A US business is taxed on its worldwide income, including business income earned in the United Kingdom. A US business may be operating in the UK through a branch or through a local entity and thus will have to pay UK tax on any taxable earnings. Additionally, a UK business may be liable to collect value-added tax (VAT). The issues are explored below:

UK Branch – A US business that is doing business in the United Kingdom, but not through a U.K. subsidiary, that qualifies for the benefits of the UK-US tax treaty will only be subject to U.K. taxation if the activities of that US business in the U.K. create a permanent establishment (as defined under the tax treaty) in the United Kingdom.

Focus on Diverted Profits Tax (DPT)The DPT is an anti-avoidance measure that seeks to eliminate tax advantages sought when either a non-U.K. resident trading company acts to ensure that it does not acquire a permanent establishment to avoid tax (or secures a tax mismatch) or when a group with a UK resident entity enters into arrangements lacking substance to exploit a tax mismatch. The DPT does not apply to small and medium businesses. DPT is 25% of profits assessed.

The rules to determine if a permanent establishment exists under the treaty are set out in Article 5 of the treaty and expanded by case-law and determinations.  The rules are applied to the facts of the business undertaken in the United Kingdom. You should immediately seek expert advice in this area if you have any questions about the application of Article 5.

A US business that is trading in the United Kingdom through a permanent establishment must pay UK corporate tax on the profits, capital gain and non-trading income of that establishment. The UK permanent establishment is considered to be a separate entity from the US business and its profits are calculated using the ‘separate enterprise principle’ which is the arms length basis using transfer pricing methods. Financing costs and interest paid by the permanent establishment to the US business are generally disallowed for the purposes of calculating U.K. taxable profits.

As the US business is also liable to pay US taxes on these branch profits that have already been taxed in the United Kingdom, the US business may claim a credit against its US tax bill for the foreign tax paid. The credit is generally limited to the amount of the US tax due on those UK branch profits.

A branch is taxed on profits attributable to that branch – and this may involve assessing the worldwide income of the US business and determining which of those profits are attributable to the United Kingdom. This calculation is open to challenge by the UK tax authorities who may require further information from the US business and seek to increase the amount of income attributable to the United Kingdom, thus many US businesses will often prefer to operate in the UK through a local entity.

UK Entity – Whereas a UK branch arises when the US business actually holds bank accounts, employees, assets in its own name a U.S. business in the United Kingdom may operate through a local entity such as a partnership or a locally incorporated subsidiary.

If a U.S. business decides to operate in the United Kingdom through a locally incorporated subsidiary this subsidiary is considered a U.K. resident taxpayer and will pay corporation tax on any profits.  Furthermore, in certain cases any dividends repatriated to the U.S. may be liable to U.K. withholding taxes (see detailed explanation below) and, finally, any such income repatriated will be subject to U.S. corporate tax on that income. A tax credit is generally available for U.K. corporate tax paid on the income repatriated. However, the rules for calculating foreign tax credits are extremely complicated entailing consideration of the U.S. business’s worldwide income. Consequently there is a high instance of taxpayer error in these calculations and they are rigorously scrutinized by the IRS.

A benefit to operating through a U.K. subsidiary is that because of the check-the-box election option a choice may be made to treat the U.K. subsidiary as opaque or transparent for U.S. tax purposes meaning U.S. tax on the profits of that subsidiary may be deferred until those profits are repatriated, or allowing losses to be utilized, by the U.S. business and the U,K. entity. This option is not available if the U.K. subsidiary is a public limited company.

If the U.K. subsidiary pays dividends to its U.S. parent, then those dividends have tax withheld at 0% (for at least 80% owners), 5% (for at least 10% owners), or 15% otherwise.  Any foreign tax withheld is available as a tax credit against any US tax arising on those dividends.

If a U.S. business creates a UK subsidiary and transfers assets to the UK subsidiary then those outbound transfers are subject to toll charges (in contrast to transfers wholly within the United States) which create recognizable income. If the US businesses decides to license the use of assets to the UK subsidiary, then those transactions must comply with the U.S. transfer pricing rule, which essentially seeks to prevent the artificial transfer of income to low tax jurisdictions. Under the UK-US tax treaty there is 0% withholding tax on royalty payments from the United Kingdom to the United States.

Focus on UK Transfer Pricing and Thin Capitalization – UK companies must comply with transfer pricing requirements (following Organisation for Economic Co-operation and Development [OECD] principles) demonstrating compliance with the arm’s length principle. The arm’s length principle also applies to the amount of interest deductible for tax purposes on debt measured in comparison to equity (thin capitalization). Most small and medium business groups are exempt from UK transfer pricing and thin capitalization rules.

Under the UK-US tax treaty there is 0% withholding tax on interest payments from the United Kingdom to the United States.

U.S. Businesses Operating in the United Kingdom Must Consider the VAT Tax

Whether you operate your US business through a UK branch or subsidiary you will most like have to consider value-added-tax (VAT).

The VAT is similar to sales tax but is charged on supplies of goods and services. The rate of VAT applicable in the United Kingdom is generally 20%, but reduced rates of 0% or 5% may apply in certain circumstances. VAT is different from sales tax in that it is administered on an input credit basis, thus a person who must charge VAT will offset VAT paid on their inputs from VAT charged on their supplies and remit the difference.  For most U.S. business in the United Kingdom, VAT paid on inputs is a cash flow expenditure, not a cost or expense.

Case Study: VAT Reclaim

A US manufacturer of commercial goods had been paying VAT when importing their products into the United Kingdom. As a US business new to the United Kingdom they were unaware that they could reclaim this VAT and had been treating the payments as a cost. The MEDOWS International Tax team was able to identify this case, calculate the time limits to make refund claims in the United Kingdom, made the declarations, and secured a multi-million dollar refund for our client after liaising with the UK tax authorities. We were able to structure their export processes so that cash flow tied up paying future import VAT was minimized.

Property transactions may also attract a VAT charge and advice should be sought in advance to ensure that VAT is minimized and able to be reclaimed.

Even if a US business does not have a trade, or office, or taxable business in the United Kingdom, a VAT rebate can be claimed on VAT paid on certain travel, conference and hotel expenses incurred in the United Kingdom. These refund claims are subject to strict rules, documentation and time limits.

If you need assistance with US and UK taxes, please contact us and we will respond promptly.