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Tax Concerns – Lexology

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This text is an extract from The Franchise Legislation Evaluate, Version 9. Click on right here for the complete information

I Introduction

This chapter appears at tax points regarding franchising. Particularly, it focuses on the tax guidelines that generally apply to franchising preparations, the tax parameters underneath which franchising operations must be structured, the tax structuring choices to contemplate and the anti-avoidance guidelines, that are more and more centered on worldwide tax structuring. On this respect the primary guidelines to be thought-about are these regarding the tax therapy of buying and selling transactions and mental property (IP), as these are on the coronary heart of any franchising association.

In these tax guidelines, we think about company franchisors and franchisees – partly for the sake of brevity and partly as a result of (so far as franchisors are involved) these are the entities mostly concerned in franchising preparations.

We additionally look on this chapter on the guidelines from a UK perspective. Whereas most of the ideas of worldwide taxation could be utilized generically in a number of jurisdictions, tax is by its very nature extremely jurisdiction-specific. In wanting on the UK guidelines we hope to focus on these ideas whereas grounding them in a real-life authorized framework. This method will give the reader a broad understanding of the tax ideas that apply to any state of affairs whereas leaving her or him free to take extra detailed native recommendation in any particular circumstance. It must be famous, nevertheless, that on 23 June 2016 the UK voted to depart the European Union (EU). The UK reached settlement with the EU concerning the phrases of the UK’s withdrawal from the EU throughout January 2020, departing the EU on 31 January 2020, and implementing legislation2 was handed by the UK Parliament giving impact to this settlement (the Withdrawal Settlement). The Withdrawal Settlement, nevertheless, supplied for a transitional or implementation interval throughout which the UK would proceed to be handled as a part of the EU for many functions, together with the EU’s single market and customs union, with a view to reaching settlement on a future buying and selling partnership with the EU throughout this era, based mostly on a non-binding political declaration agreed between the EU and the UK setting out the framework for his or her future relationship. This era ends on 31 December 2020 and, on the time of writing, the phrases of any future buying and selling relationship with the EU stay unsure . Despite this uncertainty, we’ve got, the place potential, set out how the withdrawal of the UK from the EU will have an effect on sure areas mentioned on this chapter, particularly entry to EU treaties and people UK tax legal guidelines which can be derived from EU regulation, similar to worth added tax (VAT).

Lastly, franchisors and franchisees are companies and as such are involved with all of the tax points that any enterprise can be. This isn’t a tax guide and we’ve got due to this fact centered solely on these points which can be particular to franchising companies, specifically the tax points arising from the property and providers that make up the franchising preparations. Whereas we’ve got in components talked about different tax points that could be related, we’ve got solely executed so in passing.

In broad define, this chapter will think about the next tax points so as:

the final framework for the taxation of corporations;
withholding taxes that could be relevant on cost of franchise charges and royalties;
the franchisor’s tax place;
franchisor tax planning;
the franchisee’s tax place;
switch pricing; and
worth added tax.

II The final framework for the taxation of corporations in the UK

To grasp how company franchisors and franchisees are taxed in the UK requires a broad understanding of the UK company tax regime – particularly because it applies to IP-based buying and selling entities. We due to this fact start with a really broad overview of the related UK company tax guidelines earlier than making use of these to the franchising context.

The company tax regime in the UK operates to tax corporations. An organization is outlined as any physique company or unincorporated affiliation however doesn’t embody a partnership, an area authority or native authority affiliation.3 The quantity on which company tax is chargeable is the sum of earnings computed underneath the varied charging provisions and chargeable good points computed in accordance with the principles within the Taxation of Chargeable Positive factors Act 1992 (TCGA).

An organization is topic to company tax in the UK:

if it’s a UK resident – on all its income and good points whatever the supply of the income or good points or whether or not they’re remitted to the United Kingdom4 until such income or good points come up in a everlasting institution located outdoors the UK by which case they might be exempt from tax underneath the department exemption guidelines contained in Half 2 Chapter 3A of the CTA 2009; or
whether it is non-UK resident however carries on a commerce by means of a everlasting institution in the UK – on all its income arising from its commerce by means of that establishment5 and chargeable good points on property located in the UK and used for the commerce or everlasting institution.6 The Finance Act 2019 launched provisions stopping non-UK resident corporations from artificially organising their enterprise to keep away from falling underneath the definition of a UK everlasting institution and, with impact from 6 April 2020, prolonged company tax to the UK property earnings of non-resident corporations. Company tax additionally applies to non-resident property buying and selling or growing corporations, even when the corporate doesn’t have a everlasting institution.

Firms that aren’t inside the cost to company tax can nonetheless be topic to earnings tax on sure UK-sourced earnings (usually the place tax is deducted at supply).

Broadly talking, an organization is a resident of the UK whether it is both:

included in the UK;7 or
has its central administration and management in the UK.8

The place an organization is resident in each the UK and elsewhere (e.g., as a result of it’s included in the UK however managed and managed in one other jurisdiction), it’s obligatory to contemplate whether or not there’s a tiebreaker clause within the related double-taxation treaty. The multilateral instrument (MLI) that applied Motion 6 of the Motion Plan on Base Erosion and Revenue Shifting (BEPS) venture launched into affected double tax treaties a tie-breaker provision based mostly on a mutual settlement between the related tax authorities as a substitute of the earlier provision based mostly on the place of ‘efficient administration’.

Topic to sure exemptions for preparatory or auxiliary actions, an organization can have a everlasting institution in the UK if it has a set administrative center in the UK by means of which its enterprise is wholly or partly carried on, or its agent (aside from an unbiased agent appearing within the abnormal course of its enterprise) has and habitually workouts in the UK authority to do enterprise on its behalf. A hard and fast administrative center features a department, workplace, manufacturing unit, workshop, place of administration or a constructing website.9 The ultimate report for Motion 7 of the BEPS venture (see Part V.iv) considerably expanded the Organisation for Financial Co-operation and Improvement (OECD) definition of everlasting institution to incorporate conditions by which the agent performs the principal function resulting in the conclusion of contracts which can be routinely concluded with out modification, whether or not the contracts are within the title of the enterprise or for provides of products, rights, property or providers by the enterprise. Though the UK has determined towards amending its home definition of everlasting institution to replicate Motion 7, the brand new OECD definition has been adopted in sure jurisdictions and thus has an impression on the abroad operations of UK corporations.

i Earnings chargeable to company tax

Company tax applies to income of an organization. The time period revenue is outlined as earnings and chargeable good points besides insofar because the context in any other case requires10 and is as adjusted for tax functions. Within the case of a non-resident firm with a everlasting institution in the UK, its chargeable income might be income from its buying and selling earnings arising straight or not directly by means of, or earnings from property or rights used or held by or for, the everlasting institution and chargeable good points topic to company tax.11 Nonetheless, there may be an exemption from tax for many dividends or different distributions acquired from different corporations (until, usually talking, the dividends or distributions are out of untaxed earnings).

Underneath the company tax regime, earnings is assessed into completely different charging provisions, similar to:

buying and selling earnings;
property earnings;
mortgage relationships and spinoff contracts;
intangible mounted property;
mental property, know-how and patents; and
miscellaneous earnings.

As income embody chargeable good points, company tax applies to chargeable good points moderately than capital good points tax12 (which applies for people). Chargeable good points are usually calculated in accordance with the capital good points tax guidelines. Nonetheless, the intangible mounted property regime covers good points from property included inside that regime as a substitute of the chargeable good points guidelines.

Expenditure that’s allowed for tax functions to cut back income is set in accordance with particular charging provisions. So, any disbursement or expense of an earnings nature wholly and solely laid out or expended for the needs of commerce is deductible towards income of that commerce for company tax functions in the identical method as for earnings tax.

Moreover, there are particular guidelines outdoors the charging provisions that enable tax deductions towards complete income; for instance:

capital allowances; and
aid for accounting losses on mortgage relationships and spinoff contracts.

The principles on buying and selling earnings usually take priority over different charging provisions.

Buying and selling income

The taxable income of a commerce should be calculated in accordance with usually accepted accounting apply however are topic to any tax changes.13 Subsequently, the place to begin for figuring out taxable buying and selling income is to make use of the revenue earlier than tax as disclosed within the accounts and regulate it for tax.

Some earnings and bills could also be excluded. For instance, depreciation won’t be allowed as a deduction for tax functions,14 though expenditure ‘capitalised’ in accounts could also be deferred income expenditure that may very well be deducted when amortised underneath usually accepted accounting ideas. For capital expenditure, capital allowances aid could also be out there. Additionally, capital receipts will not be chargeable to tax as earnings and will, due to this fact, not be included in calculating the buying and selling income until there’s a particular rule on the contrary.15

What’s a ‘commerce’?

