Trusts (REITs) in the UK has been included in the 2006 Finance Bill, which is expected to become law in July 2006. REITs are UK-resident companies listed on a recognised stock exchange, which elect to be treated as such. REITs will not be subject to tax on income or gains but will be required to distribute substantially all their profits. Certain other requirements, for example, in relation to interest cover, must also be met. The initial charge on conversion to a REIT will be 2% of the gross market value of the property entering the REIT regime.

Special tax laws relate to oil companies operating in British territorial waters.

Residence and taxable income
Companies resident in the UK are subject to corporate taxes on worldwide profits, regardless of where they arise.

For tax purposes, a company is UK resident if it is incorporated in the UK or, if not incorporated in the UK, if its central management and control is in the UK. In cases where, for example, a company would be resident in the UK because its management and control is in the UK but also would be resident under another country’s tax law because the company is incorporated there, its residence status may be resolved by an applicable double-tax treaty (if any) between the two countries. In determining residence, HM Revenue & Customs considers whether the directors indeed exercise central management and control and, if so, where such central management and control is actually exercised.

Non-resident companies operating in the UK are charged UK corporation tax if they trade in the UK through a PE. Taxable profits include trading income arising through or from the PE, income from property or rights used or held by the PE and chargeable gains arising on the disposal of assets used or held by the PE. The profits attributable to a PE are determined according to these rules unless there is a business-profits article in an applicable tax treaty. The lower 19% rate of corporation tax applicable to small companies (those with profits of up to £300,000; pro-rated for the number of associated companies worldwide) does not apply to UK branches of foreign companies, unless the branch benefits from a non-discrimination clause in an applicable treaty.

The profits of a foreign branch of a UK-resident company are subject to corporation tax whether or not they are repatriated to the UK. If the foreign profits cannot be remitted to the UK because of foreign tax law or government action, a deferral of corporation tax may be claimed.

In general, dividends received by a UK company from another UK company are not subject to tax unless, for example, the shareholder is a share dealer. Under anti-avoidance legislation introduced by Finance (No.2) Act 2005, certain shares may be treated as loans (eg shares whose value increases at a rate that represents a return on an investment at interest) and the dividends would then be treated as interest. These provisions should not affect routine arrangements relating to preference shares or other structures not set up for the purposes of tax avoidance.

Foreign tax suffered by deduction on the payment of foreign dividends, interest, royalties and fees to the UK is added to the net amount of income received to arrive at taxable income. Credit for such tax is given against UK tax payable. The amount of credit is limited to the UK tax on that income or profit and it is necessary to take account of expenses that are incurred in earning those profits.

When a foreign dividend is paid to a UK company, often credit will also be available against the UK liability for tax paid by the foreign company in earning those profits where the shareholding is at least 10%. Unutilised taxes on foreign dividends and foreign branches can often be carried back for up to three years or carried forward, subject to a cap.

Deductions
Companies may deduct from gross trading profits all expenditure that is wholly and exclusively laid out for the purposes of the trade. Payments of indirect taxes are often deductible, as are most charitable contributions. Complicated provisions apply to deductions for certain employee share and share option schemes that, in general, do not follow the accounting treatment.

A research and development (R&D) tax credit for large companies takes the form of a deduction, at a rate of 125% of R&D expenditure from a company’s taxable income. If the company is small or medium-sized (based on the EU definition), the tax deduction is 150% of the expenditure. If the company does not have sufficient profits to absorb the deduction, it can be surrendered for a cash refund at a rate of 16%.

Depreciation
Other than for certain intangible fixed assets (see below), tax relief is not given for accounts depreciation. Instead, capital allowances are given at a statutory rate for expenditure on certain assets.

For example, capital allowances are given on the acquisition of plant and machinery. Generally, all such expenditure in a tax year is taken to a single pool (main pool), and at the end of the year a writing-down allowance (WDA) of an amount equal to 25% of the pool is taken out of the pool and allowed as a tax-deductible expense. The net amount in the pool is then carried forward to the following year and the process repeated each year. Disposals of assets that had previously gone into the pool are taken out at sale proceeds (but limited to original cost). If there is a deficit in the pool at the end of a tax year, a balancing charge arises that is included in taxable income.

If the company is medium-sized, a first-year allowance (FYA) of 40% of the cost of an acquisition is given in the first year, and only in the following year will the expenditure minus the FYA go into the pool and qualify for the WDA. The same procedures apply for small businesses, except that they enjoy an FYA of 50% for 2006/07. A medium-sized business must satisfy at least two of the following conditions: turnover of not more than £22.8m per year, assets of not more than £11.4m and no more than 250 employees. A small business must meet two of the following conditions: turnover of not more than £5.6m, assets of not more than £2.8m and no more than 50 employees.

