11 May 2021
How to avoid permanent establishment risk
Services:
International Tax Planning
As an overseas company, setting up any kind of business presence in the UK is something to be approached with both ambition and caution. While there are multiple opportunities for doing business in the UK, there is also the need to be aware of the risk of inadvertently creating a ‘permanent establishment’. This is something that could have far-reaching tax implications.
Tara Mellett outlines the rules around permanent establishments in the UK and highlights the need for good planning and a solid understanding of the Government’s guidelines.
What do we mean by a ‘permanent establishment’?
A ‘permanent establishment’ is classified as being a dependent agent or a fixed place of business such as an office, a workshop, a place of management or even a mine. For your business presence to be classed as such, there must be a certain permanence to it.
On the face of it, the ‘fixed place of business’ seems quite easy to define but the concept of a ‘dependent agent’ is more difficult to classify. It’s about understanding if the agent you engage is independent to you, as the business.
If your business in the UK is seen as preparatory or ancillary, it’s not classed as a permanent establishment. So, you might be just carrying out marketing activity, collecting information or undertaking preparatory work prior to setting up a UK company. It’s also important to look at the trade of the overseas entity or group as a whole, to know if you are classed as a permanent establishment. If you’re in the business of marketing then initial marketing would be under greater scrutiny and may be seen as trading.
There also needs to be a degree of permanence to the activities, as a rule of thumb, anything extending beyond six months will come into question.
Why is it important to understand the permanent establishment rules?
Even under normal trading conditions, it’s difficult to expand globally and to fully understand the legal landscape in the different territories that you expand into. In the current situation, with Covid, Brexit and a global recession creating all manner of hurdles, it may be more attractive to dip your toe in the water and see how a UK expansion goes, without setting up a subsidiary company.
If you take this route, it’s important to consider how this first step into the UK market will work when it comes to taxation and legislation. Depending on what activities you carry out, you may find that you create a permanent establishment.
Should you set up a subsidiary and a UK company?
If your overseas group is looking to set up a subsidiary, you would create a legal entity, effectively creating a permanent establishment as a result. As soon as you set up a subsidiary, this becomes permanent and a fixed place of business.
The strategy that many overseas businesses will take is to send a person over to the UK (an ‘agent’), to do the research and check out the market. If this person then starts concluding business activities this creates a problem. If that person habitually exercises the authority to conclude contracts on behalf of the overseas entity, for example, this person may then become the company in this territory. If that person is under an employment contract with the overseas entity then it is unlikely to be seen as independent.
This shouldn’t be the case if the ‘agent’ is acting in the ordinary course of their business, is economically independent from the overseas entity that has contracted for their services or is legally independent from the overseas entity that has contracted for their services.
It’s vital to know when you’ve crossed that line and what will trigger that level of permanence.
This means you need to plan for:
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Which taxes you become liable for – if you do create a permanent establishment, you would need to register the permanent establishment with Companies House and file accounts and taxes with HMRC. You don’t want unexpected taxes and penalties later down the line, so it’s essential that you’re meeting those compliance requirements.
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Which HR and employment laws apply – you also need to think about the HR and employment laws that may affect you, and the question of whether your agent is dependent or independent. If you hire a freelancer/contractor to come over to the UK and do your research, that shouldn’t create a permanent establishment. But if this contractor took on clients and work, on behalf of the overseas entity then the question arises as to whether they are independent or if these activities would create a permanent establishment. They could be seen as acting as the company and would no longer be independent. It’s similar to the recent discussions around IR35 and the independence of contracted freelancers.
There may be tax planning opportunities when setting up a UK subsidiary, the UK corporation tax rate is currently set at 19% until 31st March 2023. From 1st April a Corporation Tax main rate will be introduced of 25% applying to profits over £250,000. A small profits rate (SPR) will also be introduced for companies with profits of £50,000 or less so that they will continue to pay Corporation Tax at 19%. Companies with profits between £50,000 and £250,000 will pay tax at the main rate reduced by a marginal relief providing a gradual increase in the effective Corporation Tax rate.
The filing requirements for overseas companies in the UK can be quite onerous. If you have a permanent establishment, you must be registered with Companies House and file your overseas company accounts in addition to your UK ones with them. This would mean that the overseas entity’s financial statements will be available on public record in the UK – which may not be the case in the home territory and so something to consider when looking to do business in the UK.
To protect that information being made public, you would need to set up a UK subsidiary.
Have recent changes in working practices affected the permanent establishment risk?
When I’m talking to overseas clients, companies are certainly becoming more cautious about having that level of permanence, especially in the current climate.
To be deemed as dependent, and seen as operating a permanent establishment, your employee or agent must be physically in the country. If the work was being carried out remotely from overseas, this wouldn't create a fixed place of business.
If you currently have staff working from home in the UK, you must carefully review the types of work they’re carrying out and whether it could potentially lead to creating a permanent establishment.
With so much of the workforce now home-working, it’s vital for overseas companies to know what their people are doing and if they’ve created a permanent establishment. The OECD has released guidance on the implications of the COVID-19 outbreak for businesses in terms of tax residency and PEs.
Businesses need to review any working from home arrangements that have developed under the COVID-19 lock-down arrangements in the UK. Where home working arrangements are only temporary, there should be less risk, but businesses should document the arrangements carefully, so that the temporary intent (of an employee working from home) can be demonstrated in case of a challenge from HMRC down the line.
The future of UK inward investment in 2021
We’ve seen a dip in companies setting up in the UK, mainly due to the inherent risks from the Covid pandemic and the impact of Brexit.
However, having a permanent establishment in place still helps with understanding those risks and allows your overseas group to dip a toe into the UK market, as long as you know the legal and tax implications of having this level of permanence.
Despite the future corporation tax rise detailed in the March 2021 Budget, there are plenty of benefits of having a UK presence and making it the place to expand your business.
How can Haines Watts help clients with managing the risks?
At Haines Watts Slough, we’re highly experienced in working with overseas companies that are looking at inward investment into the UK.
Working with an experienced adviser is about making sure you have your ducks in a row and knowing where the permanent establishment line lies. I had a question recently from a colleague where a client wanted to use someone to carry out certain activities in the UK on an agent basis. What the client needed was advice on what happens if the UK company signs off contracts and whether they can be seen as independent from the overseas company.
What’s important is that we know the aims of setting up shop in the UK and what the long-term goals are for the business. As advisers, we need to get involved at the planning stage once you know the UK is the target, so we can give you the best possible advice.
Get in touch with us to talk about the permanent establishment rules.