There isn’t a statutory definition for ‘commerce’ supplied within the laws and therefore the time period is interpreted in accordance with its abnormal which means. The ultimate report of the Royal Fee on the Taxation of Earnings and Revenue in 1955 summarised an important issues in figuring out whether or not a taxpayer has engaged in commerce (termed ‘badges of commerce’). The primary elements to take a look at to point whether or not a transaction is buying and selling in nature are as follows:16

frequency of transaction – repeated transactions (as distinct from a one-off transaction) can be indicative of buying and selling;
relationship to the taxpayer’s commerce – a transaction regarding the commerce that the taxpayer already carries on means that exercise as being in the midst of commerce;
material – a transaction involving property which can be usually the subject material of buying and selling can be suggestive of buying and selling (e.g., a bulk buy of whisky or bathroom paper is basically an issue of commerce, not of enjoyment);
supplementary work – work executed to restore or enhance the merchandise previous to sale suggests the transaction as being within the nature of commerce; and
revenue motive and intention – purchases made with a view to resale at a revenue or with the intention to resell within the quick time period signifies that the transactions will not be by the use of funding so must be buying and selling.

In Ransom (Inspector of Taxes) v. Higgs17 Lord Reid noticed that the time period ‘commerce’ is used to ‘denote operations of a business character by which the dealer supplies to prospects for reward some sort of items or providers’.

Reduction for buying and selling expenditure

Expenditure is deductible towards buying and selling income for tax functions whether it is of an earnings nature and incurred wholly and solely for the needs of commerce.18 If expenditure is incurred for a couple of cause, one in every of which is a non-business cause, then, an identifiable a part of the expense that may be attributed as being wholly and solely for the needs of commerce won’t be disallowed.

ii Intangible mounted property regime

The intangible mounted property regime in Half 8 of the CTA 2009 supplies a broad base for taxation of IP and aid in respect of IP expenditure. It’s based mostly on the accounting therapy, thereby usually eliminating the necessity to make capital and earnings distinctions. The regime usually takes precedence for company tax functions towards different charging regimes.19

It applies to intangible mounted property which can be:

created by the corporate on or after 1 April 2002;
acquired by the corporate on or after 1 April 2002 from an unrelated get together; or
acquired by the corporate on or after 1 April 2002 from a associated get together and both:

the asset was a rechargeable intangible asset inside Half 8 instantly earlier than acquisition;
the vendor acquired the asset on or after 1 April 2002 from an individual who was not associated to the vendor or the buying firm; or
the asset was created on or after 1 April 2002.20

It’s due to this fact sometimes called the ‘post-April 2002’ regime for IP.

Broadly talking, an intangible asset is considered created or acquired on or after 1 April 2002 to the extent that expenditure on its creation or acquisition was incurred on or after that date.21

If a part of the expenditure was incurred previous to and a few on or after 1 April 2002, the asset is handled as being two separate property with apportionment being on a simply and cheap foundation.22 Internally generated goodwill is handled as created earlier than 1 April 2002 if the enterprise was carried on earlier than that date.23

An intangible mounted asset is ‘an intangible asset acquired or created by the corporate to be used on a seamless foundation in the midst of the corporate’s actions’.24 The time period intangible asset adopts the which means utilized in UK usually accepted accounting ideas (GAAP).25

Since 2015, corporations have needed to undertake the UK GAAP contained in FRS 101 and 102, and since 2016 a small-company regime inside FRS 102 applies, though sure ‘micro’ entities can account underneath a brand new simplified accounting normal, FRS 105. FRS 101 is successfully Worldwide Monetary Reporting Requirements (IFRS) with simplified disclosure. FRS 102 is a brand new regime based mostly upon IFRS for small and medium-sized enterprises (SMEs). Underneath each FRS 102 and FRS 105, an intangible asset is an identifiable non-monetary asset with out bodily substance. Such an asset is identifiable when:

it’s separable (i.e., able to being separated or divided from the entity and offered, transferred, licensed, rented or exchanged, both individually or along with a associated contract, asset or legal responsibility); or
it arises from contractual or different authorized rights, no matter whether or not these rights are transferable or separable from the entity or from different rights and obligations.

Underneath IFRS, ‘intangible property’ are identifiable non-monetary property with out bodily substance. Belongings are identifiable if they’re separable or come up from contractual or different authorized rights (no matter whether or not these rights are separable from the entity (paragraphs 8 and 12 of Worldwide Accounting Customary 38).

Intangible property embody any IP, which implies:

any patent, trademark, registered design, copyright or design proper, plant breeders’ rights or rights underneath Part 7 of the Plant Varieties Act 1997;
any proper underneath the regulation of a rustic or territory outdoors the UK equivalent to, or much like, a proper inside paragraph (a);
any info or approach not protected by a proper inside (a) or (b) however having industrial, business or different financial worth; or
any licence or different proper in respect of something inside paragraphs (a) to (c) inclusive, similar to a licence to take advantage of a patent or copyright materials.

The principles additionally apply to goodwill (which takes its accounting which means).26

The regime doesn’t apply to an asset held:

for a objective that’s not a enterprise or business objective; or
for the aim of actions that aren’t topic to UK company tax (aside from the place held for an exempt overseas department).27

Regardless that an asset might fall into the definition, there are exclusions similar to property for which plant and equipment capital allowances have beforehand been made, rights over tangible movable property, rights loved by advantage of an property, curiosity or proper in or over land, and many others.

Royalties and different credit

The post-April 2002 regime treats all royalties and disposal proceeds (credit) as earnings and treats most prices (debits) on the acquisition and improvement of intangible mounted property as bills on the identical foundation as for accounting functions.

Credit can come up as follows:

receipts or royalties recognised within the firm’s revenue and loss account;28
accounting good points in respect of the revaluation of intangible mounted assets29 (as much as the debits beforehand introduced under consideration). No acquire can be introduced under consideration if the asset is depreciated for tax functions on a set 4 per cent foundation (see under);
accounting good points in respect of unfavorable goodwill written again following a enterprise acquisition;30
accounting good points in respect of the reversal of earlier accounting losses that led to deductible debits;31 and
accounting good points in respect of realisation of intangible mounted property.32 A realisation means an asset ceases to be recognised within the firm’s stability sheet as a result of it has been offered or there’s a discount within the accounting worth of the asset as the results of a transaction (in accordance with UK GAAP). Belongings with no stability sheet worth are deemed to have one for these functions.

Debits

Debits are introduced under consideration for tax functions in respect of expenditure on intangible mounted property when recognised for accounting functions. For instance, debits can come up:

the place expenditure is recognised within the revenue and loss account;33
the place an accounting loss arises from capitalised expenditure due to amortisation or an impairment evaluate;34
on the realisation of an intangible asset;35 and
on reversals of earlier accounting good points.36

Alternatively, an organization might elect to write down down an intangible mounted asset for tax functions at a set 4 per cent every year as a substitute of the accounting price of amortisation. An irrevocable election should be made in writing to HM Income & Customs (HMRC) inside two years of the tip of the accounting interval by which the asset is created or acquired.37 The election will take impact with respect to all capitalised expenditure in respect of that asset.

For 4 years after 2015, it was not potential to acquire a debit for the price of acquired goodwill or comparable IP. Nonetheless, the Finance Act 2019 reinstated aid for goodwill and customer-related IP acquired on or after 1 April 2019 as a part of a enterprise acquisition with eligible IP property the place the goodwill is neither a ‘pre-FA 2019 related asset’ nor acquired as a part of a enterprise incorporation.

The place transfers of intangible property happen between associated events, the switch is mostly handled as happening at market worth, both underneath Part 845 of the CTA 2009 or underneath switch pricing guidelines.

The way by which debits and credit are introduced under consideration will depend upon the use to which the IP is put. Belongings held for the needs of a commerce will give rise to buying and selling credit or debits. Belongings held for a property enterprise are taxed as income or losses of that enterprise. Non-trading property give rise to a separate head of non-trading income. If there’s a non-trading loss then the taxpayer is entitled to deduct the non-trading loss towards complete income of the related accounting interval, give up it by group aid or carry it ahead to alleviate in future durations.38

iii Pre-April 2002 regime

For IP that’s not inside the intangible mounted property regime (see above), the previous company tax guidelines proceed to use, that are in lots of circumstances equal to earnings tax guidelines. We refer to those guidelines because the ‘pre-April 2002 regime’.

Underneath the pre-April 2002 regime for company tax, quantities are usually included in or deducted from earnings to the extent that such gadgets will not be capital in nature and quantities are inside the chargeable good points guidelines to the extent that they’re capital in nature. So it’s essential to find out whether or not a receipt or expense is earnings or capital in nature. The excellence should be interpreted in accordance with the abnormal which means of the phrases by having regard to case regulation.

A number one authority on this matter, Inland Income Commissioners v. John Lewis Properties plc39 supplies the next issues to find out whether or not a receipt is earnings or capital in nature:

if the cost is for the disposal of an asset that has a permanent or long-lasting high quality then the cost is more likely to be capital;
if the cost is of a single lump sum for the as soon as and all disposal of a selected asset, it’s extra more likely to be a capital cost. If the cost is one in every of a sequence of recurring funds made at frequent intervals, it’s more likely to be earnings within the fingers of the payee; and
if the disposal of the asset is accompanied by a switch of danger in relation to it, this implies that the sum paid for the asset is capital.