Some environmentally friendly plant and machinery, and certain capitalised R&D expenditure, can qualify for a 100% FYA. The majority of capital expenditure incurred for the purposes of UK oil and gas exploration and extraction also qualifies for 100% FYA.

Some plant and machinery does not go into the main pool but into separate asset pools for each asset. This includes ships, cars costing more than £12,000 and assets for which a short-life election has been made. When such an asset is sold, the balance in the pool will give rise to either a balancing allowance (tax deduction) or a balancing charge (taxable income).

Plant and machinery that is expected to have a useful economic life of at least 25 years is included in a single class pool and qualifies only for a WDA at 6% per year. This does not apply to ships and cars.

Allowances are given for the cost of certain industrial buildings, excluding the cost of land, at a rate of 4% per year on the original cost. For second-hand buildings that have previously qualified for allowances, the purchaser is generally entitled to relief only for the lower of the consideration paid for the purchase of the building and the buildings’ original cost spread over the period starting with the acquisition and ending 25 years from when the building is first used. (If the building was first used before 1962, the period ends 50 years from that date.) Buildings may also contain fixtures that can sometimes be regarded as plant and machinery for the purpose of the 25% plant and machinery WDA.

Intangible fixed assets
Intangible fixed assets acquired or created after March 31st 2002 are taxed or relieved broadly in line with the debits and credits in the entity (not group) accounts. For example, relief is available for the amortisation of goodwill arising on the acquisition of a business.

Revaluation gains are only taxed to the extent they reverse tax deductions previously given.

An election can be made to depart from the accounting treatment and use a 4% fixed-rate allowance on a straight-line basis.

Limited rollover relief is available. Where proceeds exceed original cost, tax relief for depreciation previously given is immediately recaptured but the excess of proceeds over original cost can be rolled over into the cost of a new intangible asset, reducing its future tax-deductible cost. New assets must be acquired between 12 months before, and three years after, the date of disposal of the old asset.

A number of anti-avoidance provisions exist to prevent companies from “refreshing” old intangible assets that did not attract tax relief before April 1st 2002 by, for example, transferring assets intra-group.

Leasing
A new regime for the taxation of leasing in the UK commences from April 1st 2006. Under the legislation in force up to March 31st 2006, capital allowances were generally given to the legal owner of the asset (the lessor). For operating leases, deductions were taken as the rentals accrue, and for finance leases deductions equal the depreciation of the capitalised asset and the finance charge on the finance lease obligation. From April 1st 2006, where a lease is considered a “long funding lease”, capital allowances will be given to the economic owner of the asset rather than the legal owner. A “long funding lease” is a lease that is treated as a finance lease under generally accepted accounting principles; a lease where the present value of the minimum lease rentals is 80% or more of the fair value of the asset; or a lease whose minimum term is more than 65% of the expected remaining useful economic life of the asset. Leases of less than five years should not be long funding leases.

Losses
Losses arising in a trade in a tax year may, if the company elects, be set off in their entirety against a company’s total profits (including chargeable gains) for the same tax year. If losses remain, the company may elect for the remainder to be carried back (broadly) one year and set off against total profits. Any losses not used in these ways may be carried forward and set against trading profits of future tax years without limit.

All or part of the losses attributable to non-trading loan relationships and derivative contracts, and foreign exchange arising in a tax year may be set off against any other profits of the same tax year and/or carried back (broadly) one year. Any losses not used may be carried forward and set off against non-trading profits of future tax years indefinitely.

All or any part of losses attributable to non-trading intangible fixed assets can be set against any other profits of the same tax year. Any losses not used may be carried forward to the next period and treated as though it were a loss for that period.

Rules prevent the carry forward of losses where there has been a change of ownership of a company in certain circumstances.

The system for offsetting losses is under review by the government.

Capital gains taxation

For UK tax purposes, a company’s capital gains (chargeable gains) are calculated as the amount by which the proceeds from the sale of a capital asset exceed its indexed cost. The base date for indexation of capital gains tax for inflation is March 1982; hence the indexed cost is the acquisition cost multiplied by the ratio of the relevant price at the time of disposal to the index at the time of acquisition (or March 1982 if the acquisition was earlier). If indexation raises the acquisition value above the realised value, however, the indexation provisions cannot turn a nominal gain into a deductible loss; the gain will be reduced to nil.

