Don’t sell your business short

TaxTalk - February 2024

read timeRead time: 17 mins

New Year, new resolutions. If one of yours is to sell your international business, here’s how to stay tax-compliant and keep complications to a minimum.

At the start of another year of business acquisitions in the M&A market, shareholders selling their businesses will be keen to understand how to make the transaction process as smooth as possible.

One way of preparing is to avoid common tax-related pitfalls, which otherwise can cause delays in the sale process and potentially hamper the purchase price. We look at some of the recurring pitfalls for international businesses below.

Overseas operations

A red flag often identified during a tax due diligence exercise is the non-registration of permanent establishments (PEs) abroad. These are also known as branches.

Broadly, a company will have an overseas PE if it has either:

  • a fixed place of business outside the UK with a degree of permanence (e.g. factory, shop or office) or
  • an agent who acts habitually on behalf of the company and has the power to conclude contracts overseas. This includes overseas sales agents.

Nevertheless, the storage, delivery, marketing or display of goods overseas will not initiate an overseas branch.

When a PE is created, the local jurisdiction is likely to have certain registration requirements. Non-compliance with these can lead to penalties. Following the registration of a branch overseas, profits attributable to the branch will be taxed in the local jurisdiction. Relief for any overseas tax may then be available if these profits are also subject to tax in the UK.

What’s more, tax jurisdictions outside the UK may require other tax compliance which businesses aren’t always aware of. Examples are sales taxes and employment taxes.

If the due diligence process identifies that the company has failed to register an overseas branch, this could trigger significant additional tax exposure and compliance requirements. Remember – it’s the local legislation which will govern which taxes are relevant and which reliefs are available.

These are all considerations that must be dealt with as part of the transaction. They may result in price adjustments, additional indemnities and, in some circumstances, can delay or derail the transaction completely.

If you are thinking of selling a business, we recommend you consider any overseas operations proactively so that you can show compliance in this area.

Transfer pricing

Where transactions take place between two connected parties at a price other than what is deemed a fair market price (i.e. the price which would be charged between two parties who are independent of each other), it may trigger an adjustment in the tax calculation to reflect the difference. This includes transactions with PEs.

Small or medium-sized enterprises (SMEs) are exempt from the Transfer Pricing (TP) rules in the UK.  But the exemption does not apply to transactions between connected parties in certain overseas territories. Examples of these are Gibraltar, Hong Kong and the Channel Islands. So it’s a misconception to think that the SME exemption is a universal solution that excuses all such companies from the UK TP rules.

As well as the obligation to calculate taxable profits in line with TP, there is also an increasing requirement to ensure that documentation can support the pricing of transactions between connected parties.

In our experience, businesses often overlook this area. They may not consider transactions between connected parties for TP purposes, or there is insufficient documentation to support the pricing. These oversights may lead to inaccurate Corporation Tax returns and additional liabilities being due.

As with PEs, mentioned above, this can cause significant delays to the sale process and price adjustments on the deal or indemnity clauses.

What’s more, since a TP review should be key to a multinational’s year end routine, failure to follow these rules can raise questions around the target company’s wider control environment and compliance process.

We are primarily considering common tax pitfalls from a UK perspective. But it’s also vital to look at connected party transactions from the point of view of the counterparty’s local jurisdiction and TP requirements. Many jurisdictions do not offer companies the same SME exemption as the UK does.

Before going into a transaction it’s crucial that companies consider TP rules for all transactions between connected parties. Make sure, too, that documentation is available as part of the sale process to demonstrate this and support the pricing of these transactions.

More information on the importance of TP for start-ups, and SMEs who seek to grow internationally, can be found here.

Withholding tax on interest

As a general rule, where companies make payments of interest to an individual or overseas company, they are obliged under UK domestic law to withhold tax at 20%. But here are some examples of the key exclusions and scenarios where tax does not need to be withheld:

  • Interest payments made by a UK resident company to another UK resident company
  • Interest payments made to or by a UK bank
  • Interest on loans which will not be in place for longer than one year
  • Interest that does not arise in the UK
  • Interest paid to a person/body-corporate in another jurisdiction where the double tax treaty (if any) with the UK stipulates that the rate of withholding tax can be reduced to nil.

If no exceptions apply, the interest-paying company must withhold the tax and make quarterly payments and returns to HMRC to cover the interest withheld. Even where the rate can be reduced under a double tax treaty, it’s usually necessary to apply in advance to HMRC asking for payment to be made gross (i.e. with no tax withheld).

These exclusions can be very complex and are easily overlooked by businesses. Make sure, then, that you are compliant in this area with sufficient evidence (including the authorisation from HMRC for payments to be made gross).

For more information about any of the issues raised in this article, please contact Corporate Tax Manager Harry Gooch.