The next receipts have been held to be earnings:

funds from a lot of abroad corporations for the sale of know-how regarding aero-engine manufacture, the place the repetitive exploitation of know-how was seen as an extension of commerce;40
cost (comprising lump sum and royalty) for a non-exclusive licence to fabricate no more than 75,000 ammunition packing containers on a non-exclusive foundation at a selected royalty;41 and
lump sum consideration for info consisting of secret processes and formulae.42

The next receipts have been held to be capital:

lump sum for the grant of a 10-year sole licence in the UK;43
lump sum funds in respect of unique licences to overseas corporations in varied international locations by which the taxpayer covenanted to maintain out of that nation;44 and
lump sum cost for the taxpayer agreeing to not set up one other tyre soling plant, which was successfully an unique covenant to not compete.45

Expenditure might be labeled as capital whether it is incurred with a view to bringing into existence an asset or benefit for the enduring good thing about the commerce.46 For instance, a sum paid for the acquisition of a enterprise was held to be capital in nature.47 In Tucker v. Granada Motorway Providers Restricted,48 the Home of Lords decided that expenditure incurred for a variation of a lease was capital in nature though it had no stability sheet worth. Having regard to the case regulation,49 HMRC presents the next steering to point capital expenditure:

expenditure on an intangible profit or benefit (for instance, buying and selling agreements, licences or different intangibles) by which the identifiable asset is sufficiently substantial and enduring;50
expenditure that secures a everlasting business benefit such because the closing down of a doubtlessly damaging competitor;51
expenditure incurred in reference to the acquisition, alteration, enhancement or defence of the elemental construction of a enterprise;52 and
a cost that secures a permanent profit to the enterprise when it comes to a change in organisation or construction is more likely to be capital53 as distinct from one which has the impact of preserving the prevailing enterprise, its goodwill or property (which might be on income account).54

Different particular charging provisions

If an organization receives earnings or good points from IP rights, which don’t quantity to income of its commerce, then there are a variety of particular charging provisions that might catch such receipts.

Nonetheless, because the intangible mounted asset regime additionally applies to royalties regarding pre-April 2002 IP,55 the pre-April 2002 company tax regime for intangibles is in nearly all circumstances restricted to guidelines regarding capital disposals of such IP and sure particular circumstances, that are excluded from the regime. The final place can be that capital disposals of pre-April 2002 IP must be inside the chargeable good points guidelines. There are, nevertheless, some particular guidelines that override this therapy. We now think about these particular guidelines.

Disposals of know-how

There are 4 particular tax guidelines that might apply to disposals of pre-April 2002 know-how:

disposals in the midst of a commerce: Part 177 of the CTA 2009;
disposals of know-how as a part of a disposal of commerce: Part 178 of the CTA 2009;
different disposals of know-how: Sections 408–410 of the CTA 2009; and
capital allowances costs: Part 462 of the Capital Allowances Act 2001 (CAA 2001).

In respect of the primary rule, receipts from the disposal of know-how in the midst of trade56 are particularly handled as buying and selling earnings – even when capital in nature – underneath Part 177 of the CTA 2009 until introduced under consideration underneath Part 462 of the CAA 2001. The place the commerce can also be disposed of, the receipt is handled as a capital cost for goodwill though this can be disapplied by election.57 The power to make such an election and the extra basic buying and selling therapy underneath Part 177 of the CTA 2009 is disapplied the place the switch is between related events.

Earnings arising in a 12 months on the disposal of know-how in any other case than in the midst of a commerce, or for giving or fulfilling an enterprise in reference to such a disposal that restricts any individual’s actions (whether or not or not enforceable), are taxed underneath Sections 908–910 of the CTA 2009. A deduction is allowed for expenditure wholly and solely incurred within the acquisition or disposal of know-how (as long as it is just taken under consideration as soon as). This tax cost doesn’t apply the place:

the disposal is taxed as buying and selling earnings underneath Part 177 of the CTA 2009;
the consideration is taxed underneath Part 462 of the CAA 2001 on disposal of the know-how;
the place the consideration is handled as a capital receipt for goodwill on the disposal of a commerce underneath Part 178 of the CTA 2009; or
the place the disposal is by the use of sale between our bodies of individuals underneath widespread management.58

The time period ‘know-how’ for the above tax costs is outlined as any industrial info or methods more likely to help in:

manufacturing or processing items or supplies;
working a supply of mineral deposits (together with looking for, discovering or testing mineral deposits or acquiring entry to them); or
finishing up any agricultural, forestry or fishing operations.

There may be additionally a selected capital allowance regime for know-how (see Part VI). The place such capital allowances have been obtained and the know-how disposed of, then the disposal worth on such know-how needs to be introduced under consideration underneath Part 462 of the CAA 2001, by which case it should cut back the capital allowances out there within the interval or, if the corporate is liable to a balancing cost, be handled as a receipt of the commerce.

Disposals of patent rights

Tax is charged on any non-trading income from the sale of the entire or a part of any patent rights.59 For non-residents, the tax is charged solely on the sale of UK patent rights. The time period patent rights means the suitable to do or authorise the doing of something that, however for the suitable, can be an infringement of a patent.60 Licences are handled as gross sales. The grantor of a licence is handled as making a component sale until the licence is unique and for the remaining interval of the rights, by which case it’s handled because the sale of the entire of these rights.

The revenue introduced into cost is the distinction between any capital sums comprised within the proceeds of sale much less any deductible prices.61 The deductible prices are the capital prices of the rights offered (much less quantities met by sure different individuals – e.g., public our bodies) and incidental bills incurred by the vendor in reference to the sale of the patent rights.62

Underneath spreading guidelines, the vendor (if UK tax-resident) should unfold the income over six years for tax functions until she or he elects to tax all of it within the 12 months of receipt.63 Non-residents promoting UK patent rights might be taxed within the 12 months of receipt until they elect to unfold the earnings over six years.64 Any such election for earnings tax functions should be made on or earlier than the primary anniversary of the self-assessment submitting date for the 12 months of receipt.

The place non-residents are charged to tax underneath these guidelines, the individual paying the consideration might need to deduct tax at supply.

Capital allowances can be found for capital expenditure incurred to accumulate patent rights for the aim of a commerce inside the cost to UK tax65 or for patent rights that give rise to UK taxable earnings.66 The place there’s a disposal of patents for which such allowances have been given, then the disposal worth will should be purchased under consideration for capital allowances functions (restricted to the capital expenditure incurred on the patent). If this offers rise to a balancing cost, it might once more be taxed as a receipt of the commerce (or doubtlessly non-trading earnings).

Chargeable good points

An organization might be inside the cost to company tax on its chargeable good points whether it is resident in the UK, buying and selling in the UK by means of a everlasting institution or, from 6 April 2020, carrying on a UK property enterprise. If buying and selling in the UK by means of a everlasting institution, company tax on chargeable good points will apply to any UK-situated property utilized in or for the needs of the everlasting institution.67

The principles as as to if an IP asset is a UK asset or a non-UK asset are summarised under:68

Asset kind
UK asset if:
Goodwill
Commerce, enterprise or occupation carried on in the UK
Patents, logos and registered designs
Registered in the UK
Rights or licences to make use of a patent, trademark or registered design
Rights exercisable in the UK
Copyright, design proper, franchises
Rights exercisable in the UK
Rights or licence to make use of the copyright, work or design by which the design proper subsists
Rights exercisable in the UK

Capital good points tax (and company tax on chargeable good points) applies on a disposal of an asset.69 Disposals embody half disposals70 in addition to conditions the place capital sums are derived from property,71 which incorporates capital sums acquired as consideration to be used or exploitation of property and capital sums acquired for forfeiture, give up or refraining from train of rights. Equally, the extinction or abrogation of a proper or restriction over an asset by the individual entitled to implement it’s thought-about a disposal of such a proper or restriction.72

A rechargeable acquire or loss is calculated because the proceeds acquired on disposal (consideration) much less the bottom price (price of the asset, expenditure wholly and solely incurred for the aim of enhancing the worth of the asset, prices incidental to the acquisition and prices incidental to creating the disposal).73 For a company taxpayer, the bottom price could be elevated by indexation (i.e., the bottom price is elevated consistent with the retail worth index) from the date of acquisition till 31 December 2017 (the allowance being frozen from that date). The consideration might be deemed to be the market worth (as distinct from the precise quantity acquired) the place the transaction is between related events or not at arm’s size.74 Positive factors will not be chargeable to company tax on chargeable good points if they’re topic to tax as earnings.75

iv Reorganisations

To permit intra-group transactions to be effected in a tax-neutral method, there are particular guidelines that enable property to be transferred inside a UK group with out crystallising capital good points tax or a tax cost underneath the intangible mounted asset rules76 topic to ‘de-grouping costs’ if the transferee leaves the group inside six years of the date of the switch.77 A situation of such transfers is that the transferee is inside the scope of company tax in respect of the asset after the switch.78 The Finance Act 2019 launched adjustments to the de-grouping cost, which is able to not apply the place an organization that owns intangibles leaves a bunch as a part of a share disposal that qualifies for the Substantial Shareholdings Exemption. In these circumstances, property that will in any other case have been topic to the cost stay at their written-down worth.

