TaxTalk – February 2023
There are many reasons why a business may decide to operate internationally. But it’s important to take tax advice before going any further. Chris Riley sets out some key priorities.
When expanding into overseas markets, it is vital to understand the taxation considerations involved so that liabilities can be reported and payments settled at the correct time.
But, first of all, will you be operating overseas, or selling overseas? It is fundamental to distinguish between selling (from the UK) to overseas customers, and ‘setting up shop’ in another jurisdiction.
Generally speaking, another country can only expose you to Corporation Tax if you have actual physical operations there – meaning you are represented by premises and employees – or if you have set up a new company located there.
Similarly for payroll taxes, this may seem obvious, but only employees actually working in a country will be subject to tax on their wages. So if you’re merely shipping products to overseas customers, or providing services remotely, these areas of tax are unlikely to be a risk.
Our excellent article by Nadav Shayovitz considers in more detail the specific complexities that will arise from a VAT perspective, particularly in respect of expansion into EU markets.
Local legislation will govern which tax exposures are relevant, and which reliefs are available, which must also be balanced against the needs of the customer where options arise. In some cases involving physical goods, you may be able to decide not to deal with the local indirect tax consequences and leave that for the customer to resolve on delivery. But anyone who has had to traipse to the post office to settle a £5 duty charge before they can receive a t-shirt ordered online will know that this is not a way to build long-term customer relationships.
Branch versus subsidiary
Assuming you’ll be operating overseas, consider whether to set up the overseas operation as an extension of the UK business (creating an overseas branch as a result). Alternatively, you may ringfence the activities in a standalone subsidiary.
As a new legal entity is not required, it’s usually easier and cheaper to initially form a branch. That way ongoing costs may also be lower. But a subsidiary may bring greater benefits, such as ease of opening a bank account or entering into legal agreements (like a lease for premises).
From a Profits (Corporation) Tax perspective, the treatment of profits arising overseas should not normally give rise to an additional cost over that chargeable locally, due to various UK tax exemptions. But a branch overseas may be considered riskier, as profits are calculated on an apportionment of the total profits. In a subsidiary, by contrast, they are based on clear individual transactions. What’s more, it may not be possible to access local tax reliefs with a branch.
You should also consider additional costs of extracting profits back to ‘home’, which may occur. A subsidiary may be required to pay withholding taxes on dividends and interest payments, whereas a branch may suffer a higher rate of tax than a resident company in some jurisdictions.
The existence of a tax treaty between the UK and the overseas jurisdiction may reduce, but will never increase, these overseas exposures.
For Payroll tax purposes, employees overseas will likely be treated similarly (I.e. taxed locally) whether they work for a branch or subsidiary. In all cases however, where an employee moves between jurisdictions, personal tax is likely to be a consideration in both (or all) jurisdictions, and care is required to ensure that where income is potentially taxable twice, advance planning is undertaken to ensure accurate data is captured so that double tax relief operates effectively.
Don’t ignore transfer pricing
The UK offers a very generous exemption from transfer pricing requirements for SMEs that transact with connected businesses based in jurisdictions that have a tax treaty with the UK. This includes most of the developed (and developing) world.
The exemption also extends to transactions within the UK, so transfer pricing doesn’t appear on the radar for many purely domestic groups.
Transfer pricing is the requirement that transactions between related parties are entered into on an arms-length basis. If they aren’t, and profits are understated as a result, the Corporation Tax calculation is required to amend the figures to reflect this alternative price.
Most jurisdictions apply transfer pricing rules, and few have an exemption regime for SMEs that is as generous as the UK’s.
So you ignore transfer pricing at your peril. The risk is that in several years’ time, the overseas tax authority increases your profits and tax liabilities for the transactions between their jurisdiction and the UK, with no automatic right to reduce the UK profits by the same amount. This could lead to a double tax charge.
Similar adjustments may also arise using transfer pricing principles for local VAT, Customs Duty and – where employees work in more than one jurisdiction – the split of salary costs (and payroll tax exposures) between the two.
Beware of local taxes
Although the UK tax system may be very complex, many UK domestic businesses are only regularly affected by national level Corporation Tax, VAT and employment taxes, together with business rates for the properties they occupy. These three key taxes are replicated at a national level in most overseas jurisdictions. The main exception is that sales taxes, rather than VAT, are relevant in some countries (such as the US).
Nevertheless, in many jurisdictions, significant further tax exposures and complications will also arise locally. Businesses operating in the US, for example, will be exposed to state taxes, and potentially also city taxes. These could be in the form of additional profits-based taxes or sales taxes, for example, together with additional charges on employment costs.
If you have a choice when deciding to take your first steps in a new country, you should find out about the potential exposures (and in some cases, available incentives) in each location, as they may have a significant impact on the tax costs of operating your business.
Further support
So it’s always valuable to take advice before expanding your business to a new country. You can search online for the headline rates of key taxes. But you really need a local expert who knows your business to learn about the application of those taxes locally, and potentially other lower-profile taxes. That will allow you to plan and structure efficiently from the outset. Through our membership of PKF Global, PKF Littlejohn has access to local experts in 150 countries around the world, so a clear answer is never far away. If you would like further advice, please contact Chris Riley.
