Restricted international mobility, plunging exchange rates and impending recession arising from the COVID-19 crisis throw up significant tax implications.
We have already discussed the implications of the statutory residence test for individuals trapped in the UK because of the crisis in another article (link here).
As illustrated below, the ramifications for businesses are extensive and include potential unanticipated tax charges which would be especially unwelcome given current pressure on cash flow.
Many UK companies will be looking for funding from wherever possible, so tax will be a secondary issue but this is still worth understanding.
Loans from overseas group companies
If a UK company borrows from a non-UK group company, it is necessary to consider whether the borrower has an obligation to deduct withholding tax from payments of interest. The determining factor here is whether the interest is “short” (no withholding) or “annual” (obligation to withhold). A loan which is intended to last for less than 12 months is short, but an issue which is likely to arise is that a UK borrower may not be able to repay on time, so the loan may be rolled over. This is addressed in the HMRC Savings and Investment Manual at SAIM9076, which states that without clear evidence that the intention was for the loan to be less than 12 months, HMRC “will be unable to accept” that this was the case, in which case withholding tax is due. This is clearly worth addressing.
It may also be appropriate to consider whether the interest can be paid gross under the relevant Double Tax Treaty. The UK borrower needs agreement from HMRC before making the payment of interest, which requires the overseas lender to apply and complete the appropriate form. In the current circumstances, it may take some time to get this approval, and so applying as soon as the loan is made may be sensible.
Exempt distributions from overseas subsidiaries
Subject to conditions, distributions received by a UK parent from an overseas subsidiary are exempt from UK corporation tax. Paying a dividend up to the UK from an overseas subsidiary might be a response to cash flow problems in the UK. However, a reduction in employee headcount could have implications if it results in a group becoming “small”.
The conditions determining whether the distribution exemption applies depend on whether the company is small or large, a small company for these purposes being one with 50 or fewer employees and less than €10 million turnover or less than €10 million gross balance sheet assets.
Giving the differing condition applying to large and small companies, it is possible for a dividend that would be exempt if received by a large company to be taxable on a small company, in particular if the paying company is located in a non-qualifying territory. In our view, furloughing an employee should not reduce the headcount for this purpose. However, part-time employees are treated as a fraction of a person for this test, and so reducing employee hours can reduce the headcount.
The 50 employee threshold would have to be missed for two consecutive accounting periods for a group to move from being medium-sized to being small. This may therefore not be an immediate problem but a failure to identify this issue could mean that a cash injection from a subsidiary is reduced by a 19% tax charge.
Travel restrictions could have implications for company residence. HMRC have commented on the issues where board meetings are held in the UK, but there are also issues for certain companies if board meetings are held outside the UK.
Where a non-UK domiciled individual sets up a company, he may use a non-UK incorporated company so that the shares are excluded property for UK inheritance tax.
For such non-UK incorporated companies, if management and control is exercised from the UK, for example if board meetings take place in the UK, the company will be treated as UK tax resident, and within the UK corporation tax net.
If the directors of a non-UK incorporated but already UK resident company were to now hold board meetings outside the UK, for example because of travel restrictions, the company would be treated as having migrated from the UK, giving rise to a potential corporation tax exit charge as its assets would be treated as having been disposed of and reacquired at their market value. Such a “dry” UK corporation tax charge could have a very unhelpful impact on cash flow.
Exchange rate-related gains in investment companies
From the UK perspective, sterling has weakened significantly against the dollar. Dollar denominated assets might therefore give rise to a sterling gain significantly greater than the face value of the gain in dollars.
While this is difficult to avoid in the instance of individuals and trustees, some investment companies might be able to mitigate the impact by electing for the US dollar rather than sterling to be the company’s functional currency prior to realising dollar denominated gains.
Entrepreneurs’ Relief, Substantial Shareholding Exemption and trading losses
Reliefs such as Entrepreneurs’ Relief, and the Substantial Shareholding Exemption are premised on non-trading activities of a company or group falling below a threshold.
For example, Entrepreneurs’ Relief on the disposal of shares requires that the company is a trading company, or the holding company of a trading group. A trading company is one whose activities does not to a substantial extent include non-trading activities. HMRC practice takes “substantial” in this context to mean more than 20%, taking into consideration income from non-trading activities, the asset base of the company, expense incurred and time spent by the employees on various activities, the company’s history, and considers these indicators in the round.
Many companies or groups will include an element of non-trading activity. Where trading activity has diminished significantly because of the COVID-19 crisis, it may be that the non-trading activities become “substantial” in comparison with the result that the qualifying conditions for these reliefs might not be met.
If companies propose to reduce their activities temporarily, they should ensure that the evidence their intention to recommence operations once they are able to. This should bolster the argument that company assets continue to be trading assets for the purposes of the substantial non-trading activities tests.
Evidencing that company continues to trade is also important to ensure that crisis-related trading losses can be set against future profits of the same trade rather than being treated as losses of a trade that had ceased. Furloughing employees rather than making them redundant should provide evidence that the trade continues.
Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS)
The Enterprise Investment Scheme and Seed Enterprise Investment Scheme provide income tax and capital gains tax reliefs for investors into early stage companies. Both reliefs are subject to qualifying conditions for the investor and the investee company including time limits.
For example, money raised by a new EIS share issue must be spent within two years of the investment or, if later, the date that the trade started, on the qualifying business activity only. Given the downturn in activity, for existing investments, spending the money appropriately in that two-year window may be more difficult.
There are also rules which clawback or restrict relief where value is received by an investor, and so any situation where the company meets a cost of an investor, or makes a payment to him, in a difficult time, could have a high cost in lost tax relief.
Where an EIS company needs money but a funding round is not possible, an existing investor might consider making a loan to the company, but care is needed because the repayment of a loan can trigger a clawback of relief.
Statutory clearances in respect of transaction including share exchanges, share buybacks, demergers and transactions in securities require HMRC to provide a substantive response within 30 days.
Given the current circumstances which impact HMRC employees too, it is not clear how the 30-day timetable will be adhered to. Of course, clearance applications are not compulsory. The reliefs at stake apply automatically provided the relevant conditions are satisfied. However, clearances do provide certainty to taxpayers and in the absence of such certainty, particularly for more complex transactions, taxpayers may be reluctant to proceed.
These examples illustrate the wide-ranging implications and highlight the importance of not taking anything for granted considering the crisis: time limits, the availability of reliefs and proposed transactions should be reviewed afresh.