Taking tax into the equation –
UK Tax Competitiveness
Robert Aziz, Head of Corporate International Tax, and Kam Sanghera, Senior Tax Manager Corporate International Tax at BDO LLP, take a look at how the UK offers an attractive place in which to invest and do business, from a tax perspective
The last few years have seen numerous headlines on the issue of UK tax competitiveness. A number of high-profile companies have relocated offshore the seat of their group holding company citing tax reasons as one of their main motivations. More recently, in the run up to the UK general election and with the UK in urgent need of revenues to reduce the fiscal deficit, UK tax competitiveness with tax rates and tax rises have been high on the political agenda and a key factor in the minds of individuals and businesses alike.
It is the UK government’s stated goal that they are “committed to making the UK an increasingly attractive place in which to invest and do business”. So how attractive is the UK for inward investment from a tax perspective? We can look at UK tax competitiveness by considering the tax relief that is available for investment, the tax burden on profits earned while in the UK, and finally how the tax system deals with profit repatriation as well as investment realisation.
Tax Relief for Investments
The UK does allow deductions for tax purposes of interest expenses incurred in financing investment. UK tax competitiveness has seen a tightening of the tax rules in this area in recent years to counter the use of excess debt. The UK now has an interest limitation rule, the Worldwide Debt Cap, and also anti-arbitrage rules to counter the use of hybrid instruments and structures (which aim to provide interest deductions in the UK and equity treatment or non taxation of the receipts in the investing jurisdiction), as well as the usual business purpose and debt/equity rules.
Nevertheless, most inward investors can, with careful planning, obtain significant deductions in the UK for financing costs. The UK also provides tax deductions against profits for any expenditure on intellectual property (IP) and this includes goodwill on the purchase of a trade or business (but not goodwill on the purchase of shares).
Another incentive improving the UK tax competitiveness that was recently announced was the introduction of a beneficial regime for IP which would apply a 10% corporation tax rate to income arising from April 2013 on patents registered after the enactment of Finance Act 2011. The shape and detail of the regime is awaiting discussions with stakeholders. There are also generous tax allowances such as Research and Development (R&D)tax credits, which encourage greater R&D spending in order to promote investment in innovation. The R&D tax deduction available for small to medium enterprises (SMEs) and large companies is 175% and 130% respectively of actual cost incurred.
In April 2008, new legislation impacting on UK tax competitiveness was introduced, allowing the first £50,000 of expenditure on plant and machinery to be eligible for 100% tax depreciation. Other expenditure on plant and machinery attracts a 20%/10% allowance on a reducing-balance basis.
The taxation of UK profits
As a starting point, the UK remains a relatively low-tax economy with a favorable corporate tax rate for companies with profits over £1.5 million currently paying tax at a rate of 28% which means UK tax competitiveness compares favorably with most European countries.
A reduced rate of 21% applies to companies with taxable profits of £300,000 or less. In addition to this and unlike some other nations (including the US) the UK has no regional (or state) income taxes and there is no tax on excess profits or alternative minimum taxation.
The UK government has also put in place a number of pieces of tax legislation that aim to make the UK an attractive international business location thanks to the UK tax competitiveness. One such area of legislation is the substantial shareholdings exemption for capital gains on the sale of qualifying shares. This is an important relief that enables a UK company to sell an investment in both a UK and a foreign subsidiary tax-free.
The UK has also recently enacted a foreign dividend exemption, which applies to most dividends received by UK companies on or after July 1, 2009. This has significantly improved UK tax competitiveness in the tax environment for UK companies investing overseas and the attractiveness of the UK as a holding (or sub holding) company jurisdiction.
Other rules that inward investors into the UK should be aware of include the UK’s transfer pricing rules. The transfer pricing rules apply to transactions with both domestic and foreign companies, including a requirement to prepare documentation to demonstrate compliance with arm’s length standards.
However, unlike many countries, there is an exemption to UK transfer pricing rules for companies which are “small” or “medium” in size (a company qualifies as medium sized if the group’s headcount is less than 250, and either its annual turnover is less than €50 million or its gross assets on the balance sheet are less than €43 million). The UK also has the equivalent of Subpart F rules, which are the controlled foreign company (CFC) rules that are applicable where a non-UK resident company broadly is controlled by a UK company and is subject to a lower level of taxation (generally less than 75% of the tax it would have paid if UK resident).