To forestall property being taken out of the UK tax internet by migrating corporations offshore, there are additionally costs underneath capital good points and chargeable intangible asset guidelines ought to an organization migrate its tax residence offshore,79 albeit with potential to postpone any cost if the corporate stays a 75 per cent subsidiary of a UK firm.80 Following ECJ case law81 and a request from the European Fee to alter UK regulation, the Finance Act 2013 noticed an modification to the migration guidelines whereby an organization can both pay the exit cost in instalments or pays the tax 10 years after migration or, if earlier, on disposal of the property.

For chargeable good points property and for chargeable intangible property, there are in sure circumstances guidelines that enable property to be transferred to corporations resident offshore in a tax-neutral method supplied in Part 140, Part 140A, Part 140C, Part 140E and Part 140F of the TCGA and equal guidelines Chapter 11 of Half 8 of the CTA 2009. For instance, Part 140 applies to a UK firm carrying on a commerce outdoors the UK by means of a everlasting institution that transfers the commerce for a difficulty of shares or shares and mortgage inventory whereby it owns after the transaction not less than 25 per cent of the transferee’s abnormal share capital. Any acquire is rolled over into the shares though should be payable if any of the property are transferred inside six years. The principles in Part 140A to 140F of the TCGA cowl conditions set out within the EU Merger Directive and EU Tax Merger Directive82 in addition to the European Directive establishing the European Firm and European Cooperative Society. These provisions will stay in drive after the tip of the transition interval on 31 December 2020, however the remaining Member States will not deal with the UK as a member of the EU, so these provisions will stop to be out there to UK corporations after the nation leaves the EU. The principles on mergers are outdoors the scope of this chapter, however a franchisor looking for emigrate a part of its commerce offshore might want to think about whether or not it might fall inside any of those specific guidelines. It may also think about transferring property to a overseas everlasting institution, which may very well be exempt from tax underneath the exemption in Chapter 3A of the CTA 2009.

III Deduction of tax at supply

There are a selection of provisions that give rise to deduction of tax at supply on IP royalties that might apply to franchising preparations. Part 906 of the Revenue Tax Act 2007 (ITA) requires an individual who pays a royalty or different sum for using IP that’s inside the cost to earnings tax or company tax to an individual whose standard place of dwelling is outdoors the UK (or makes a periodic cost to sure individuals who’ve acquired their rights from such a UK individual) to withhold tax on the fundamental price and to account for that tax to HMRC.

For this objective, IP means:

copyright of literary, creative or scientific work;
any patent, trademark, design, mannequin, plan or secret system or course of;
any info regarding industrial, business or scientific expertise; or
public lending proper in respect of a guide.

There are exclusions for copyright funds regarding cinematographic movies or video recordings, or their soundtracks.

If a cost doesn’t fall inside the provisions of Part 906, it might nonetheless give rise to an obligation to deduct tax at supply underneath:

qualifying annual funds (ITA, Sections 900 and 901);
patent royalties (ITA, Part 903); and
capital funds made for patents (ITA, Part 910).

We think about these in additional element under.

i Qualifying annual funds

Qualifying annual funds are topic to deduction of tax underneath Sections 900 (funds by people) and 901 (different payers) ITA. Underneath Part 899 ITA, a qualifying annual cost should meet the next situations:

it should be an annual cost;
it should come up in the UK;
the cost should be charged to tax underneath varied provisions, together with:

to earnings tax underneath:
ITTOIA, Part 579 (royalties from IP);
ITTOIA, Chapter 4 of Half 5 (telecommunications rights);
ITTOIA, Chapter 7 of Half 5 (annual funds not in any other case charged); or
to company tax underneath Chapter 7 of Half 10 CTA 2009 if the recipient is an organization (annual funds not in any other case charged to tax); and

the cost should not represent curiosity and should not embody sure different funds (e.g., charitable donations).

An annual cost is one that’s payable underneath a authorized obligation and is able to recurring over a interval of greater than 12 months.83 The quantities should be earnings receipts, and never a capital receipt, so a capital quantity paid in instalments wouldn’t represent an annual cost. The quantities should even be ‘pure earnings revenue’ within the fingers of the recipient. Broadly talking, pure earnings revenue involves the recipient with out the recipient having to do something in return. Subsequently, funds for items or providers can’t be an annual cost.84

A person who makes a qualifying annual cost will solely be required to deduct tax if the cost is made for real business causes in reference to the person’s commerce, occupation or vocation.85 There isn’t a comparable take a look at for corporations.

Within the franchising context, that is unlikely to use following the adjustments to the deduction of tax guidelines enacted within the Finance Act 2016. These adjustments successfully broadened the definition of royalty, simplifying the withholding tax therapy the place funds are being made to an individual whose standard place of dwelling is outdoors the UK. Subsequently, funds to non-residents might be coated by Part 906 ITA and funds to UK corporations will usually be excluded from the duty to deduct tax (see Part III.iv). The qualifying annual cost withholding tax cost will due to this fact solely apply the place the franchisor is a UK unincorporated enterprise.

ii Patent royalties

To the extent {that a} patent royalty will not be a qualifying annual cost and isn’t coated by Part 904 (annual funds made in consideration of dividends or exempt consideration, which is unlikely to be relevant within the context of franchising), it might be topic to deduction of tax underneath Part 903 of the ITA. This part applies to a royalty or different sum in respect of using a patent, which arises in the UK and is charged to earnings tax or company tax. Once more, following the 2016 adjustments, this may solely apply the place the franchisor is a UK unincorporated enterprise.

iii Gross sales of UK patent rights

If a UK individual buys rights in a patent from a non-resident vendor that’s chargeable for UK tax in respect of the sale underneath Part 587 of the ITTOIA 2005 or Part 912 of the CTA 2009, then the purchaser is obliged to deduct fundamental price tax from the acquisition worth and account for this to HMRC.86 For these functions ‘patent rights’ means a proper to do or authorise the doing of any factor that, however for the suitable, can be an infringement of a patent, and thus consists of licences. For non-resident sellers the costs solely apply to patents granted underneath UK regulation.

iv Excepted funds

The above necessities to deduct tax underneath Sections 901 (qualifying annual funds), 903 (patent royalties), 906 (IP royalties) and 910 (proceeds of sale of patent rights) don’t apply the place the payer is an organization, native authority or partnership (with a company or native authority accomplice) if such a payer has an inexpensive perception that the cost is an excepted cost and, within the case of deductions underneath Sections 901 and 903, the payer itself has no ‘modified internet earnings’ (calculated underneath Part 1025 of the ITA) that will be topic to earnings tax.

Excepted funds embody funds the place the individual beneficially entitled to the earnings is:

an organization resident in the UK;
an organization not resident in the UK that carries on a commerce in the UK by means of a everlasting institution and the cost might be introduced under consideration in computing the UK chargeable income of the non-resident firm;
a physique of the sort listed in Part 936 of the ITA (broadly, sure public our bodies and entities which can be usually tax exempt; e.g., charities); or
a partnership beneficially entitled to the earnings, every accomplice by which should be an entity inside (a) to (c) or the European Funding Fund.

If the payer ‘moderately believes’ that an exemption applies it might pay gross, but when that perception proves incorrect, the withholding obligation is re-imposed so the payer is in danger. There isn’t a basic mechanism for HMRC to certify that funds could also be made gross underneath these guidelines.

v Supply of royalty

The Finance Act 2016 additionally launched guidelines to outline the supply of royalties or different sums paid in respect of IP the place the payer is non-UK resident however the cost is made in connection partly with a commerce carried on by a UK everlasting institution of the payer. Underneath these new guidelines, the entity might want to apportion on a simply and cheap foundation the proportion of the cost that pertains to the commerce carried on by means of the UK everlasting institution.

vi Anti-treaty procuring guidelines

The 2016 adjustments additionally launched anti-treaty procuring guidelines.87 Underneath these guidelines, aid won’t be out there underneath a double-tax treaty the place a cost to a related individual is made underneath a double-tax treaty tax avoidance association (the place acquiring treaty aid is opposite to the article and objective of the treaty and is the primary, or one of many principal, functions of the preparations) and any tax so deducted will not be creditable towards company tax of a recipient firm.

vii EU Curiosity and Royalties Directive

Council Directive (EC) No. 2003/49 (the Curiosity and Royalties Directive) launched a standard system of taxation relevant to curiosity and royalty funds made between related corporations of Member States. These provisions have drive in the UK (ITTOIA, Sections 757–767 and Part 914 of the ITA) and supply an exemption from earnings tax on royalties the place:

the payer of the royalty is a UK firm or a UK everlasting institution of an EU firm; and
the individual beneficially entitled to the earnings is an EU firm however not such an organization’s UK everlasting institution or non-EU everlasting institution.

Each corporations should be 25 per cent associates, that’s, one firm holds not less than 25 per cent of the capital or voting rights within the different or there should be a dad or mum firm of each corporations that holds such a share in every.

