International groups of companies can be used to reduce tax
An international business structure is likely to have different entities in different tax jurisdictions. As different tax jurisdictions will have differing tax rates and laws, such a structure could use cross border arrangements to gain a tax advantage.
The simplest way to do this is for a company in a low tax jurisdiction to charge a group company in a high tax jurisdiction a higher than normal price for the goods or services that it provides. This shifts group profits from the high tax company to the low tax company, saving tax, and is known as Transfer Pricing.
As well as arrangements needing to fall outside the general anti-abuse rules (GAAR), targeted anti-avoidance legislation has been put in place to prevent this kind of exploitation:
The transfer pricing rules allow HMRC to make an adjustment for the amount overcharged, effectively imposing an open market value on the transactions so as to increase the taxable UK profits and prevent profits being moved out of the UK. A corresponding adjustment can be claimed in respect of the recipient company, where required. There may be exemptions available for small (turnover and balance sheet <€10m each, fewer than 50 employees) and medium-sized (turnover <€50m, balance sheet <€43m and fewer than 50 employees) companies.
Within the transfer pricing rules is legislation regarding ‘thin capitalisation’, which is similar to transfer pricing example set out above, except a large loan is made between the companies so that the interest payments on the loan shift the profits. Where a company’s debts far exceed its equity, it is considered thinly capitalised, in which case HMRC can make an adjustment to the interest charged or allowed in the UK in order to reduce it to the level equivalent to a loan that would reasonably made to that company by an independent third party.
Where an overseas resident company is controlled by a UK resident person or persons, it is a controlled foreign company (CFC). Where a UK company owns a shareholding of over 25% in the CFC, it must report its share of the CFCs chargeable profits (calculated under UK rules) on its corporation tax return and pay the tax due to HMRC. There are various exemptions to the CFC rules, depending on the circumstances and location of the CFC.
If your business is part of an international group, or you have overseas group companies which may be affected by these rules, Tax Innovations can determine the impact of cross border arrangements on your business, and help you to ensure that the impact of these rules are minimised.