So, how can UK businesses optimise their corporate tax position following the pandemic, while adapting their organisations for post-coronavirus trading? Lucy Mangan, tax partner at accountancy firm Menzies LLP, offers Finance Monthly her thoughts.
Financing the business
The economic turmoil created by the coronavirus pandemic has pushed cashflow management up the corporate agenda. To support this, many businesses will be looking to secure additional loan funding from third party lenders or other group companies but may not be aware that increased borrowing can have a huge impact on their tax liability and therefore negatively affect their cash position.
If a company’s borrowings, either from a group company, or obtained from a third party lender due to support from its wider group (e.g. guarantees) exceed the amount that it could have borrowed from an independent lender on its own, HMRC may consider it to be thinly capitalised. In either scenario, any interest charges on the excessive amount of the loan are disallowed for corporation tax purposes. To stay on the right side of the law, organisations with high debt to equity ratios and/or low interest cover should seek expert advice around the deductibility of their interest charges.
Another important tax point for businesses to be aware of when securing additional funding is the potential for corporate interest restrictions. Where the total net interest charge of all UK companies in a group exceeds £2 million in a 12-month period, their ability to deduct interest for corporation tax purposes may be restricted. The amount of deductible interest will need to be calculated. Any restricted interest is carried forward and potentially offset in later years and it’s also worth noting that groups that do not use their full interest allowance in any period can carry forward any unused balance by filing a formal claim with HMRC. Through careful planning, companies can ensure that they structure their borrowings to maximise the tax deductibility of interest and protect any unused allowances for future use.
Any restricted interest is carried forward and potentially offset in later years.
If borrowing from overseas, companies should also be aware of the UK’s anti-hybrid rules, which can restrict interest deductions. They should also remember to consider withholding tax obligations. If loans become non-recoverable, this could also affect the tax treatment for the lender or borrower, so expert advice should be taken at the earliest possible stage.
Losses and devaluation of assets
Although this will vary between businesses, the pandemic is likely to have negatively impacted the profitability of many organisations. This situation may also be exacerbated by their assets losing value, which in turn could have a knock-on effect on their accounting profit/loss.
An important first step is for companies and groups to have a clear picture of their likely taxable profits or available losses (both for the current year and those brought forward). Tax losses may not be the same as the ‘book’ profits/losses, particularly if assets have been impaired.
Having a clear idea of their likely taxable profits or losses for the year will ensure that the company or group is in the best position to accurately calculate estimated corporation tax payments for the current period, ensure that excessive payments are not made and potentially obtain refunds from HMRC. This could be either due to overpaid tax or claims to carry back losses against prior years’ taxable profits. This approach could prove a valuable means of boosting cashflow in the months ahead.
Changes to working arrangements – risk of tax presence
Due to travel restrictions, among other factors, many businesses are having to deal with new ways of structuring their operations and their management and employees may have worked from new locations during the pandemic.
This may include changes to the international footprint of the business. If this is the case, it’s important to keep a close track of what is happening and where, as this could result in a new taxable presence for the company in the foreign jurisdiction, potentially by way of creating a Permanent Establishment (PE). It could also create or a shift in the tax residency of the company following changes to the location of the company’s directors or management.
In respect of changes to tax residency, the OECD has advised this is unlikely to be the case if changes have only been made on a temporary basis. Groups should seek to identify where the place of management of each company is likely to reside in the future and whether this could lead to a change to its tax residence. Companies should ensure they keep a clear record of their individual circumstances in case required by a tax authority at a later date
A tax presence can give rise to a wide range of tax liabilities, including payroll, corporate taxes, VAT (or equivalent) and potentially exit charges. To determine whether this is the case, business leaders should carefully review local laws and relevant tax treaties, as well as considering any recent guidance provided by the country’s tax authority.
A tax presence can give rise to a wide range of tax liabilities, including payroll, corporate taxes, VAT (or equivalent) and potentially exit charges.
While the current focus of any business must of course be on protecting its future performance and assessing all the current risks to the business and how these can best be managed, it is also important to review how the global business strategies and operations may have changed. Transfer pricing opportunities and risks for the business should also be considered.
Groups may need to quantify and adjust transfer pricing policies for exceptional events such as redundancies, increased expenses or reduced sales as a result of COVID-19. The tax position in each country should then be considered, including the expected profit and loss profiles. Business leaders can then decide what charges are now appropriate, and any steps that can be taken to remove inefficiencies.
Currently, many businesses are still in survival mode, focused on making the changes needed to keep trading and get through the next few months. However, with a longer-term view and effective planning, they can consider the impact of a range of pandemic response strategies on their corporate tax liability, optimising their financial position.