Fee gross is permitted the place the payer moderately believes the exemption applies, however (as for the excepted funds guidelines) the payer is in danger if that perception is wrong. As a sensible matter, if the payee is an EU firm, the payer’s danger could be eradicated because the payee firm might make a declare underneath the relevant double-tax treaty that ought to lead to HMRC issuing a cost route to the payer to use a decreased or zero price of withholding (see additional under).

Underneath the phrases of the UK–EU Withdrawal Settlement, the UK ceases to be a Member State of the EU and UK corporations receiving funds from related corporations in EU Member States will not profit underneath the Curiosity and Royalties Directive. Nonetheless, UK corporations can nonetheless depend on Sections 757–767 ITTOIA and Part 914 ITA to remove withholding tax on funds of royalties to related corporations in EU Member States. Any change to this association would require an extra change to UK home regulation.

viii Double-tax treaties

Royalties paid by a UK resident to a resident of a rustic with which the UK has a double-tax treaty (DTT) could also be exempt from withholding taxes because of the operation of a royalty article of that DTT. Even when the royalty article doesn’t extinguish the withholding tax legal responsibility it should usually impose a restriction on the quantity that may be deducted. There are, broadly talking, three principal kinds of tax treaty upon which most are based mostly; these are the OECD Mannequin Tax Conference, the UN Mannequin Tax Conference (normally adopted by growing nations) and the US Mannequin Tax Conference.

In respect of royalties, Article 12 of the OECD Mannequin Tax Conference supplies as follows:

1 Royalties arising in a Contracting State and beneficially owned by a resident of the opposite Contracting State shall be taxable solely in that different State.
[The UN Model treaty specifically allows tax to be deducted at source up to a percentage.]
2 The time period ‘royalties’ as used on this Article means funds of any form acquired as a consideration for using, or the suitable to make use of, any copyright of literary, creative or scientific work together with cinematograph movies, any patent, commerce mark, design or mannequin, plan, secret system or course of, or for info regarding industrial, business or scientific expertise.
[The US Model treaty also covers ‘other works’ as well as certain gains derived from the alienation of any of the above property. The UN Model treaty also applies the royalty provisions to fees for the use of or right to use industrial, commercial or scientific equipment.]
3 The provisions of paragraph 1 shall not apply if the helpful proprietor of the royalties, being a resident of a Contracting State, carries on enterprise within the different Contracting State by which the royalties come up by means of a everlasting institution located therein and the suitable or property in respect of which the royalties are paid is successfully related with such everlasting institution. In such case the provisions of Article 7 (enterprise income) shall apply.
[The UN Model is similar in this respect save that it also has a carve-out for independent personal services supplied in the state and for other business activities carried on in the state of the same or similar kind as those effected through the permanent establishment.]
4 The place, by cause of a particular relationship between the payer and the helpful proprietor or between each of them and another individual, the quantity of the royalties, having regard to the use, proper or info for which they’re paid, exceeds the quantity which might have been agreed upon by the payer and the helpful proprietor within the absence of such relationship, the provisions of this Article shall apply solely to the last-mentioned quantity. In such case, the surplus a part of the funds shall stay taxable based on the legal guidelines of every Contracting State, due regard being needed to the opposite provisions of this Conference.

A non-resident licensor should, until Part 911 of the ITA applies (see under), make an utility to its personal home tax authorities claiming aid underneath the related article of the DTT and demonstrating that it fulfils the necessities of that article. Following the BEPS, 82 international locations (together with the UK) signed an MLI to amend their DTTs. These adjustments tackled a lot of key motion factors arising from the BEPS venture, one in every of which is ‘treaty procuring, specifically placing an organization in a jurisdiction to make the most of its DTT community. The place each events to a DTT have signed and applied the MLI, that DTT will now embody a ‘principal objective take a look at’, which successfully denies treaty advantages the place it’s ‘cheap to conclude that getting that profit was one of many principal functions of any association or transaction’. Even with out the principal objective take a look at, if the recipient is a ‘conduit’ automobile, it might wrestle to fulfill the helpful possession requirement following the case of Indofood Worldwide Finance Ltd v. JPMorgan Chase Financial institution NA.88 This UK case (the precept by which is being utilized usually by many tax authorities – though cf. the Canadian circumstances of Prevost89 and Velcro90) means that the which means of helpful possession in tax treaties is extra restricted than the authorized take a look at and won’t apply the place a conduit automobile has back-to-back preparations to pay on receipts of curiosity or royalties.

As soon as glad the treaty situations apply, the non-resident’s tax authority will certify to HMRC that the licensor is entitled to aid underneath the related DTT and HMRC will then direct the payer to make future funds on the price specified underneath the related DTT.

Underneath Part 911 ITA, a UK firm that makes a cost of royalties in any other case topic to deduction of tax might, if it thinks match, calculate the sum of earnings tax to be deducted by reference to the speed relevant within the related tax treaty (if decrease than the UK price) and make the cost on that foundation (that’s, with out receiving a cost route from HMRC following a treaty declare). Nonetheless, the corporate should moderately imagine that, on the time the cost is made, the payee is entitled to aid in respect of the cost underneath a related tax treaty. As earlier than, the payer is in danger if the payee will not be entitled to a decreased price of withholding underneath the treaty. Nonetheless, the payee could make a declare underneath the treaty that may end result within the payer receiving a route to pay at a decreased price from HMRC and therefore, if there may be any doubt, mitigate danger.

ix Offshore receipts

Initially proposed as an extension to royalty withholding tax, new guidelines enacted by Part 15 of and Schedule 3 to the Finance Act 2019 impose an earnings tax cost on gross receipts acquired by a non-UK entity the place that entity owns IP used to generate gross sales income in the UK. Though not technically a withholding tax, the tax (which got here into impact on 6 April 2019) is collected by means of self-assessment from the non-UK resident, however members of the identical ‘management group’ (see under) are collectively and severally liable. The principles have been designed to focus on multinational teams that maintain intangible property in low-tax offshore jurisdictions and use that IP to generate income from UK prospects or present gross sales within the UK. They aim teams that realise earnings from UK gross sales in low-tax offshore jurisdictions that should not have a full tax treaty with the UK.

There are three exemptions from the earnings tax cost: the place the overseas tax is not less than half of the UK tax, the place there may be enterprise undertaken within the non-UK territory and the place the UK gross sales don’t exceed £10 million within the 12 months.

These guidelines are focused at multinational teams, however franchisees must be conscious that the joint and a number of other legal responsibility provisions are broadly drawn (Part 608O ITTOIA). If the tax stays unpaid for six months after the payable date, the UK tax authorities can accumulate that tax from an individual in the identical management group because the non-UK resident entity at any time within the tax 12 months to which the cost applies. Part 608S ITTOIA supplies that two individuals might be in the identical management group if they’re consolidated for accounting functions, one in every of them has a 51 per cent funding within the different, or a 3rd individual has a 51 per cent funding in every of them.

x Points regarding royalty funds within the franchising context

A significant element in any franchising settlement might be a cost of royalties to be used of the model and different IP licensed to the franchisee. As acknowledged above, a franchisee paying a royalty to be used of IP might need to deduct tax at supply. The way by which a deduction might be required will depend upon the kind of IP and the residence of the payee. Within the context of a franchising association, funds are more likely to be made to a company franchisor that may both be UK tax-resident or non-resident. Funds to UK tax-resident company franchisors by UK franchisees shouldn’t give rise to any withholding tax points.

If the cost is to a non-UK tax-resident firm by a UK-based franchisee, withholding tax applies to all royalties and different funds in respect of IP. Assuming that the recipient will not be buying and selling in the UK by means of a everlasting institution, royalties will give rise to an obligation to deduct tax until the UK guidelines are overridden by a tax treaty or, assuming there is no such thing as a particular change of regulation post-Brexit and there’s a adequate connection, the Curiosity and Royalties Directive (as applied into UK regulation in ITTOIA and ITA).

In any occasion, the franchisor might be finishing up important actions underneath the franchising settlement, together with exercising management capabilities and offering help and help providers on a recurring foundation. The way by which the franchisor carries out these capabilities might give rise to a everlasting institution of the franchisor in the UK. On this occasion, the funds could also be handled as acquired by such a everlasting institution and due to this fact as excepted funds.

Because the franchisee’s obligation to deduct tax at supply is closely depending on the franchisor’s tax standing (e.g., whether or not it has a taxable everlasting institution in the UK), the franchisee should examine the therapy of the funds it makes on this respect to make sure that it appropriately deducts and accounts for any tax. If the franchisee fails to deduct tax at supply, it should nonetheless need to account for the tax to HMRC along with curiosity and penalties. It might, relying on the phrases of the settlement, have the ability to deduct the quantity it has did not deduct at supply from future funds, however that is more likely to be potential solely the place there was a real error of reality.91 Moreover, the franchisee might underneath the phrases of the franchising settlement have a ‘gross-up obligation’ for any tax deducted on funds. Whereas an settlement to pay royalties with out deducting tax underneath Part 906 is void underneath Part 909 of the ITA, that is unlikely to use to a gross-up provision as such a provision will improve the quantity payable and due to this fact additionally improve the tax deducted at supply – so it isn’t an settlement to pay with out deduction of tax.

