Many US companies seeking to expand into Europe will start with a presence in the UK due to the language and cultural connections, as well as the UK's legal framework and access to capital markets.
For some companies, this will involve establishing a subsidiary company or a formal branch in the UK. For many companies, however, they may want to dip their toes into the market by hiring a local consultant or employee without establishing a local office or other physical presence. Often such employees/consultants will initially be carrying out promotional, marketing or sales activities. Sometimes however, the employee/consultant will be carrying out technical research or back office activities.
This note looks at the potential tax implications arising from such informal arrangements; in particular, whether they can incur local tax liabilities or registration obligations. We consider the position in respect of US headquartered companies looking to expand into the UK.
Often the first issue to be considered from a tax perspective when a local hire is made is whether the local consultant or employee constitutes a permanent establishment ("PE") of the US company for tax purposes.
A non-UK resident company will only be subject to UK corporation tax if it carries on a trade in the UK through a PE in the UK.
The question whether a non-resident is exercising a trade within the UK is a question of fact, which has to be answered after a review of all the facts. The most important factor is the place where the contracts for the sale of the goods or services in question are made. If the contracts are made in the UK, a trade is being carried on within this country. However, if the contracts are made abroad, it may be possible to show that no trade is being carried on within the UK. However, the place where the contracts are made is not the determining factor if there are other circumstances present that outweigh its importance. Therefore, if the whole of the trade is exercised in the UK, then the company will be trading in the UK even if contracts are concluded offshore.
Where a trade is carried on through a PE, the company is, in broad terms, taxable on the profits and gains attributable to the PE in the UK. Where a company is trading in the UK without a PE, it could be subject to income tax in the UK. However, this position is generally overwritten by double tax treaties (it is in the case of the UK/US treaty) and is also difficult to enforce taxes in the UK in the absence of either a PE or an obligation to deduct tax at source. Effectively therefore a US company will be subject to tax on its trading income in the UK if it has a PE here.
The UK definition of a permanent establishment is modelled on, although not identical to, the definition in the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention. A company will have a PE in the UK if either:
- it has a fixed place of business in the UK through which the business of the company is wholly or partly carried on ("Establishment PE"); or
- it has an agent acting on behalf of the company who habitually exercises authority in the UK to do business on behalf of the company ("Agency PE").
An agent of independent status acting in the ordinary course of his business will not constitute a PE, nor will preparatory or auxiliary activities give rise to a PE.
Historically companies looking to sell into the UK would need to appoint a local distributor or sales agent in order to achieve this. With the advent of the internet, it is possible for many companies to sell remotely into the UK without any local agent and no PE risk. For such companies, having a server alone in the UK may not create a PE as HMRC take the view, contrary to most countries, that a server will not of itself constitute a PE.
However, many companies get to a size where their businesses will benefit from a local presence. This could be an independent consultant or a UK employee.
If a consultant is used, and such consultant does not in fact amount to an employee, then the only part of the PE definition that would be of relevance would be the Agency PE. If it is preferable to avoid a PE in the UK, it would therefore be necessary:
- to have a local agent of independent status who is acting in the ordinary course of its business; or
- if the agent is a dependent agent, to ensure that the agent does not have authority to conclude contracts on behalf of its principal.
Where a local employee is chosen to represent the company without the company having its own establishment in the UK, many companies consider that provided the employee does not have authority to conclude contracts then there should be no PE. However, in this circumstance, as the employee is effectively an emanation of the company, an Establishment PE may be created without the company realising.
In this situation, the question is often whether the employee's place of work, eg home (or other office) constitutes a fixed place of business of his employer. For this to be the case, the home in the UK must be "at the disposal" of the employer (OECD commentary on Article 5(1), Model Tax Convention).
There is Canadian case law, of persuasive authority, in the context of agency workers indicating that for a home to be at an overseas company's disposal, factors such as the overseas company paying the expenses of the home, stipulating what facilities the home contains and the overseas company employees being able to turn up unannounced expecting the worker to be present are relevant (American Income Life Insurance Company v The Queen (2008) DTC 3631 (Tax Court of Canada) and Knights of Columbus v The Queen (2008) DTC 3648 (Tax Court of Canada)).
