For a primer on UK taxes for private clients, please start here –
This morning, I had a call from an Asia-based, British client that led me to pen this article.
Tax residence and fiscal domicile
UK residence is central to the taxation of businesses. A UK-resident company is subject to UK corporation tax on all its worldwide profits, wherever they arise. A non-UK resident company that carries on a trade in the United Kingdom through a UK PE is also subject to UK corporation tax on its profits, wherever they arise, but only to the extent such profits are properly attributable to such PE.
Chapter 3A in Part 2 of the Corporation Tax Act 2009 exempts all profits (including chargeable gains) attributable to non-UK PEs of UK-resident companies from UK corporation tax. To apply, the UK company must make an irrevocable election. Elections are made on an individual company basis, covering all PEs of the electing company. The relevant profits of the non-UK PEs are determined in accordance with the relevant double taxation treaty (DTT) with the jurisdiction where the PE is based. The regime contains anti-avoidance rules to prevent the artificial diversion of profit from the UK to an exempt PE.
If a company is not UK-resident, nor has a UK trade carried on through a UK PE, its exposure to UK tax is limited, primarily to taxes on UK-sourced income.
i Corporate residence
A company can be UK-resident either by being incorporated in the United Kingdom under the UK Companies Acts or, if incorporated outside the UK, by virtue of having its central ‘management and control’ exercised in the United Kingdom.
This test derives from case law, notably the leading case of De Beers Consolidated Mines v. Howe, in which the House of Lords adopted a fact-based test of UK residence, which became known as the central management and control test.
The De Beers case laid down two important principles:
1. that a company is UK-resident if managed and controlled in the United Kingdom,
2. that where such management and control is exercised is a question of fact.
These principles were expanded and clarified in later cases.
In the case of American Thread Co v. Joyce, the House of Lords made it clear that management and control is not day-to-day management but strategic and policy decisions, and that such decisions are generally as a matter of fact taken by directors. HMRC is threatening to change this test so it is more akin to the OECD test for a ‘place of effective management’, which takes into account wider management functions.
However, while the presumption is that management and control are exercised by a company’s board, the facts are still paramount, so if, factually, control is exercised outside the board, one looks to where that control is actually exercised. When considering where the ‘central management and control’ exists, it is essential to distinguish cases where management and control are exercised through a company’s constitutional organs from cases where the decisions of those constitutional organs are usurped, and to further distinguish between cases where an ‘outsider’ proposed, advised and influenced decisions taken by the constitutional organs, and cases where such an outsider dictated the decisions and ‘usurped’ such constitutional organs.
The cases illustrate the importance of ensuring that the board exercises real discretion and does not merely rubber-stamp decisions taken elsewhere, and that contemporaneous records supporting this are kept.
Residence questions are rarely clear-cut, and the determination will be dependent on what occurs in practice and on the supporting evidence.
Sometimes different tests of residence are applied in different jurisdictions, with the result that a company may be regarded as resident in more than one jurisdiction.
In such cases the company is dual-resident, and one has to look to DTTs to avoid exposure to double taxation and specifically to provisions often referred to as tiebreaker provisions. Treaties that follow the OECD model usually contain a clause that refers to a company being resident in the jurisdiction where it has its ‘place of effective management’. The OECD commentary states that the place of effective management is the place where key management and commercial decisions necessary for the conduct of the company’s business are made, which is normally where the board of directors makes its decisions, but stresses that one must consider all facts and circumstances.
HMRC takes the view that this means that, when looking at the ‘place of effective management’, one has to have regard for the day-to-day management of the company, and not just the highest level of decision-making required by the UK management and control test.
ii Residence through a UK branch or PE
As stated above, a non-resident company is only subject to UK corporation tax if it carries on a trade in the United Kingdom and such trade is conducted through a UK PE. There are two notable exceptions to this rule:
(1) diverted profits tax (broadly where there is manipulation to avoid a UK PE);
(2) where a non-UK resident company has UK real property income. From 6 April 2020 non-UK companies that carry on a UK real property business or have other UK property income will be charged UK corporation tax on such profit (certain capital gains derived from UK real property will also be taxed).
What constitutes a trade is a question of fact determined by looking at certain criteria known as ‘the badges of trade’ laid down by UK case law, as there is no satisfactory statutory definition of what constitutes trading.
The UK definition of a PE is based on the OECD Model Treaty definition and means a fixed place of business through which its business is wholly or partly carried on. A fixed place of business includes:
UK law also follows the OECD model in excluding from the definition of what constitutes a UK PE activities carried on at a place of business that are preparatory or auxiliary in character. For activities to be regarded as preparatory or auxiliary in character they must be sufficiently remote from the actual realisation of profits by the enterprise that it would be difficult to allocate part of that profit to the potential UK PE. Such activities include:
In addition, if a non-UK company has a UK agent that habitually exercises authority to conduct the company’s business in the United Kingdom, such agent will also be a PE of the company unless such agent has independent status and acts for the non-UK company in the ordinary course of its (the agent’s) business.
It is not enough for a company to have a PE in the United Kingdom: it must also be trading in the United Kingdom, not just with it. To determine this, one must look at where the operations take place and where the profits arise, and a key factor is where the contracts are entered into (see Firestone v. Llewellin).