UK CORPORATE TAX REGIME
UK corporation tax is charged on the worldwide profits (income plus gains) of any company that is resident in the UK.
A company is UK resident if it is incorporated in the UK or if its centre of management and control is in the UK. If a company has a majority of UK resident directors it is likely to be UK resident, although the test is where management is actually exercised.
CORPORATION TAX RATES (2004/5)
Profits less than £ 10,000 nil
Profits between £50,000 and £300,000 19%
Profits over £1,500,000 30%
If profits lie between £10,000 and £50,000 tax is charged on the first £10,000 at 0% and at 23.75% on the balance.
If profits lie between £300,000 and £1,500,000 tax is charged on the first £300,000 at 19% and at 32.75% on the balance.
All of the limits referred to above are divided by the number of worldwide trading companies under common control.
BASIS OF CORPORATION TAX CHARGE
The computation of taxable profits consists of disallowing certain items of expenditure, most notably capital items, depreciation and entertaining.
In place of depreciation a capital allowance is given on most plant and machinery at a rate of 25% on a reducing balance basis. Plant and machinery includes items such as furniture, computers, and most shop fittings. Depending upon the size of the company and the type of expenditure first year allowances ranging from 40% to 100% of qualifying expenditure may be available.
Buildings do not generally attract capital allowances although a 4% allowance is given on factories and hotels.
Expenditure in respect of certain types of innovative research and expenditure may qualify for enhanced tax allowances equivalent to 125% or 150% of the expenditure actually incurred dependant upon the size of the company.
Transfer pricing rules allow the UK tax authorities to dispute the price charged for sales between connected parties and to tax the parties as if the transactions were at an open market price. In the US the IRS has similar powers and it is therefore important that any charges between a UK and a US company can be justified as commercial pricing. As the UK corporation tax system is one of “self assessment” the onus is on the company to have their inter group pricing arrangements documented in a fashion that supports the contention that they have been set using the arm’s length principle (i.e. that the terms are identical to those which would have been agreed between two unconnected parties when undertaking transactions with similar conditions).
The transfer pricing rules extend to the area of "Thin Capitalisation". In this area the UK tax authorities can disallow interest paid to an overseas parent to the extent that inter company borrowing exceeds that which would be commercially available from a bank. A subsidiary will therefore normally need to be funded by a mixture of share capital and inter company debt.
There are no absolute rules on what constitutes thin capitalisation. The UK tax authorities will try to take a commercial view of what an independent lender, such as a bank, would be prepared to lend the business, taking into account such factors as security, interest cover etc.
The most common choice of structure is either registration as a branch or forming a UK subsidiary.
A branch is simply a part of the existing overseas company. It is required to file accounts in the UK but these do not need to be audited. It is subject to UK corporation tax. For US companies, the main advantage of a branch is that tax relief for initial losses can be obtained against the profits of the overseas operation. However, it is normal to convert a branch into a subsidiary once it becomes profitable and this may give rise to a taxable capital gain.
A subsidiary involves slightly greater compliance costs since the accounts are required to be audited. The audit requirement currently applies to all UK companies with turnover over £1,000,000. For US companies, although losses cannot be used against US profits they can be carried forward until the UK company makes profits. The double tax treaty between the US and the UK also allows a UK company to pay interest to a US parent without the deduction of withholding tax. Treaty benefits do not apply automatically and a claim is necessary by any company wishing to receive interest gross in these circumstances (see www.inlandrevenue.gov.uk).
UK companies pay dividends out of their taxed profits with no deduction for the dividend paid. Conversely, with the exception of companies which trade in shares, a UK company will not pay corporation tax on the receipt of a dividend from another UK company.
A UK company does not have to account for any tax at the time of payment of a dividend. Despite this, the recipient is deemed to have received a net dividend with an accompanying tax credit equivalent to 10% of the gross amount.
GROUP OF COMPANIES
Each UK company is taxed separately. However, in situations where at least 75% of one company’s ordinary share capital is owned by another company it is generally possible to surrender losses incurred by one company to mitigate the profits made by the other.
UK PERSONAL TAX REGIME
Individuals are chargeable to income tax on their worldwide income if they are UK resident. However, for individuals who are not UK domiciled, i.e. they do not intend to remain in the UK indefinitely, special rules apply. A non-UK domiciled individual is only taxable on overseas income and gain to the extent that the money is brought into the UK.
The rules in respect of domicile are currently under review and significant changes to the basis of taxation for non-UK domiciled individuals are widely expected.
Personal tax rates
There are few allowable deductions for individuals.
Capital gains tax is charged at the individual's highest rate of tax on disposals of capital assets. However, business assets (most commonly shares in a trading company in which an individual works) benefit from taper relief which will generally reduce the effective rate of tax on any gain to 10% after two years of ownership.
It may be possible for a non-UK domiciled individual to avoid capital gains tax on the disposal of shares in a UK company if they are held in an offshore trust. However, this structure may not be effective for US tax purposes.
Inheritance Tax (“IHT”) is charged at 40% on death and at 20% on certain lifetime transfers. Each individual has an exemption, currently £263,000 (£272,000 from 6th April 2005), below which no tax is payable. Individuals domiciled in the UK are subject to IHT on their worldwide assets whereas non-UK domiciled individuals are generally only subject to IHT on their UK assets. There are a wide range of exemptions and relieves which may be available to mitigate IHT charges.
National Insurance is a payroll tax used to fund the Welfare system. It consists of both employers and employees contributions. The employee suffers a deduction of some 11% of salary, on amounts between £91 and £610 per week and 1% on salary in excess of £610 per week. The employer pays 12.8% of salary in excess of £91 per week but with no upper limit.
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