The OECD has published a discussion draft on changes to the commentary to its model tax treaty which deals with this point and, whilst not having legal effect, is nevertheless a useful guide. This states that:
"Whether or not a home office constitutes a location at the disposal of the enterprise will depend on the facts and circumstances of each case. In many cases the carrying on of business activities at the home of an individual (e.g. an employee) will be so intermittent or incidental that the home will not be considered to be a location at the disposal of the enterprise. Where, however, a home office is used on a regular and continuous basis for carrying on the business activities for an enterprise and it is clear from the facts and circumstances that the enterprise has required the individual to use that location to carry on the enterprise’s business (for example, by not providing an office to an employee in circumstances where the nature of the employment clearly requires an office), the home office may be considered to be at the disposal of the enterprise……Where, however, a cross-frontier worker performs most of his work from his home situated in one State rather than from the office made available to him in the other State, one should not consider that the home is at the disposal of the enterprise because the enterprise did not require that the home be used for its business activities"
Operating PAYE and accounting for NICs
UK employers, such as UK resident subsidiaries or branches, must deduct income tax and national insurance contributions (NICs) from their employees' pay and submit these payments directly to HMRC under the pay as you earn (PAYE) rules along with employers' NICs. Where overseas employers have no tax presence in the UK but have employees in the UK, the system cannot operate in this way and instead, employees must make PAYE payments to HMRC themselves under the direct payment scheme (regulations 141-147, Income Tax (Pay As You Earn) Regulations 2003 (SI 2003/2682)) together with payments in respect of employees' NICs. Employer's NICs will not be payable. Often overseas employers set up an arrangement with a payroll company for PAYE and employees' NICs to be deducted from the employees' pay and historically these have often been set up with offshore payroll providers to avoid employers' NIC.
Legislation is therefore being introduced in Finance Bill 2014 to ensure that PAYE and NICs (both employees' and employers' NICs) cannot be avoided through having an offshore payroll provider.
Irrespective of whether a US company has a physical presence in the EU, it may be subject to VAT obligations in respect of its EU sales. The rules in this respect are complicated and depend on whether the US company is importing goods or services into the EU and also whether supplies are made to business customers or end consumers.
Broadly speaking, in the absence of a physical presence in the EU:
- Services provided to business customers should not give rise to any VAT obligations on the US entity as its EU business customers should account for any VAT under the "reverse charge" procedure.
- Services provided to consumers are generally supplied where the supplier belongs (so in the case of a US supplier, its services should be supplied in the US, meaning there should be no VAT). However there are a number of important exceptions to this including electronically supplied services. So services supplied over the internet (eg downloads) to customers belonging in the EU will be provided in the EU and local VAT will be chargeable. In this case there is a special registration scheme whereby a non EU business only needs to make one VAT registration in the EU and can charge under this VAT number at the appropriate VAT rate for the jurisdiction in which the consumer is based.
- Goods sold into the EU will give rise to import VAT at the time they are entered into free circulation into the EU. The person responsible for this will be the importer. Many non EU businesses employ import agents to deal with VAT formalities on their behalf. If the US company is the person who is incurring the import VAT charge, it will often make sense to register for VAT in the UK and invoice the customer for the goods, particularly when dealing with business customers. This allows the supplier to recover the VAT and provide a VAT invoice to the business customer which in turn can recover the VAT on that invoice.
Where the supplier belongs in the EU, the rules change so:
- for business to business supplies of services, the recipient should still account for VAT under the reverse charge procedure unless the supplier belongs in the same jurisdiction as the recipient;
- the place of supply for business to consumer supplies of services where the supplier and recipient belong in the EU, will generally be where the supplier belongs. However, this will change from 2015 such that, for example, the above rules for electronically supplied services supplied from outside the EU will also apply for intra-EU supplies.
In looking at the VAT rules, it should also be noted that these are not necessarily the same as the PE rules for direct taxes. In particular, the VAT rules for place of supply are dependent on where the supplier or customer "belongs". A business belongs in the country (at least for UK VAT purposes) where:
- it has a business establishment, or some other fixed establishment, or
- if the business has no such establishment where the person's usual place of residence is located, or
- if the business has more than one such establishment, the establishment most directly concerned with the supply
In this respect, the "business establishment" of an enterprise is defined in a similar way to residence of a company, so it looks at where key management decisions are made and where the central administration is based. By contrast, a fixed establishment is taken to mean an establishment from which the activities of the organisation are carried out and which has the permanent presence of both the human and technical resources necessary for making or receiving the supplies of services in question. There have even been cases in which the registered office of a UK company amounts a fixed establishment for the purposes of receiving services, even if no business activities are carried out there.
This article is part of the International Tax Bulletin for April 2014.