In a tax year (accounting period), all the chargeable gains and losses are aggregated. If there is a net gain, it is included with the company’s taxable income to arrive at its chargeable profits. If there is a net loss, it is not included in chargeable profits and is carried forward to the next accounting period to offset chargeable gains.

A company can defer paying tax on a chargeable gain from certain disposals of land, buildings and fixed plant used in a trade if the company acquires a qualifying replacement asset within 12 months before or 36 months after the sale. If the cost of the new asset is at least equal to the sale proceeds, all of the chargeable gain is rolled over. The tax cost of the replacement asset is reduced by the deferred gain. If the total cost of all replacement assets is less than the sale proceeds but more than their original cost, then part of the gain may be rolled over. One member of a corporate tax group may roll over a chargeable gain on an asset into new assets acquired by another group member.

Any chargeable gain on the disposal of goodwill that was in existence in March 2002 may be deferred if replacement assets are intangible fixed assets (see above).

If both the purchaser and vendor are members of the same capital gains group, the asset will be treated as though it had been sold at a price so as to give rise to neither gain nor loss. In broad terms, a group is a parent company and companies in which it holds directly or indirectly at least 75% of the share capital, provided the parent is also entitled to more than 50% of their assets for distribution and more than 50% of their assets available on a winding up.

Gains realised by companies on the disposal of certain shareholdings (substantial shareholdings) are not chargeable gains. Broadly, the conditions are: the selling company must have owned at least 10% of the shares of the company being sold for at least 12 months in the two years prior to disposal; the selling company must be a sole trading company or a member of a trading group; and the company being sold must also be a trading company or holding company of a trading sub-group. Complex qualifying provisions apply.

Following the introduction of a self-contained code for the taxation of intangible fixed assets (see above) that broadly assimilates to income all profits and gains on intangibles based on their accounting treatment, disposals of post-commencement intangible fixed assets are no longer taxed as capital. This applies only to assets within the regime, which are broadly those acquired after March 31st 2002; special rules apply to acquisitions from related persons. Disposals of assets not in the regime—such as goodwill, which existed in March 2002—continue to be taxed as capital gains.

Similarly, the self-contained code for the taxation of loan relationships, derivative contracts, and foreign-exchange gains and losses means that these are also not taxed as capital.

The 2006 Finance Bill includes three targeted anti-avoidance rules in relation to capital losses. Broadly, these rules seek to prevent the contrived creation of capital losses, the buying and selling of gains (to use against losses) and losses, and the conversion of income into capital gains (to use against losses).

Withholding tax

Dividends. The UK does not normally impose withholding tax on dividends. However, from January 1st 2007, a listed company that has the special tax status as a Real Estate Investment Trust will be required to deduct tax at 22% from dividends paid to non-residents. The rate may be reduced by an applicable tax treaty.

Interest. A 20% withholding tax is generally imposed on interest payments to non-residents, unless the rate is lowered under an applicable tax treaty. Interest payments to qualifying EU companies may be exempt if they meet the conditions for the EU Interest and Royalty Directive.

Royalties. A 22% withholding tax is generally imposed on royalty payments to non-residents, unless the rate is lowered under an applicable tax treaty. Royalty payments to qualifying EU companies may be exempt if they meet the conditions for the EU Interest and Royalty Directive.

Foreign income and tax treaties

The profits of non-UK-resident subsidiaries of UK-resident companies are normally subject to UK tax only when they are paid as a dividend to the UK shareholder, unless the controlled foreign companies (CFC) provisions apply.

The UK is a party to more than 100 double-taxation treaties. Some cover only a few items, but those with the UK’s major trading partners encompass a wide range of taxes. The treaties often exempt interest, royalties and licensing payments from UK and foreign withholding taxes. Where foreign withholding taxes might apply on dividends paid to UK companies, the rates are normally reduced, often to zero, either under a double-taxation treaty or as a result of the EU parent-subsidiary directive. Each treaty must be carefully reviewed in every instance.

The EU Interest and Royalty Directive, effective from January 1st 2004, exempts from withholding taxes payments of royalties and interest between companies in different EU member states, in limited circumstances. One of the key conditions is that where a UK company is paying interest or a royalty to a company in another EU state, one of the companies must have a direct interest in at least 25% of the capital or voting rights of the other, or a third company must have a direct interest in at least 25% of the capital or voting rights of both companies. Therefore, payments between companies in the same group where there is not a direct interest are not included. With regard to its application to UK companies making payments of interest and royalties, it will often not have any practical effect since many tax treaties with EU member states already exempt from UK withholding tax on interest and royalties if certain conditions are satisfied.

