The strategic and commercial benefits of business expansion into Europe have, in recent years, given rise to a surge of new opportunities and openings for US businesses, especially in light of the recent accession to the EU of several more countries. With its sympathetic corporate tax and personal tax regime, the UK is a particularly attractive location for such expansion. But what UK entity and trading structure should businesses consider to maximise post-tax earnings and what tax considerations should be factored into the decision-making process when establishing operations in the UK?

IS UK TAX A KEY BUSINESS DRIVER?
The first consideration is whether UK tax is a genuine business issue – hence, if UK tax paid can ultimately be recovered against the US tax payable on the repatriation of UK profits, there is no overall additional tax cost. Consequently, the US foreign tax credit position is crucial in the decision-making process.

WHAT ENTITY STRUCTURE OPTIONS ARE AVAILABLE?
The two types of entity through which US businesses typically trade in the UK are a branch (or “permanent establishment”) and a subsidiary (in its most common form, a limited liability company). From a UK tax perspective, there is little to choose between them because both are generally dealt with under the same tax rules with similar compliance obligations. Typically, it is non-tax considerations and the group’s global tax agenda that dominate the strategic thinking. However, there are some tax differences between the two possibilities as set out below.

The best tax advice is to plan in depth

Branch taxation
A branch is not a separate legal entity, but an extension of the US entity operating the UK business. Consequently, UK profits or losses will automatically flow to this US entity and will be included in the computation of its taxable profits or losses. There is, therefore, no control over the repatriation of these profits or losses. Typically, a new entity (“NewCo”) may be established to operate the UK branch and, indeed, other branches in a number of jurisdictions. Hence, it is key to ensure that NewCo is established in a location with an extensive double tax treaty network with the other operating branches’ jurisdictions.

The UK tax authorities have the right to tax the branch profits, determined by applying arm’s length principles, even though NewCo has also paid tax on these profits in its home country. Without a mechanism to provide relief, this can give rise to potential double taxation. Relief is, however, typically available through the operation of domestic and international tax law (ie, the double tax treaty network) and is generally in the form of a credit against tax suffered in NewCo’s home country.

Subsidiary taxation
A subsidiary is, however, a separate legal entity and has a greater compliance burden than that imposed on a branch. This compliance cost is an important consideration when deciding your UK entity structure. A decision should be made as to which group entity will be the subsidiary’s parent and, as with a branch, this will depend on the overall group structure and the US tax agenda.
Profits and losses generated by the subsidiary will form the basis of its taxable profits or losses. There is no automatic profit or loss repatriation to the parent company and repatriation is more complex for a subsidiary as there are specific UK legal requirements to consider. However, the major benefit is flexibility and control over the allocation of profits or losses within the group.

The UK business can, for ease of management and tax compliance, initially be conducted through a branch – conversion to a subsidiary can be a subsequent commercial decision. The tax consequences of a future incorporation of the branch should be considered at the time of set up.

WHAT ARE THE NON CORPORATE TAX ISSUES?
Tax should never be seen as the sole business driver in the establishment of an overseas entity and key non-tax related considerations in respect of the choice of trading entity include:

• The need to “ring fence” the UK business in terms of commercial liabilities
• A business exit route strategy
• The need to demonstrate to customers, suppliers and employees, and so on, a commitment to the UK market
• Obtaining finance including the lease of property, plant and machinery, and so on
• The ability to obtain government-backed grants
• Funding requirements and methods

There are, of course, other non-tax reasons for looking closely at the UK trading structure, such as the desire to build equity value in the UK (perhaps with a view to a UK listing) and the group’s repatriation policy.

VAT
The UK – and indeed the EU in general – also operates an indirect taxation system: Value Added Tax (VAT). Businesses operating in the UK are required to register for VAT if the value of their supplies (either real or intangible) exceeds certain annual limits. On most supplies, VAT is currently levied at 17.5% and this levy is collected from customers and paid over to the UK authorities via monthly or quarterly returns. Any VAT incurred on purchases or expenses in the regular operation of a business can normally be offset against the VAT levy paid to the authorities – hence, the aim behind the levy of VAT is that it should not, in general, be an actual cost to a business but only to the final customer.

This is, however, very much dependent on the specifics of the UK business and its supplies as some sectors are free from VAT, while businesses in other sectors cannot recover all of the VAT charged to them. Furthermore, the impact on the group’s VAT position of trading through a branch or subsidiary should also be considered.