In apply, even the place UK regulation dictates that there must be a deduction of tax at supply for the royalty aspect of any charges, an acceptable DTT might nicely apply to provide rise to zero or a decreased price of withholding tax. Underneath Part 911 the payer needn’t deduct tax as long as it moderately believes that on the time the cost is made the payee is entitled to aid underneath an relevant DTT. The franchisee ought to due to this fact search to make sure that the franchisor (or if completely different, the related entity licensing the IP rights) advantages from aid underneath the relevant treaty. This will likely embody ascertaining its nation of residence, guaranteeing it’s taxable in that nation underneath related guidelines (e.g., not receiving the earnings in a department in a 3rd nation that’s exempt from tax within the nation of residence), guaranteeing that the royalties are ‘beneficially’ owned by the recipient for treaty functions and that the franchisor doesn’t have a everlasting institution in the UK or, if it does, that the royalties will not be successfully related with such a everlasting institution, in addition to ascertaining whether or not anti-avoidance guidelines, similar to Part 917A ITA, apply. In addition to investigating the franchisor’s potential to acquire treaty aid, the franchisee might search to acquire guarantee safety on this respect underneath the franchising settlement.

IV Tax ideas for franchisors

i Tax therapy of receipts

Though UK franchisors might be taxable on all charges acquired or receivable, the character of such taxation will depend upon the kind of price. A UK franchisor will due to this fact must understand how its charges are to be handled for tax functions.

On this respect a typical franchise settlement will comprise charges payable for the next:

providers;
reimbursement of bills;
royalties to be used of logos;
funds for know-how;
funds for show-how;
patent royalties;
funds for copyrighted materials (e.g., instruction manuals); and
contributions to promoting supplies.

The charges are more likely to comprise each an preliminary price and common ongoing funds. In apply, the charges are sometimes not separated out within the above constituent parts within the documentation however are merely an ‘preliminary price’ and ongoing ‘service charges’ plus extra quantities for reimbursement of expenditure and contributions to promoting.

As we’ve got seen, a UK franchisor will, broadly talking, be paying company tax on all its income albeit underneath completely different charging provisions. UK franchisors will usually be carrying on a commerce in the UK and their income might be topic to company tax as buying and selling income.

For UK franchisors whose IP was created or acquired on or after 1 April 2002, the income and losses regarding any intangible property might be calculated underneath the intangible mounted asset regime whether or not the receipt is capital in nature or not, however such income and losses will in any occasion be taxed as a part of the franchisor’s buying and selling income to the extent that the related IP property are held for the needs of a commerce carried on by the transferor,92 which is able to nearly definitely be the case. Subsequently, the franchisor must be topic to company tax on the income in its accounts topic to any normal tax changes (e.g., for disallowable expenditure or switch pricing). If the transaction includes a ‘realisation’ of a rechargeable intangible asset, then it’s potential {that a} tax cost underneath the chargeable intangible property regime might qualify for rollover aid if reinvested in new IP.93 Nonetheless, realisation for the needs of those guidelines means a transaction ensuing, in accordance with usually accepted accounting apply, within the asset ceasing to be on the corporate’s stability sheet or in a discount within the accounting worth of the asset (or would do if it had a stability sheet worth).94 On this foundation it’s unlikely within the overwhelming majority of franchising preparations {that a} realisation would happen for the needs of those guidelines in respect of its actions carried out in the midst of its basic franchising enterprise.

UK franchisors, whose IP doesn’t fall inside the intangible mounted property regime, might must analyse transactions in additional element to find out the style of taxation. For a lot of franchisors, HMRC are more likely to settle for that each one charges merely represent a part of the franchisor’s buying and selling income for company tax functions so in apply, within the overwhelming majority of circumstances, the tax therapy would be the similar as for these within the intangible mounted property regime. Franchisors might, nevertheless, search to separate the charges into their element components and tax them accordingly. If HMRC or a taxpayer want to segregate the earnings between buying and selling and different parts, the allocation would should be an inexpensive apportionment and justifiable.95 If the related IP property are segregated from the commerce (e.g., held in a unique firm from the workers chargeable for offering providers), then a extra detailed evaluation of the parts of any cost might be obligatory.

Ought to the consideration be break up into its element parts these may very well be taxed as follows.

Preliminary price

If payable to a buying and selling firm moderately than an IP holding firm, that is more likely to represent a buying and selling receipt. Arguably there could also be a capital sum for a component disposal of goodwill or a capital sum derived from an asset and taxable underneath Part 22(c) or (d) or Part 29(5) of the TCGA. The place the franchise pertains to a brand new jurisdiction, it will likely be troublesome to say that there was any disposal of a capital asset; HMRC’s view is that there’s not usually any discount within the franchisor’s goodwill because of getting into into any new franchise agreements – quite the opposite its goodwill is normally enhanced.96 Moreover, underneath regular ideas it might usually be troublesome to say for a franchisor that the charges it generates are capital in nature. Subsequently, the cost is most certainly to be liable to company tax on earnings as a buying and selling revenue moderately than a capital receipt. HMRC in its steering cites Jeffrey v. Rolls-Royce97 as authority for treating the preliminary price as a buying and selling receipt in regular circumstances. Particularly, it highlights that on this case (regarding disposals of know-how that had been handled as earnings) the circumstances have similarities to many franchising circumstances, particularly:

the transactions had been repeated;
there was a deliberate coverage of growth by granting licences;
advantages aside from know-how had been supplied; and
no capital asset diminished in worth.98

It’s irrelevant that the cost is in instalments.99

Nonetheless, if it may be proven that there was a component disposal of current goodwill, then this may very well be taxed inside the capital good points guidelines – for instance the place the franchisor disposes of current buying and selling websites to a franchisee. To the extent that there was a disposal of goodwill topic to capital good points tax (or company tax on chargeable good points), then any acquire may very well be topic to rollover aid if the franchisor reinvests the acquire in chargeable intangible property 12 months earlier than or inside three years after the disposal.100 Equally, if there was a realisation of goodwill or different IP inside the intangible mounted asset regime, the acquire could be rolled over into a brand new chargeable intangible asset.101

Know-how

A disposal of know-how could also be taxed as earnings underneath Part 908 of the CTA 2009 or as a part of the buying and selling income of the corporate underneath Part 177(2) of the CTA 2009 (disposal of know-how the place commerce continues). This won’t, nevertheless, be the case the place the know-how has certified for capital allowances and is introduced under consideration underneath Part 462 of the CAA 2001, or it’s taxed on disposal of a commerce as a part of the goodwill of the commerce underneath Part 178 of the CTA 2009 or the disposal is a sale between related individuals.

Present-how

Charges for coaching the franchisee’s employees and ongoing coaching will usually be a part of the buying and selling receipts of the franchisor.

Promoting funds

The place franchisees contribute to central promoting prices incurred by the franchisor, the receipts will sometimes be income receipts taxable as buying and selling income with a corresponding deduction allowed for the promoting spend. One would anticipate the earnings and expenditure to be matched for accounting functions and usually one would anticipate promoting expenditure to be an earnings expense such that there is no such thing as a internet tax payable (until the franchisor is receiving greater than it’s spending). To the extent that the expenditure has not been paid, any provision within the accounts will should be sufficiently correct to permit a deduction.102

Capital funds in respect of patent rights

The place patent rights are transferred, any receipt might give rise to a taxable receipt underneath Part 912 of the CTA 2009, unfold over six years until tax is elected to be paid earlier.

Royalties

As acknowledged, apart from franchisors that will maintain the IP individually from the remainder of the commerce, all receipts are more likely to represent taxable buying and selling income. Subsequently, characterising the receipts as royalties is unlikely to have a sensible impact for company tax functions.

Premises

Sure franchisors will search to offer a franchisee with suitably fitted out and branded premises. The tax therapy of any charges for doing this may depend upon the character of those preparations.

ii Worldwide points

We now have a look at the choices out there for a UK taxpayer when carrying on a global commerce. If the franchisor is finishing up its full franchising enterprise, together with offering providers and licensing all IP from one entity in the UK, it will likely be receiving the above combined provide of providers and funds to be used of IP. Assuming that the franchisor’s actions will not be undertaken by means of a everlasting institution in a unique jurisdiction, the charges ought to all be taxable underneath the UK company tax guidelines both as buying and selling earnings, income from IP or doubtlessly, for the preliminary price, chargeable good points (if the franchisor’s IP is pre-April 2002 IP).

There was a distinction between overseas supply earnings and UK supply earnings. This distinction, broadly talking, disappeared for company tax functions when the tax guidelines had been rewritten into CTA 2009 and CTA 2010. Subsequently, all buying and selling earnings is handled underneath the identical provisions of CTA 2009, as is all IP earnings. There may be now not a basic distinction between UK and overseas supply earnings besides that double-tax aid is on the market on foreign-sourced earnings.