The precise conditions of the treaty or directive should always be consulted, in particular any anti-avoidance provisions or special qualifying conditions. In addition, if tax on interest is to be deducted at a rate lower than the normal rate (20%) in accordance with a treaty or directive, consent must first be received from HM Revenue & Customs. Tax on royalties may sometimes be paid at the rate set out in a treaty or directive without consent rather than the normal rate (22%). But there may be adverse consequences for the payer where it is subsequently shown that the conditions for the reduced tax rate were not met.

Transactions between related parties

Transfer pricing
Under the self-assessment system, it is a company’s responsibility to ensure that for tax purposes transactions with related parties reflect arm’s-length prices. The provisions apply extensively, embracing the internationally accepted standard for setting prices. UK companies are expected to have and retain adequate documentation to show that prices paid or charged meet the criteria.

The transfer-pricing rules also apply to intra-UK transactions and thin-capitalisation rules have been brought into the transfer-pricing regime.

SMEs are exempt from the transfer-pricing rules (if their transactions are with UK-related businesses, or related businesses in countries with which the UK has a double-tax treaty with a non-discrimination article), as are subsidiaries that were dormant on April 1st 2004 (provided they remain dormant). HM Revenue & Customs has power of direction for medium-sized companies in exceptional circumstances, where there has been deliberate manipulation and a significant loss of UK tax. For these purposes, a company is small if it and other group companies have less than 50 employees and annual turnover and/or balance-sheet totals are less than €10m. The corresponding limits for a company to be medium-sized are 250 employees, annual turnover of €50m and balance-sheet total of €43m.

Compensating adjustments are available to the UK counterparty to a transfer-pricing adjustment made by another group company, and balancing payments can be made between the companies to restore their cash position.

Controlled foreign company
Generally speaking, a CFC is a company that is not resident in the UK, is controlled by UK residents, and is subject to a lower level of taxation (generally less than 75%) of what it would have paid had it been UK resident. If these conditions are met and no exemption applies, the UK company will pay corporation tax on its share of the CFC’s income (ignoring capital gains). The UK CFC regime is currently being challenged before the ECJ.

Thin capitalisation
Anti-avoidance measures to address excessive debt of UK-resident companies (and UK PEs of foreign companies) are included as part of the transfer-pricing rules. When considering whether the interest on a loan from, for example, a foreign parent is deductible, the arm’s-length principle must be followed. Generally the ability of a borrower to support the loan is looked at on a standalone basis (ignoring the status of the group of which it is a part and any guarantees made to support the borrower’s loan), except that assets that it owns (including group companies) can be taken into account. There are no safe harbour provisions.

Group relief
Relief for losses between companies in a group is given by a system of group relief; one company surrenders its loss and another company claims the loss. The UK does not tax groups of companies on the basis of a consolidated tax return.

Two companies are members of a group if (very broadly) one company (parent) owns at least 75% of the share capital of the other (subsidiary) or another company (parent) owns at least 75% of the share capital of both companies (subsidiaries). The holdings can be indirect. The parent must also be entitled to at least 75% of the assets for distribution and at least 75% of the assets available on a winding up of the subsidiary or subsidiaries.

If the claimant company and the surrendering company are both members of the same group, the claimant can claim all or part of the surrendering company’s current-year trading losses, non-trading loan relationship losses or losses attributable to non-trading intangible fixed assets against its total profits for the corresponding tax year. Losses that are brought forward cannot be surrendered.

Until recently, another condition for relief was that if the surrendering company was non-UK-resident, only the losses attributable to its UK PE were available for relief. As a result of the ECJ decision in the Marks & Spencer case, where losses of a foreign subsidiary cannot be used in the country in which the subsidiary is located (eg because the subsidiary has ceased to trade), these losses can be surrendered to a member of the UK group if all other requirements for the surrender of losses are met. The UK government’s interpretation of this decision is included in the 2006 Finance Bill. The new relief will apply only where either both the surrendering company and claimant company are both owned by a UK-resident company or the surrendering company is owned by the claimant company, which must be UK-resident. In both cases, ownership is direct or indirect and is at least 75%. The surrendering company must have incurred a foreign tax loss that is unrelievable (all possibilities for relief having been exhausted) in the home state (or elsewhere), and where that subsidiary is either resident in the European Economic Area (EEA) or has incurred the relevant losses in a PE in the EEA. Any foreign losses are limited to the amount recomputed under UK tax principles.

