Dive into the world of PAYE investigations. Uncover the facts, implications, and insights in this informative blog
Increased rates of globalisation mean that you do not need to be a large multinational to operate across borders. More and more businesses are recognising the benefits of operating a global model with operations in more than one country.
If you have a company in the UK which is connected to a parent company overseas, the subject of profit repatriation will need to be considered. This is the process of moving the profits earned in the UK back to the parent company in another country.
As you might expect, it is not simply a case of moving money from one operation to another. There may be tax implications or other rules to be aware of; below is an overview of the primary issues.
In the UK, the basic rules stipulate that any interest paid by a borrower must be after the deduction of income tax at 20%. It is possible to reduce the rate under a treaty claim, but the process is not straightforward as transfer pricing issues must be taken into account.
Interest paid to a non-UK company is still subject to 20% withholding tax unless a reduced rate can be applied under a double tax treaty. This cannot be assumed; an application must be made to HMRC by the recipient and they must wait for permission to be granted before proceeding on that basis.
When reaching their decision, HMRC will consider whether the loan can be considered under the principles of arm’s length in respect of interest cover, interest rate and debt quantum. This is where the connection to transfer pricing applies, and companies will be expected to maintain accurate documentation to support their policies on intra-group pricing.
Small and medium-sized businesses have an exemption from keeping detailed rules about transfer pricing, but still must be able to demonstrate the principles. If a transaction is shown to lack proper economic substance, a 25% charge can be levied where there is suspicion of financial manipulation.
Withholding tax at 20% may also apply to royalties but there is a difference in the process. Recipients are not required to wait for approval from HMRC providing they reasonably believe at the time of paying the royalty that they would qualify for the lower treaty rate.
However, royalties are subject to the same rules regarding arm’s length transactions. This means that there must be a correlation to transfer pricing policies and that the UK payer would receive a benefit from making the payment. Not all royalties which are paid may meet the qualifying criteria so it is essential to have proper internal scrutiny with a dual pricing and tax policy in place.
The EU Interest and Royalties Direction (EU IRD) which allowed payment without withholding tax was repealed on 1 June 2021. This means that the same approval from HMRC will now be required, even if a company previously held clearance under the EU IRD.
Dividends are treated differently to royalties and interest as in the UK they are paid without any withholding tax deduction. This is on the proviso that there are sufficient distributable reserves in the company.
The exemption of withholding tax applies no matter where the recipient is ordinarily resident for tax purposes. Complications can arise as not all of the retained profits shown in the company accounts can be classed as distributable. It is usually advisable for the company accountant to be asked to confirm the portion of retained profits that are distributable.
Once the annual company accounts have been finalised, it is normal for the final dividends to be paid. This takes place once per year. The shareholders would be usually approved by the shareholders after receiving a recommendation from the directors either at a general meeting or via a written resolution.
Once this shareholder approval is given, then the company must pay the dividends. This should either be immediate or at a future date if stated within the shareholder written resolution.
Directors can decide to pay interim dividends at any time throughout the fiscal year without approval from the shareholders.
When recommending payment of a dividend, directors have obligations that they must fulfil. This includes having due regard for the ongoing success of the business, safeguarding its assets and exercising reasonable skill, diligence and care. If a dividend is paid when the business is insolvent, the directors may be personally liable.
A reduction in withholding tax can only apply to transactions that meet the terms for arm’s length pricing. Withholding tax at 20% will be payable on any excess amounts, and the UK transfer pricing legislation may impact deductibility. A further complication is that there may be restrictions on the treaty rates due to a limitation of benefits clause.
One common misconception is that any withholding tax which is deducted from payments made is available to be offset against the liability for corporation tax. This is not the case.
The tax relief for the company which is paying may be limited due to the corporate interest restrictions. This applies to groups of companies (or individual companies) that have a net interest expense that exceeds £2 million over 12 months. This restriction applied to both interest and other types of financing costs.
By far the most frequent pitfall for companies expatriating profits is the definition of arm’s length transactions. By failing to have definitive and comprehensive transfer pricing policies in place, companies may find that royalties, interest and management fees may not be able to claim the full tax relief previously anticipated.
To get the maximum benefit from profit repatriation, the tax position of the recipient should be considered. Without taking this into account, more tax may be payable than otherwise would be the case. For example, paying interest which attracts withholding tax at 20% to a recipient who has a zero rate of tax in their resident country.