Double-tax aid in the UK takes two types: treaty aid and unilateral aid. Treaty aid is aid granted underneath an relevant double-tax treaty. Part 2 of the Taxation (Worldwide and Different Provisions) Act 2010 (TIOPA) supplies for double-tax preparations in respect of a territory outdoors the UK with a view to affording aid from double taxation to have impact by way of an Order in Council. The taxes coated by such preparations embody earnings tax, company tax, capital good points tax and taxes imposed outdoors the UK of an identical character to those taxes. In addition to invoking the ‘royalties’ provision of any relevant tax treaty, a lot of different provisions could also be relevant to a franchisor, similar to (within the case of the OECD Mannequin Treaty):

Article 7 (Enterprise Earnings) – which, broadly talking, restricts the suitable of a territory to tax enterprise income until earned by means of a everlasting institution in that territory (which is in flip outlined in Article 5);
Article 13 (Capital Positive factors) – which once more restricts the suitable of a territory to tax capital good points to these accruing to a everlasting institution in that territory though on this case it may well additionally tax good points from immovable property located in that territory; and
Article 23 (Double Taxation) – which seeks to keep away from double taxation and supply aid by means of exemption or credit score.

Unilateral aid (i.e., double-tax aid given within the absence of any safety underneath a double-tax treaty) is supplied underneath Part 9 of the TIOPA in respect of earnings ‘arising’ and good points ‘accruing’ within the territory for which tax aid is sought. Unilateral aid is supplied in respect of tax on earnings or capital good points that corresponds to earnings tax, capital good points tax or company tax and consists of state, provincial or native earnings taxes or taxes levied by a municipality or another native physique.103

Double-tax aid could be problematic within the following respects:

the place the receipts relate to a commerce exercised in the UK, HMRC might search to argue that the supply of the earnings is the UK commerce and never the funds for IP arising offshore. Equally the place the IP rights are, say, UK registered rights for which the franchisor might however has not but made subsequent registrations domestically, then arguably the supply of the earnings can be the UK rights. In these circumstances earnings from abroad franchisees is technically UK supply earnings. Nonetheless, that is coated by extra-statutory concession B8.104 This states as follows:
A UK resident might obtain earnings consisting of royalties or ‘know-how’ funds from a overseas resident. Whereas particularly circumstances there could also be particular circumstances that may require to be taken under consideration, typically such earnings must be handled as follows.
a) Funds made by an individual resident out of the country to an individual carrying on a commerce within the UK as consideration for using, or for the privilege of utilizing, within the overseas nation any copyright, patent, design, secret course of or system, trademark or different like property could also be handled for the aim of credit score (whether or not underneath double-taxation agreements or by the use of unilateral aid) as earnings arising outdoors the UK, besides to the extent that they characterize consideration for providers (aside from merely incidental providers) rendered on this nation by the recipient to the payer. b) Merchants resident within the UK will not be entitled to say credit score for any tax which is levied within the overseas nation in respect of funds for providers that are rendered within the UK and will not be merely incidental providers. In any such case the web quantity of the cost (after deduction of any overseas tax borne by them on the funds) is included within the computation of income for UK tax functions.
The prohibition on credit score for overseas tax charged on funds for providers rendered within the UK could also be overruled by the phrases of these double-taxation agreements which have a royalties Article which incorporates technical providers within the definition of royalties (see INTM153130) or a separate technical charges Article (see INTM153140) and people agreements deem the supply of such funds to be within the nation of which the payer is a resident. In such circumstances, though the providers are rendered within the UK, credit score is due for the overseas tax charged on these funds.
If the proprietor of a proper similar to a patent, trademark or copyright will not be engaged in any commerce to which the suitable relates however derives earnings by exploiting that proper, the supply of the earnings could also be regarded for the aim of credit score as positioned within the nation the place the suitable is enforceable.

The place a franchisor is offering providers in addition to IP from the UK, any native tax deducted at supply on the service aspect won’t qualify for double-tax aid as a credit score until particularly allowed as technical providers underneath an acceptable double-tax treaty or until it’s merely incidental to the availability of IP. Within the absence of a credit score aid the overseas tax could also be handled as a deduction from earnings.105
The place the franchisee has sub-franchisees in a unique jurisdiction, aid might not be out there. Unilateral aid for overseas tax in a territory is supplied towards earnings ‘arising’ within the territory. On this case, relying on how the preparations are structured, the sub-franchise earnings might not be earnings of the franchisor however of the franchisee and it might not come up within the ‘territory’ however in a 3rd nation. This place is relaxed within the uncommon circumstance {that a} franchisee is within the Isle of Man or the Channel Islands as there is no such thing as a requirement for earnings to come up in these territories to permit credit score for tax charged there.106 Equally, tax treaties may even present double-tax aid for losses within the different treaty state. Care ought to due to this fact be taken to keep away from this case or to make sure that the suitable tax leakage is handled appropriately within the related documentation. To the extent that aid will not be out there, once more the tax could also be deductible as an expense of the commerce.
Unilateral aid supplies credit score for abroad tax calculated by reference to earnings arising or a acquire accruing towards UK tax calculated by reference to that earnings or acquire. Equally, treaty aid is restricted to aid towards UK tax arising on the identical supply of earnings as bears the tax. Subsequently, if an organization with overseas supply earnings doesn’t have any UK tax to bear (e.g., as a result of there are deductible bills or buying and selling losses to set towards it), the credit can’t be used towards different sources of earnings (e.g., if the double-tax aid is towards buying and selling income, it can’t be used towards funding earnings).

V Franchisor structuring

Over the previous 40 years, as companies have grow to be more and more cell and worldwide, and significantly for the reason that digitalisation of the economic system, multinational operations have more and more used tax planning as a device to maximise their after-tax returns. There was a recreation of cat and mouse between multinational operations and the income authorities as extra subtle buildings have grown as much as minimise taxes, tax authorities have launched guidelines to dam such buildings and well-advised companies have launched much more subtle tax buildings and mitigation methods to beat such guidelines.

As we speak, with a troublesome worldwide financial state of affairs and the tight budgetary situations going through many Western economies, politicians, press and public are more and more scrutinising the tax affairs of multinational corporations. That is significantly the case within the sectors of the economic system that rely closely on intangible property similar to manufacturers which can be extremely cell and that may, if positioned in low-tax jurisdictions with minimal substance necessities, have a dramatic downward impact on a bunch’s efficient company tax price.

This growing scrutiny is resulting in elevated crackdowns on worldwide tax avoidance behaviour and tax arbitrage, with measures such because the BEPS venture, which is being run by the OECD and G20 (see Part V.iv). On the similar time, nevertheless, many governments are looking for to cut back company tax charges and supply company tax incentives to draw inward funding. In an space similar to franchising, the place income considerably derive from IP, there have been historically important alternatives to find IP in a low-tax jurisdiction to minimise taxes. Nonetheless, the impact that an excessively aggressive tax construction might have on status is turning into a key enterprise concern, significantly for consumer-facing companies.

This part provides a basic overview of the tax methods a franchisor might think about in seeking to cut back its efficient tax price and descriptions the anti-avoidance guidelines which were launched to restrict overly aggressive planning.

A typical type of tax planning for franchisors was to take their IP and operations offshore from the UK to a jurisdiction with a decrease tax price. By doing this they’d hope that earnings may very well be rolled up in a lower-taxed jurisdiction thus avoiding or not less than deferring UK tax.

For tax functions, a related IP holding entity (IP Co) ideally shouldn’t be topic to:

income tax in that entity;
withholding taxes on funds by that entity (e.g., dividends or curiosity); and
withholding taxes on royalty funds to that entity.

Subsequently, tax planning would contain contemplating which entity can be efficient in decreasing income tax and withholding tax, thereby helping to decrease the efficient price.

This entity might both be:

an entity topic to tax (taxable entity) similar to an organization included in the UK; or
an entity not topic to tax (non-taxable entity) similar to an organization included in a tax haven.

As tax havens should not have first rate tax treaty networks, withholding taxes might dictate having an entity with a low degree of taxation within the construction (and due to this fact entry to a tax treaty community). Examples of related jurisdictions that will meet these standards are the UK, Luxembourg, Belgium, the Netherlands, Cyprus and Eire. The supply of sure tax benefits in these jurisdictions might, relying on the circumstances, give rise to a aggressive efficient tax price. Such benefits to be thought-about might embody:

a low company tax price on royalty earnings;
the provision of aid – the ‘taxable’ jurisdiction might provide engaging aid for holding IP or enterprise analysis and improvement (R&D) actions. For instance, ‘patent field’-type regimes in the UK, Netherlands, Belgium and Luxembourg give rise to low tax charges or partial exemption for sure kinds of IP royalties. The states can also present taxable amortisation of bought IP, precise and in sure circumstances deemed deductions for curiosity bills and R&D tax credit; and
the provision of double-tax treaties or the EU Curiosity and Royalties Directive to cut back withholding taxes and maximise double-taxation aid, as detailed in Part III.vii.

An more and more vital issue to keep in mind when wanting on the location of any automobile is that the automobile is more likely to require ‘substance’ to acquire the related tax advantages. It’s due to this fact nearly at all times higher to find corporations in jurisdictions the place there are folks with the requisite abilities and expertise to handle the enterprise carried on by such an organization. This requirement for substance has been significantly enhanced following the BEPS venture (e.g., the brand new switch pricing regime for intangibles).