A limited form of group relief is available between members of a consortium and a consortium company.

Turnover and other indirect taxes and duties

VAT
Value-added tax (VAT) is the largest single source of indirect tax revenue in the UK. VAT applies to most sales of goods and services; in effect, it is levied on the value added at each stage of the production and distribution chain, as well as on imports. Companies act as VAT collectors, paying to HM Revenue & Customs the tax recoverable from their customers and receiving a credit for the tax they pay to suppliers. Thus VAT is offset at each stage until the goods or services reach the final consumer or an exempt business.

There is a standard VAT rate of 17.5% and a reduced rate of 5%. Some supplies are zero-rated and others are exempt. Zero-rated supplies are treated as a taxable supply, so input tax can be credited against any output tax. Zero-rating applies for private housing, some animal feeds, seeds and live animals, most food (excluding catering), public transport, children’s clothes, sewerage services, protective clothing, and newspapers and books. For exempt activities, however, no tax is chargeable on sales, but no VAT is recoverable on related purchases (subject to de minimis limits). Exempt activities include bank lending (but some services supplied by banks are taxable), rent (but landlords can sometimes “opt to tax”), education and healthcare payments.

Both incorporated and unincorporated businesses must register for VAT if taxable turnover exceeds £61,000. Registration is also required if taxable turnover is expected to exceed £61,000 in the next 30 days. A VAT-registered company with taxable turnover that falls below £59,000 may de-register if it wishes.

Businesses with supplies of £600,000 or more are required to disclose specific VAT avoidance schemes. Businesses with supplies exceeding £10m must disclose the use of schemes that have the hallmarks of avoidance.

For goods imported from outside the EU, VAT is payable at the time and place of entry to the UK. Payment can be made on the 15th day of the following month if there is a deferment account, but a financial guarantee is required to operate a deferment account. The Simplified Import VAT Accounting Scheme (SIVA) allows authorised traders to apply to reduce the level of financial guarantee required for VAT purposes only. There is no VAT on the temporary import of certain goods if the same goods are subsequently re-exported within a specified time.

There is a different mechanism for levying VAT on goods from EU countries. Crossborder shoppers and travellers are free to import goods having borne VAT in the country of purchase. Businesses continue to pay VAT in the country of final consumption (the destination principle), but because all fiscal controls have been transferred from the border to the central fiscal authority in each EU member state, suppliers must submit to their national fiscal administration a list of the total sales to each of their buyers in other EU states on a quarterly or monthly basis. EU Arrivals and Despatches declarations are made through Intrastat on a monthly basis if the annual threshold (now £225,000) is exceeded; otherwise, declarations are not required.

The largest traders must submit on a monthly basis more-detailed intra-EU trade information on each operation. Limited exemptions from the system’s administrative demands apply for SMEs. An origin-based VAT system is to replace this system eventually, but EU member states have so far failed to agree on how to implement it. It will therefore probably take some years to put the final system into practice.

Customs duty
Customs duty is an EU-wide tax levied on the importation of goods into the EU. The EU operates a common customs tariff that, in effect, means the same amount of customs duty will be levied on imports irrespective of where in the EU the importation is made. The “Customs Union” is the foundation of the EU, ie no customs duty is applied on the movement of goods between EU member states. In addition to the tariff, a common set of rules covering trade policy, external trade relations, health and environment controls and agricultural policy operates to enable the single market to work effectively.

Customs duty is normally a percentage rate applied to the cif value of the imported consignment. This is a trading term meaning the cost (of the goods), insurance (the premium, if any, paid to insure goods during the international movement) and freight (the transport charges of the international movement). Customs legislation also allows for certain cost elements to be removed from, or added to, the cost of the goods. Unlike import VAT, customs duty is not normally recoverable and represents a bottom-line cost to the importer that needs to be considered prior to importation.

The customs tariff classification of imported products determines the rate of customs duty that will be applied, which can currently range from a free rate up to 74%.

The origin of the imported products can also affect the customs duty payable, as the EU offers certain countries reduced customs duty rates where the goods originate under the terms of specific agreements. For example, certain South African imports can have a reduced rate applied because of a reciprocal trade agreement with the EU, and certain Indian products can have a reduced rate owing to a preference agreement designed to assist in the country’s economic development.

