Part 3 of 4
This is the Finance Act 2023 version of this article. It is relevant for candidates sitting the ATX-UK exam in the period 1 June 2024 to 31 March 2025. Candidates sitting ATX-UK after 31 March 2025 should refer to the Finance Act 2024 version of this article (to be published on the ACCA website in 2025).
In the first two parts of this article GF Ltd was formed, began trading, and incorporated a subsidiary (WA Ltd), which acquired a business in the UK. In this part, GF Ltd will start a new manufacturing business overseas. Once you have read about the company’s plans, stop and think about the possible tax implications before reading on.
GF Ltd’s business has grown considerably and it expects to have taxable total profits of £800,000 in the year ending 31 March 2025. GF Ltd’s subsidiary, WA Ltd, is expected to have taxable total profits of £100,000 in the same period. Kai and Fay have been looking to expand overseas in order to take advantage of cheaper manufacturing costs. They started a new manufacturing business in Marineland on 1 April 2024.
It is anticipated that the overseas business will make a trading loss of £60,000 in the year ending 31 March 2025, a profit of £80,000 in the year ended 31 March 2026, and a profit of £100,000 per year in future years.
The system of corporation tax in Marineland is broadly the same as that in the UK, although loss relief is only available to companies resident in Marineland. In addition, the rate of corporation tax is 50% regardless of the level of profits, and there is no withholding tax when dividends are paid to overseas shareholders. There is no double tax treaty between the UK and Marineland.
The tax implications arising out of going global are:
The tax implications of the Marineland business depend on the legal structure used. From a tax point of view there are two distinct ways of establishing the business:
A permanent establishment is not a separate legal entity but is an extension of the company that owns it. The profits or losses of the permanent establishment belong directly to the company that owns the permanent establishment.
A UK resident company can elect to exclude the profits and losses of its overseas permanent establishments from UK corporation tax. This election is irrevocable and applies to all of the company’s existing and future permanent establishments. The current position of GF Ltd, and any plans for the future, will need to be considered when deciding whether or not make this election.
The detail of the rules concerning this election is complex. It can be assumed in the exam that the election is available in respect of all overseas permanent establishments.
Provided this election has not been made, and the permanent establishment is controlled from the UK, the trading loss made in the year ending 31 March 2025 could be offset by GF Ltd (or WA Ltd) against its income and gains of that year, thereby reducing the company’s UK corporation tax liability. Once the permanent establishment is profitable, the company owning the permanent establishment will be subject to 50% Marineland corporation tax on the profits of the permanent establishment because it is trading within the boundaries of Marineland.
The profits will also be subject to UK corporation tax because a UK resident company is subject to tax on its worldwide income and gains. However, the UK corporation tax liability in respect of the profits of the permanent establishment will be fully relieved by double tax relief, as the rate of corporation tax in Marineland is higher than that in the UK. Accordingly, there will be no UK corporation tax to pay on the overseas profits.
A subsidiary is a separate legal entity. A company incorporated in Marineland will be resident in Marineland for tax purposes provided it is not managed and controlled from the UK. Its profits or losses will then be subject to the tax regime of Marineland.
The trading loss of the year ending 31 March 2025 would be carried forward and deducted from the company’s future total profits (income and gains). Once the company is profitable, it will be subject to tax in Marineland at the rate of 50%.
Any dividends paid to the UK parent company will be exempt from UK corporation tax.
Where a UK resident company acquires a company that is resident outside the UK the rules relating to controlled foreign companies (CFCs) should be considered. A CFC is a company which is:
However, even though a subsidiary in Marineland would fall within the definition of a CFC, there would not be a CFC charge because of the high rate of tax in Marineland. The 50% rate of tax will mean that the local tax paid by the company in Marineland is likely to be considerably more than 75% of the amount of tax that the company would have to pay in the UK if it were UK resident, such that the tax exemption from the CFC charge will apply.
Provided the election to exclude the profits and losses of overseas permanent establishments from UK corporation tax has not been made, it is usually suggested that a permanent establishment should be used where an overseas enterprise is expected to make initial losses. This strategy enables the losses to be offset against any other profits of the company. However, the particular facts of the situation must be considered carefully.
The use of a permanent establishment in Marineland will enable GF Ltd to offset the losses against its profits for the year ending 31 March 2025. This will save UK corporation tax at the main rate of 25%.
The use of a subsidiary would mean that the losses could not be offset in the year ending 31 March 2025 as the subsidiary will not have any other income. However, in the following year the losses will reduce that year’s profits and save tax in Marineland at 50%. Accordingly, provided the group is willing to wait for a year (from a cash flow point of view), a greater tax saving can be achieved by using a subsidiary in Marineland rather than a permanent establishment. This assumes, of course, that the anticipated profits materialise in the year ending 31 March 2026.
It must also be recognised that a subsidiary is an associate for the purpose of determining whether or not the companies in a group are required to pay corporation tax in quarterly instalments whereas a permanent establishment is not. Accordingly, the use of a subsidiary (rather than a permanent establishment) could accelerate future corporation tax payments.
Part 4 of this article considers the implications if the rate of corporation tax in Marineland had been considerably lower, such that it would then be necessary to consider the application of the CFC rules.
There are a number of matters to consider where a new overseas business is expected to make a loss. These include: whether or not the exemption election in respect of overseas permanent establishments has been made, the tax that can be saved in respect of the losses and the effect on the group’s cash flow position of increasing the number of associates.
The corporation tax issues relating to groups are considered in two further articles:
Written by a member of the ATX-UK examining team
The comments in this article do not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content of this article as the basis of any decision. The authors and ACCA expressly disclaim all liability to any person in respect of any indirect, incidental, consequential or other damages relating to the use of this article.