WHICH UK BUSINESS MODEL CAN BEST MINIMISE UK TAX COSTS?
Ultimately, the business model needs to reflect the overall commercial objectives. If this includes the minimisation of UK
tax, then the right balance needs to be struck between the operational and tax agendas. Through careful structuring of the UK trading model (that is, its activities and commercial risk profile), the profit or loss outcome and, hence, the UK tax position can be influenced. By considering different operating models and their respective UK tax profile, it is possible to achieve an acceptable operational/tax compromise. The UK and the US have “transfer pricing” rules designed to prevent the erosion of the tax due to each respective revenue authority via the group’s manipulation of its cross-border intragroup trading arrangements. Hence, intragroup transactions need, for tax purposes, to be conducted on arm’s length terms and according to an agreed and reasonable methodology.

There are several accepted models in the arena of structuring trading arrangements: buy/sell distributor; stripped buy/sell; commission agent; commissionaire, and so on. This is simply convenient terminology for describing different trading structures, all of which can produce different tax answers because of their specific activities and risk profiles. For example, stripped buy/sell is, in essence, a buy/sell distributor that has had certain business risks removed such as bad debt, so that a lower level of profit can be justified. However, the key issue is the specific business fact pattern and commercial objectives, both of which should be taken into account at the outset and before the UK entity and business model is established.

WHAT ARE THE MAJOR ISSUES FROM A PERSONAL TAX PERSPECTIVE ON US CITIZENS COMING TO WORK IN THE NEW UK BUSINESS?
US citizens and Greencard holders remain subject to US income tax on their worldwide income even if they are working outside the US Depending on the amount of time spent in the UK, a UK tax liability will almost certainly arise on their employment income or income derived from business activities in the UK. However, via the use of either the US/UK double tax treaty or a system of foreign tax credits, there should be no double tax on the same source of income. In addition, US taxpayers living overseas are entitled to exclude some of their salary and overseas housing costs from US tax. Alternatively, if an individual spends very limited time in the UK, and assuming certain other conditions are met, tax may well not be payable outside the US.

As regards personal investment income or gains, UK income tax and capital gains should only be due on UK-based income and gains. This is on the basis that the US is an individual’s permanent home and that the individual continues to have an intention to return there. Providing there is no remittance to the UK of such income from overseas, UK taxes should not be due on this overseas income.

HOW ARE SOCIAL SECURITY CONTRIBUTIONS IMPACTED?
Whilst an individual’s liability to UK tax is, in general, dependent on their residence status, the requirement to pay social security depends on the situs of the employment contract. If the contract remains in the US and there is an intention to remain on overseas assignment for five years or less, the individual and company will continue to be liable to US social security contributions (FICA). Alternatively, if the contract moves to a UK employer, there will be a liability to UK social security (National Insurance) from the date the UK employment commences. However, if the UK employer is a branch of the US company, there may still be a requirement to pay FICA, in which case UK social security would not be payable.

WHAT ABOUT OTHER ISSUES – 401K RETIREMENT PLANS, FOR EXAMPLE?
If an individual was contributing to a 401K plan before the commencement of the overseas assignment, it should be possible to continue these contributions during the assignment. Subject to certain limits, personal 401K contributions should be tax deductible in the UK and any employer matching contributions can be provided tax free. A new pensions regime is being introduced in the UK with effect from 6 April 2006 (“A Day”) which will impact individuals contributing to a 401K and advice should be sought to avoid any additional tax burdens arising from these legislative changes. The impact of a move from the US on any other benefits programme in which an individual was participating prior to departure should also be a key consideration.

WHAT ABOUT COMPLIANCE?
The salary relating to a UK employment will be subject to monthly PAYE withholding, even if this income is paid from the US. Individuals resident or working in the UK will also, in general, be required to submit a UK tax return and there will also be a requirement to file US returns, both federal and state (if applicable).

The best tax and business advice is to plan in depth prior to making and implementing irrevocable decisions. If the strategic thinking is right at the outset and the correct UK corporate structure is established, the opportunities for a profitable business in the UK will be maximised. Further, a successful UK expansion could also then be used as the blueprint for subsequent start-ups in the EU where the rules are, very broadly, similar to the UK.

For further information on how Deloitte can provide assistance in the UK or elsewhere, contact Lynne Rennie on:
Tel: +44 207 007 1845
E-mail: lrennie@deloitte.co.uk.