Various facilities are available that can help importers’ cash flow and reduce or mitigate the cost of customs duties. Customs warehousing allows the payment of import charges to be delayed until removal into the EU or not paid at all if the goods are exported outside of the EU. Inward processing relief allows relief to be claimed when goods are imported for manufacture and re-export. Conversely, outward processing relief allows relief to be claimed where EU goods have been exported for manufacture and returned to the EU. There are many other opportunities to ensure that the duty cost is mitigated, but much is dependent on the exact import operations undertaken or those that are envisaged.

The authorities’ main focus currently is on the automation of customs compliance procedures.

Excise taxes
Unlike customs duty, excise duty is a local tax levied on certain products at specific national rates. Products that are liable for excise duties include alcohol, tobacco and mineral oils (such as petrol). VAT is normally charged on the excise-duty-inclusive price.

In principle, excise duty is due when the appropriate goods are released for consumption in the UK. An EU regulation on the holding and movement of excise products allows for companies that trade in excise goods to be approved for the receipt, storage and despatch of products under excise duty and VAT suspension. A similar concession is provided to those involved in the production of such products, such as oil refineries, breweries and distilleries.

Excise duty is also levied on the importation of goods from both EU and non-EU countries unless deposited in an approved excise warehouse facility.

Stamp duty
Stamp duty applies to a transfer of UK shares at 0.5%. Stamp Duty Reserve Tax (SDRT) is charged at 0.5% on an unconditional agreement to transfer UK shares for consideration in money or money’s worth, whether oral or written. This charge can be cancelled by payment of stamp duty on completion of that agreement by means of a written transfer instrument (usually a stock transfer form). A special higher rate charge of 1.5% may apply where UK shares are transferred or issued into a depositary receipt system in return for American Depositary Receipts or into a clearance service.

SDRT at 0.5% is also charged on surrenders of units in a unit trust scheme to the managers of that scheme. A separate SDRT regime applies in these cases.

Stamp Duty Land Tax (SDLT) is charged on transfers of UK real property. Freehold transfers and assignments of leases are charged to SDLT on the consideration payable for the transfer or assignment at the applicable rate depending on the rate band within which the amount of consideration falls. The rate bands for SDLT differ for residential and commercial property.

SDLT is also charged on grants of leases. Rent is charged to SDLT at 1% of the net present value of the rent payable over the term of the lease discounted at the rate of 3.5%. Premiums are treated in the same way as freehold transfers at the applicable rates.

Other taxes

The UK government imposes other taxes, the most important being national insurance contributions (see 7.4). There is also an annual duty on licences for motor vehicles, linked to carbon dioxide emissions (for private cars) or based on weight (for commercial vehicles).

Companies must pay a municipal property tax, called rates, collected from the owners (or sometimes the tenants, depending on arrangements in a lease) of all business property. Rates are based on the annual rental value of the property as assessed by HM Revenue & Customs. The rates are a deductible business expense for corporate tax purposes. At one time, they varied by municipality, but a uniform business rate (UBR) is now levied at a uniform rate per pound of rental value: 42.2 pence per pound in England in 2005/06, based on 2003 rental values. Relief is available for small businesses. The central government collects the UBR and distributes the proceeds to local authorities on a per-capita basis.

Petroleum revenue tax (PRT) on North Sea oil and gas is the most important industry-specific tax. It is charged on the profits from individual oilfields developed before 1993. The rate is now 50%. Oil companies are also subject to a 20% supplementary charge to corporation tax in respect of North Sea oil and gas profits.

An airport-departure tax is levied at £5 for economy travel to European Economic Area (EEA) countries, Switzerland and EU applicant countries, and £20 for economy travel to other destinations. Rates for both destinations are doubled for business and first-class fares.

The standard rate of tax on general insurance premiums is 5%. There is a selective higher rate of 17.5% on some policies, such as travel insurance.

Tax compliance and administration

Companies are obliged to self-assess their corporation tax liability. Large companies (annual taxable profits exceeding £1.5m, reduced pro rata by the number of associated companies) must make corporate tax payments in four equal quarterly instalments, based on the expected tax liability for the year. Payments normally begin in the seventh month of the financial year in question. Other companies pay tax in a single sum nine months after the end of the company’s financial year.

Withholding taxes are payable quarterly if the accounting year ends on a quarter-end date. Payment is otherwise made five times a year.

Interest is payable to HM Revenue & Customs for underpayment of corporation tax. Penalties are imposed on companies for late payment of employees’ income tax withholding. These are payable monthly, along with national insurance contributions (NIC), but small companies may pay them quarterly.


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