Setting up a subsidiary in the UK

This guide is based on UK law for the tax year 2021-22. It does not provide an exhaustive analysis of the law. We therefore recommend that you seek professional advice 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. A company formation agent, solicitor, accountant or chartered secretary can, for a fee, carry out the process. Alternatively, a limited company can be registered online using Companies House web incorporation service.

Setting up a private limited company, the most common form of company, is a quick and easy process which can generally be achieved within a week. There are, however, other forms of UK companies – for instance, public limited companies whose shares can be listed on a stock exchange.

All UK limited companies must prepare and file annual accounts. If the company is over a certain size – if its turnover exceeds £10.2 million or its balance sheet exceeds £5.1m 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 under PAYE (Pay As You Earn). 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. This also applies to payments to directors of limited companies.

New rules applying from 6 April 2021 require businesses to operate PAYE and pay NICs in respect of workers contracting through an intermediary, such as a personal services company, if those workers would have been employees if they had been engaged directly.

PAYE must also be operated in relation to non-UK employees (e.g. 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. In particular, there are specific rules for assignments within the EU, which may change as a result of Brexit, and under reciprocal agreements within certain countries (including the US). However, for short term assignments within the EU or from the US, it is usual for the employee to remain in their home system.

Amounts deducted as PAYE and NICs are paid to HMRC monthly or quarterly.  Information about tax and other deductions under the PAYE system is transmitted to HMRC by the employer every time an employee is paid, together with information about employees leaving and joining. Annual end of year returns by employers are therefore no longer necessary.

Employers must also account for PAYE and NICs on most benefits provided to employees, such as the provision of a company car or housing. A return of benefits must be made annually on form P11D.

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 by nine months after the end of its accounting period; and
• file by 12 months after the end of its accounting period.

If the company’s profits for an accounting period are at an annual rate of more than £1.5m, the company must normally pay corporation tax for that period in instalments, the first two of which are due before the end of the relevant accounting period. The limit of £1.5m 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 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 £20m 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 can surrender its losses to another company of the group to reduce the corporation tax liability of that company. Where the losses of the group exceed £5m 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 rate of corporation tax is 19%, but will rise to 25% from April 2023. The corporation tax computation starts with the profits shown in the annual accounts which have been filed at Companies House.

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'. Furthermore, 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. UK tax legislation also lists items which are not deductible, such as entertainment expenses.

Additional tax relief is available for qualifying research and development (R&D) expenditure. The rate of tax relief available, and the way in which relief is given, depends upon whether the company is a small or medium sized company (SME) or a large company and in each case a number of conditions have to be fulfilled.

Tax depreciation

Capital allowances are a tax relief designed to allow the cost of some of a company’s assets to be written off against its taxable profits. They take the place of the depreciation shown in the financial (commercial) accounts, which is not deductible for corporation tax purposes.

Although there are several categories of capital allowances, most UK companies will claim capital allowances on plant and machinery. Tools, machinery, computers, furniture, vehicles and other equipment purchased for a company’s business will generally qualify for plant and machinery allowances.

An annual investment allowance gives businesses 100% tax relief for capital investments in respect of plant and machinery assets. It is usually £200,000 but has been temporarily increased to £1m until 31 March 2023.

For expenditure in excess of this or for items which do not qualify for the annual investment allowance, such as cars, writing down allowances are given on a reducing balance basis. Certain fixtures and ‘integral features’ in buildings also qualify for plant and machinery allowances The main rate of writing down allowance is 18% – there is a special rate of 6% which applies mainly to assets with an expected life of more than 25 years and to integral features in buildings, such as lifts and heating and air conditioning systems. It is possible to treat an asset as a 'short life asset' to write off the cost of the asset over the life of the asset. The cut-off period is eight years from the end of the chargeable period in which the asset was purchased.

A 3% annual structures and buildings allowance is available for expenditure on the purchase, construction or renovation of non-residential buildings and structures. The rate was 2% before 1 April 2020. The allowance is available provided the expenditure is incurred on or after 29 October 2018 and all relevant construction contracts were signed on or after that date. The allowance is given on a straight-line basis over 50 years.

Sales taxes

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 either:

• the turnover for the previous 12 months has gone over a specific limit - called the ‘VAT threshold’ (currently £85,000);
• it is likely that the turnover will soon go over this limit.

Businesses may also choose to register even if their supplies are below the VAT threshold to recover any VAT paid on supplies made to them.

A VAT registered business must submit VAT returns at regular intervals – usually quarterly – and send them to HMRC. 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.

VAT is therefore a flow-through tax for most businesses with cashflow implications only. VAT is a real cost for businesses which make exempt supplies, such as financial institutions.

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

The UK has introduced a 2% digital sales tax from April 2020 on UK derived revenues of social media platforms, search engines and online marketplaces.

Profit repatriation

Subject to additional requirements for public companies and investment companies, the amount of distributable profits is generally 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.

Interest

Withholding tax

The basic rule is that all interest paid by a UK borrower must be paid after deduction of income tax at the rate of 20%. However, many double tax treaties provide for a reduced rate of withholding 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 has also launched 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 in order to receive interest payments gross. Passports are granted for five year periods and holders may apply for renewal by letter to HMRC.

Deductibility

In general, 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 which must use an amortised cost basis for tax purposes. 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. An Advance Thin Capitalisation Agreement (ATCA) can be negotiated with HMRC in appropriate cases. The corporate interest restriction applies where a group's net interest in the UK exceeds £2m. Interest deductions are restricted where they exceed 30% of tax-EBITDA (earnings before interest, tax, depreciation and amortisation).

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 brandnames in addition to copyright, design rights and patent royalties.

Income tax is charged directly on a non-UK resident person that is also not resident in a jurisdiction with which the UK has a double tax treaty that contains a non-discrimination provision on gross income from intangible property held in low-tax jurisdictions to the extent that the income is referable to UK sales.

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.

There is an exemption from the detailed rules for small and medium companies. The definitions of small and medium companies are based on EU provisions.

The UK’s diverted profits tax can impose a 25% charge - increasing to 31% from April 2023 - 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.

The UK as a holding company location

Groups investing in Europe may wish to do so via a holding company based in Europe. The UK regime has a number of attractive features for holding companies:

• Interest is generally deductible, subject to thin capitalisation requirements and the interest deduction restriction;
• Dividend income is generally exempt;
• No withholding tax is due on dividends paid to shareholders;
• Gains made on the sale of shares in trading subsidiaries are generally exempt from tax;
• An extensive tax treaty network is available.

However, the detailed rules can be complex. In particular, the UK has anti-avoidance rules on Controlled Foreign Companies (CFCs).

Overall, there is likely to be a minimal UK tax burden on the activities of a holding company, but there are significant compliance requirements and detailed advice will be required.