The UK CFC legislation is currently being overhauled, with proposals to simplify the rules in part and widen some of the exemptions available to avoid catching bona fide commercial arrangements. Many of the proposals should improve the current regime and therefore increase UK tax competitiveness and the attractiveness of the UK for international business. Like many European countries, the UK operates VAT that 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. The cost of VAT is borne by the final consumer or by any business organization in the chain of supply that is unable to recover the VAT which it incurs. The standard rate of VAT in the UK is currently 17.5%, which is lower than most European countries The UK also has lower social security contributions than most European countries. Employers are required to make pay-related social security contributions, together with employee payroll deductions.
A large slice of the UK government’s tax revenue is generated by social security contributions, with employees paying National Insurance Contributions (NIC) at a rate of 11% on income between £5,715 and £43,875 and 1% on income exceeding this amount and employers paying NIC at a rate of 12.8% on all income in excess of £5,715. These are the current rates and there are proposals on the statute books to increase these rates by 1% across the board with effect from April 6, 2011.
Executives earning over £150,000 are now taxed at a rate of up to 50%. Those earning an income of up to £150,000 are taxed at 40% which is relatively low; while, for lower earners (less than £37,400), a starting rate of 20% applies. The increased income tax rate to 50% plus the additional NIC charge of 1% has decreased the UK tax competitiveness and attractiveness of the UK as a place where companies can locate key executives or senior employees. Against this, however, it should be noted that the UK personal capital gains rate is 18% which offers a significant differential for those individuals who can earn capital as opposed to income profits.
Profit repatriation and realisations
The UK is one of the few countries that does not impose a withholding tax on dividends under domestic law (although a 20% withholding tax does apply to dividends paid to non residents by REITS – subject to relief under a treaty). This means that profits can be repatriated free of tax to any investor jurisdiction and this (together with the UK’s exemption from tax on dividends received) adds to the UK tax competitiveness makes the UK a very attractive location for international businesses.
Interest and royalties paid to non residents are subject to a 20% withholding tax, unless reduced under a treaty or exempt under the EC interest and royalties directive. The UK has a very comprehensive treaty with the US that provides for zero withholding tax on UK royalty and interest payments where the US recipient qualifies for the benefits of the treaty. Overall, the UK has an excellent treaty network having entered into double tax agreements with most modern economies. In addition to this, it is also worth pointing out that under its domestic rules the UK does not subject a non resident to UK capital gains tax unless the asset being disposed of is held through a UK permanent establishment.
Therefore, a US individual or corporation disposing of shares in a UK company (or real estate) will not be taxed on such a disposal in the UK.
The Future
So what does the future hold for UK tax competitiveness and the UK tax-regime? The recent UK budget deferred many of the potential tax raising decisions until after the General Election. Possible future changes could be:
- An increase in VAT has become widely acknowledged as almost unavoidable. The two mainstream political parties, Labour and the Conservatives, have gone on record to say that a rise in VAT looks inevitable.
- A lower threshold for the 50% income tax rate, with further restrictions in personal pension tax relief and further freezes/reductions in allowances.
- A cut in the main rate of corporation tax – to 25% – as well as a deferral (or abolition) of the proposed increase in employers’ NIC.
It remains to be seen what changes will come to fruition. Overall, the UK should remain an attractive location for corporate investment, but the rise in the employee tax burden is a negative factor when assessing the overall attractiveness.
For more information, contact:
BDO LLP
Robert Aziz
Partner – Head of Corporate International Tax
55 Baker Street
London W1U 7EU
Tel: +44 (0) 20 7893 3434
E-mail: robert.aziz@bdo.co.uk
Kam Sanghera
Senior Tax Manager – Corporate International Tax
55 Baker Street
London W1U 7EU
Tel: +44 (0) 20 7893 2446
E-mail: kam.sanghera@bdo.co.uk
Website: www.bdo.uk.com
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