Tax Considerations for UK Companies Expanding Overseas: Permanent Establishment, Overseas Subsidiary, and Controlled Foreign Companies

When a UK company aims to expand its operations overseas, a variety of options come into play.

Photo by Kyle Glenn on Unsplash

Permanent Establishment

Definition: A Permanent Establishment (PE) arises when a company has a place of management, a branch, an office, a factory/workshop etc, in another country, even if it's not formally registered as a company overseas. It functions as an extension of the parent company and is not a separate legal entity.

Considerations:

Double Taxation Relief (DTR): Profit from an overseas PE is subject to UK corporation tax. However, double taxation relief is available if the profit is also subject to taxation overseas. The amount of DTR for this profit is the lower of the tax payable in the UK and in the overseas country.

Electing to Tax Overseas: A company can choose to have the PE taxed only overseas. This election is irrevocable and applies to all future PEs of the company. If the election is made, the company may lose relief and capital allowances, which can have a big impact, especially if the PE is expected to be initially unprofitable.

Overseas Subsidiary

Definition: An overseas subsidiary is a separate legal entity - a company registered abroad but owned by the UK parent company.

Considerations:

• The business group expands by one company, reducing the threshold for considering the group as a large company and requiring payment on account for corporation tax.
• Losses incurred by the subsidiary cannot be relieved against UK profits for tax purposes. Instead, they can only be carried forward against future profits of the subsidiary, delaying tax relief and posing uncertainty regarding future profitability.

Controlled Foreign Companies

Definition: A Controlled Foreign Company (CFC) is a foreign entity controlled by UK residents or entities. It is defined by UK tax law as a company incorporated outside the UK, where UK residents hold a significant interest in its shares or voting power (>50%) and have control over its operations, activities, or distribution of profits.

Conditions for CFC status:

1. The overseas company is controlled (>50% owned) by UK entities.
2. The company is resident overseas.
3. Dividends are repatriated to UK owners.
4. The overseas country has a lower tax rate than the UK.
5. Each owner will be subject to the CFC charge if they own at least 25% of the foreign company.

The purpose of CFC rules is to prevent UK taxpayers from artificially shifting profits to low-tax jurisdictions. Exceptions and exemptions may apply based on various criteria, including profit levels, profit margins, territory exclusions, and tax rates.

Exceptions and Exemptions: If any of the following applies, there will be no CFC charge. 

1. Low profit exemption. If the CFC has taxable total profit <=500,000 and non-trading profit <=50,000. Both part of the condition must be satisfied to apply. 
2. Low profit margin. If the accounting profit is <=10% of allowable expenditure. 
3. If the CFC is in an excluded territory country.
4. The overseas country has a tax rate that is at least 75% of the UK tax rate. 
5. Exempt period. No CFC charge in the first 12 months of existence of the CFC. 

Photo by Jason Leung on Unsplash

The CFC charge calculation

If a foreign company qualifies as a CFC and no exemption applies, the UK owner must calculate the CFC charge using a specific formula and include it in their UK tax liability.
CFC Charge= % Ownership x Chargeable profit (exclude chargeable gains) of the CFC x UK Tax Rate - Foreign Tax Paid

Understanding these tax considerations is essential for UK companies expanding their operations globally, ensuring compliance with tax laws and optimizing financial strategies.

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