Setting up a UK subsidiary: key tax considerations

This guide is based on UK law for the tax year 2024-25. It does not provide an exhaustive analysis of the law and professional advice should be sought before investing in the UK.

Founding the company

A UK company must be registered with the Registrar of Companies at Companies House. Incorporation is the process by which a new or existing business is formed as a company.

Setting up a private limited company, the most common form of company, is a quick and easy process. A limited company can be registered online using Companies House web incorporated service. 

All UK limited companies must prepare and file annual accounts. If the company is over a certain size – if its turnover exceeds £10.2million or its balance sheet exceeds £5.1million or it has more than 50 employees on average – it must have an annual independent audit.

Directors are personally responsible for submitting yearly accounts and the company’s annual return to the Registrar of Companies. Penalties are payable in the event of non-compliance.

Upon registration of a new company, Companies House will pass on the details to HM Revenue & Customs (HMRC). The company will also need to contact its local HMRC office within three months of formation. The company will need to register online for corporation tax. See HMRC's website.

Salary taxes

Earnings from employment in the UK are subject to tax at source, which is deducted through the PAYE (Pay As You Earn) system. Social security contributions, known as National Insurance contributions (NICs), are also due from both employer and employee.

All UK employers have a legal obligation to operate PAYE and pay NICs on the payments they make to their employees (and workers who are considered employees for tax purposes). This also applies to payments to directors of limited companies.

PAYE must also be operated in relation to non-UK employees - such as overseas nationals - who perform their duties in the UK for a UK employer. The rules for NICs are different and will depend on the length of the assignment and the country where the employee was working previously. For short term assignments within the EU, or from the US, it is usual for the employee to continue to make social security contributions in their home jurisdiction. 

Amounts deducted as PAYE and NICs are paid to HMRC monthly or quarterly. Information about tax and other PAYE deductions is transmitted to HMRC by the employer every time an employee is paid, together with information about employees leaving and joining. 

Employers must also account for PAYE and NICs on most benefits provided to employees, such as the provision of a company car or housing. 

Corporate income taxes

Corporation tax is a tax on the taxable profits of companies. A UK resident company is liable to UK corporation tax on all its worldwide profits.

Companies must self assess their corporation tax liability. The deadline to pay corporation tax is before the deadline to file the company tax return. Generally, the company must:

• pay its corporation within nine months after the end of its accounting period; and
• file its tax return within 12 months after the end of its accounting period.

If the company’s profits for an accounting period are more than £1.5million, the company must normally pay corporation tax for that period in instalments, with the first two instalments due before the end of the relevant accounting period. The limit of £1.5million is divided between the number of subsidiaries in the worldwide group, so a relatively small UK subsidiary of a large overseas based group may have an obligation to make quarterly instalment payments.

If the company has a 12-month accounting period, it will have to pay corporation tax in four equal instalments due as follows:

• six months and 13 days after the first day of the accounting period;
• three months after the first instalment;
• three months after the second instalment – 14 days after the last day of the accounting period;
• three months and 14 days after the last day of the accounting period.

Very large companies with annual taxable profits over £20million in an accounting period are required to pay corporation tax instalments four months earlier.

Each UK company which is a member of a group must file its own tax return and pay its own corporation tax. There is no system of consolidated return filing. However, a loss-making company may be able to surrender its losses to another group company to reduce the corporation tax liability of that company. Where the losses of the group exceed £5million there is a restriction on the amount of losses that can be carried forward. Affected groups can only use carried forward losses against up to 50% of their profits.

The main rate of corporation tax is 25%. A lower rate of 19% applies for companies with profits under £50,000.

Taxable profits for corporation tax include:

• profits from taxable income such as trading profits and investment profits – except dividend income which is generally exempt;
• capital gains – known as ‘chargeable gains’ for corporation tax purposes.

The accounting profits are adjusted for items such as tax depreciation allowances, known as 'capital allowances'. Some expenses recorded in the statutory accounts may not be deductible for tax purposes and will therefore be added back in calculating taxable profits. The basic rule is that expenditure is only deductible if it is incurred 'wholly and exclusively' for the purposes of the company's trade.

Additional tax relief is available for qualifying research and development (R&D) expenditure.

Tax depreciation

A UK corporation tax deduction is not available for expenditure by a company on capital assets. 

Instead, a tax relief called a capital allowance may be available for certain types of expenditure. 

The aim of capital allowances is to give tax relief for the reduction in value of certain capital assets, by letting the business write off the cost of the assets over a number of years against the taxable income of the business. 

Some buildings may qualify for new structure and buildings allowance. If allowances are not available in respect of the building itself, relief may be available for certain plant and machinery such as lifts, heavy systems, air conditioning and sanitary fittings. 

Writing-down allowances are available in respect of expenditure on certain types of plant and machinery. Writing-down allowances are annual allowances that a company can claim to reduce - 'write down' - any remaining balance of capital expenditure on plant and machinery that the company has not already claimed a capital allowance for. This is referred to as a 'pool' of 'unrelieved' expenditure. 

There are two different rates of capital allowance - the main rate of 18% and the 'special rate' of 6%.

Most plant machinery will fall within the main pool. However, certain assets in a building are designed as 'integrate features' and only quality for allowances at the lower special rate. These assets include:

• an electrical system (including a lighting system)
• a cold water system
• a space or water heating system, a powered system of ventilation, air cooling or air purification, and any floor or ceiling compromised in such a system 
• a life, an escalator or moving walkway; and
• external solar shading. 

Certain other assets with a working life of over 25 years are designated as 'long-life assets' and qualify for allowances at the lower special rate. 

Fuel expensing

Companies are also entitled to a 100% first-year tax deduction for the costs of new qualifying plant and machinery. The tax relief, known as full expensing, was initially set to expire on 31 March 2026, but became permanent following a UK government announcement in Autumn 2023. A 50% first year allowance is also available for certain ‘long-life’ capital assets. There is no cap on the amount of expenditure that can qualify for relief.

Annual investment allowance 

Companies can also claim an annual investment allowance (AIA) of £1million, which allows for full tax relief for expenditure on qualifying plant and machinery. Where a company is a member of a group, only one AIA is available for the group.

Enhanced capital allowances 

Enhanced capital allowances give 100% capital allowances on certain designated plant and machinery. 100% allowances are available on a restricted number of items including zero-emission goods vehicles and cars with low CO2 emissions. Enhanced capital allowances on qualifying expenditure on plant and machinery may also be available in designated freeport tax sites, investment zones and enterprise zones.

Value added tax (VAT)

Value added tax (VAT) is a tax charged at 20% on most goods and services provided by businesses in the UK.

 Some supplies, such as those related to financial services, education and health, are exempt from VAT. Others such as those related to food, books and residential buildings are zero-rated.

Any business which provides 'taxable supplies' (i.e. sells goods or services which are not exempt from VAT) is liable to register for VAT if its turnover for the previous 12 months has exceeded a prescribed threshold (currently £90,000), or it is likely that it will soon exceed this limit. 

In some circumstances, businesses may also choose to voluntarily register even if not required, to enable recovery of any VAT paid on supplies made to them. 

A VAT registered business must submit VAT returns to HMRC at regular intervals - usually quarterly. The return shows

• the VAT the business has charged on sales to customers in the period – known as output tax
• the VAT the business has paid on purchases in the period – known as input tax, which is attributable to taxable supplies made by the business.

If the amount of output tax is more than the input tax, then the difference must be paid to HMRC. If the input tax is more than the output tax, the difference must be claimed back from HMRC.

Generally, VAT is a flow-through tax for most businesses with cashflow implication only and the ultimate cost is borne by the end-consumer. However, VAT is a real cost for businesses which may exempt supplies, such as financial institutions. 

Those who make zero-related supplies are not required to charge VAT to their customers but can usually recover any input tax they incur in connection with these supplies. 

Profit repatriation

Broadly, the level of distributable profits is equal to the retained earnings shown in the company’s annual filed accounts. The UK does not impose withholding tax on the payment of dividends to a non-UK entity.

Withholding tax on interest

The basic rule is that all interest paid by a UK borrower must be paid after deduction of tax at the rate of 20%. However, many double tax treaties provide for a reduced rate, or even a complete exemption from UK withholding tax. The borrower must be authorised by HMRC to make gross payments of interest (without deduction of tax). HMRC also operates a 'passport' scheme to speed up and simplify the treaty relief process. Under the scheme, an overseas company may apply to HMRC for 'passport holder' status to receive interest payments gross. Passports are granted for five-year periods and holders may apply for renewal by letter to HMRC.

Deductibility of interest 

Generally, a UK company can claim a tax deduction for the financing costs shown in its annual accounts. However, detailed rules apply to loan relationships with connected parties. If a company has excessive related party debt, HMRC may argue that it is thinly capitalised and seek to reclassify part of the debt as equity – therefore preventing interest payments from being deductible. It may be possible to negotiate an Advance Thin Capitalisation Agreement (ATCA) with HMRC. There is a corporate interest restriction which applies where a group's net interest in the UK exceeds £2million. Interest deductions are restricted where they exceed 30% of tax earnings before interest, tax, depreciation and amortisation (EBITDA).

Royalties

Royalty payments made by a UK company are usually deductible for corporation tax purposes provided that they do not exceed a market rate. Diverted profits tax could restrict or prevent the deduction (see below). UK companies may be required to deduct tax at the basic rate (20%) from certain royalty payments that are made to non-UK residents. UK companies are required to deduct tax on payments made in respect of trademarks and brand names in addition to copyright, design rights and patent royalties.

Transfer pricing and diverted profits tax

All goods and services supplied between related parties, such as companies of the same group, must be priced on an arm’s length basis. The UK has detailed transfer pricing rules, which require companies to maintain proper documentation to support their intra-group pricing policies.

The UK’s diverted profits tax can impose a 31% charge in certain circumstances where a foreign company exploits the permanent establishment rules, or where a UK company or a foreign company with a UK taxable presence creates a tax advantage by using transactions or entities that lack economic substance.