If IP is held in a taxable construction, tax planning will focus round minimising the tax price (e.g., utilizing particular tax regimes relevant in that jurisdiction), maximising reliefs (e.g., amortisation of acquisition price, R&D reliefs and finance prices) and avoiding withholding taxes.

For an IP Co to be tax-efficient, the licensees can be residents of jurisdictions that don’t apply withholding tax on funds to the IP holding automobile or which have appropriate double-tax treaties to cut back or remove any withholding tax.

One additional solution to cut back withholding taxes was through the use of one other entity (royalty firm) by means of which the royalties would stream. By flowing the royalties by means of a royalty firm (1) with an appropriate tax treaty with the licensee’s jurisdiction (eliminating or decreasing withholding taxes on royalties); and (2) included in a rustic that doesn’t levy withholding tax on royalty funds (or has an appropriate tax treaty with the jurisdiction by which the IP Co is positioned), withholding taxes on the royalties may very well be mitigated (topic to anti-avoidance guidelines).

Nonetheless, varied tax treaty provisions stop ‘treaty procuring’. Once more, the BEPS venture has made planning by means of ‘conduit’ and comparable buildings tougher, because it has resulted within the inclusion in tax treaties of varied provisions that stop treaty abuse. Moreover, anti-avoidance guidelines might apply to disclaim treaty advantages or the tax authorities might not view the royalty firm as being entitled to the royalties for treaty functions.107

If a UK entity had been to arrange a construction with an offshore subsidiary IP Co or royalty firm, the next hurdles would should be overcome to realize its goals:

Tax cost on switch of IP: if any of the IP transferred has a price then the switch is more likely to be taxable; if the franchisor is ready to just accept some tax now to enter into the construction what can be the extent of taxation?
Managed overseas firm (CFC) guidelines: if the IP is in an offshore entity, might its income in any occasion be attributed to the UK underneath CFC or comparable guidelines?
Substance: will the offshore firm be handled as non-resident or buying and selling in the UK by means of a everlasting institution in any occasion and can it have adequate substance to be seen because the proprietor of the IP and to profit from tax treaties and many others.?
Diverted income tax: this is applicable to sure buildings that should not have adequate financial substance or that artificially keep away from having a everlasting institution in the UK.

As well as, all related anti-avoidance measures and the offshore receipt guidelines (see Part III.ix) would should be thought-about intimately and overcome. In abstract, it’s more and more troublesome for a UK enterprise to switch its IP out of the UK to minimise the enterprise’s efficient tax price.

i Tax costs on transferring IP to an offshore licensing entity

A taxable acquire could also be crystallised when a franchisor disposes of the related property to an offshore firm. In looking for to switch IP to an offshore entity, the franchisor must think about the property to be transferred rigorously.

If we think about the character of the property to be transferred, every can have a barely completely different therapy when looking for to both switch the asset or just register new lessons of such IP in an offshore jurisdiction. On this respect it must be borne in thoughts that completely different IP has completely different traits. Goodwill could be very native to a enterprise or it may be worldwide; patent rights, nevertheless, can’t be enforced outdoors the jurisdiction of registration however might confer precedence registration rights abroad. A franchisor seeking to switch IP offshore will due to this fact need to analyse rigorously every asset from each a authorized and an financial perspective to find out whether or not any worth is being transferred to the offshore entity and whether or not such a switch is due to this fact taxable (both as a result of the offshore acquirer pays a market worth or is deemed to take action underneath switch pricing or comparable guidelines).

Particularly, completely different property might be taxed as follows:

for buying and selling corporations topic to the intangible mounted asset regime, disposals of intangibles might be taxed as buying and selling revenue underneath Half 8 CTA 2009. Rollover aid underneath Chapter 7 of Half 8 might apply if the proceeds of sale (if any) are reinvested in intangibles; and
for intangible property that aren’t within the above regime, the tax therapy might be as described above, that’s:

goodwill might be taxed as a capital good points asset and might be taxed underneath Part 21, Part 22(c) or (d) or Part 29(5) of the TCGA with arm’s-length pricing substituted if obligatory by Part 17 of the TCGA;
patents might be topic to tax both as a buying and selling revenue or underneath Part 912 of the CTA 2009 with tax being doubtlessly unfold over six years. Probably, if capital allowances have been claimed, an quantity might should be introduced under consideration underneath the capital allowance guidelines;
know-how: Part 177, the power to elect underneath Part 178 and Sections 908–910 of the CTA 2009 won’t apply to transfers between related events. On this occasion, the switch will both represent buying and selling income, give rise to a rechargeable acquire or be taxed underneath the capital allowance guidelines relying on the circumstances; and
copyright, logos, designs and design rights will equally be taxed both as buying and selling earnings or underneath chargeable good points guidelines.

The place an organization has a stable UK enterprise however is seeking to broaden internationally by means of franchising preparations, it might search to separate its IP between that which pertains to the UK and that which pertains to jurisdictions outdoors the UK. It might then search to switch the non-UK IP to a tax-friendly jurisdiction and argue that the non-UK IP has no or little worth on the time of such a switch. Whether or not or not that is justifiable is a query of valuation, which is able to depend upon the extent to which the franchisor has already carried on any commerce overseas or has any pre-existing enforcement rights within the related offshore jurisdictions, together with precedence registration rights. This may fluctuate between completely different lessons of IP. Nonetheless, the ‘substance’ necessities (see Part V.v) will make this troublesome to realize until actual business actions are additionally positioned in that jurisdiction.

Ought to there be any taxable revenue or acquire on the switch, the franchisor will look to see whether or not it has any tax property (similar to losses) that it may well utilise towards a acquire. Firms seeking to migrate their property offshore can also think about the reorganisation guidelines outlined above to find out if they might achieve this with out crystallising a tax cost. It must be borne in thoughts, nevertheless, that lots of these guidelines require a bona fide (and never a tax avoidance) intention to fall inside the related provisions.108 Alternatively, a franchisor might think about licensing the IP in a fashion that doesn’t give rise to a disposal of the asset however that offers rise to tax on the licence charges over a lot of years. Whether or not a licence quantities to a disposal is determined by its phrases and whether or not the receipt falls into earnings or capital as set out above. An unique licence for a protracted interval is more likely to represent a disposal whereas a non-exclusive licence for a brief interval will not be.

ii Managed overseas firm guidelines

Underneath the UK’s CFC guidelines contained in Half 9A of the TIOPA 2010, if an organization resident outdoors the UK is managed by individuals resident in the UK, then the income of the non-resident firm (along with any creditable native tax) could be apportioned to UK tax-resident company shareholders and charged to UK tax.

Management by UK individuals consists of circumstances the place an organization is managed by two shareholders every holding 40 per cent or extra of the controlling rights and one in every of which is resident in the UK. The principles are designed to focus on transactions that artificially divert income from the UK.

The principles regarding CFCs are extremely technical and detailed (and due to this fact past the scope of this chapter). Nonetheless, there are a variety of useful exemptions that remove this cost. The primary entity-level exemptions to a CFC apportionment are:

the exempt interval exemption: broadly talking permitting a interval of grace of not less than 12 months from coming underneath UK possession;
the excluded territories exemption: this exempts corporations resident in sure territories from the CFC guidelines supplied:

the CFC’s ‘dangerous’ earnings (e.g., earnings that’s exempt from tax domestically) will not be over 10 per cent of its accounting income or if extra, £50,000; and
the CFC doesn’t have important IP earnings that derives from IP transferred from associated individuals resident in the UK (or if not so resident, the IP was held for a everlasting institution of such individuals in the UK) or IP that in any other case derives from IP held by such individuals;

the low income exemption: broadly talking this is applicable the place the CFC both has:

income of lower than £50,000; or
income of lower than £500,000 of which not more than £50,000 are non-trading income;

the low revenue margin exemption: the place the CFC’s income will not be greater than 10 per cent of its related working expenditure; and
the tax exemption: the place the CFC’s tax is not less than 75 per cent of what the corresponding UK tax on such income would have been.

Anti-avoidance guidelines connect to stop the exemptions making use of in abusive conditions.

Even when the CFC will not be exempt underneath the above guidelines, its income are solely apportioned to related UK shareholders and topic to tax underneath the CFC guidelines to the extent that these income fall inside one of many ‘gateways’. CFC gateways embody:

income attributable to UK actions;
non-trading income;
buying and selling finance income;
captive insurance coverage enterprise; and
sure subsidiaries of FSA-regulated corporations.

Of most relevance for franchising actions would be the first two of those gateways. If an organization’s income meet a lot of exams as to non-attribution to the UK, it won’t fall inside this primary gateway. One among these exams is an IP situation that’s much like the above IP take a look at within the excluded territories exemption.

The intention behind these exemptions and gateways is to cease the CFC guidelines catching commercially pushed buildings. Nonetheless, due to the complexity of those guidelines they might catch what would possibly appear to be business buildings and due to this fact should be thought-about in all circumstances the place corporations are owned straight or not directly by UK corporations.

iii Diverted income tax

This tax applies the place:

funds are made by a UK resident (or the UK everlasting institution of a overseas firm) to a different individual that lacks financial substance and there may be an efficient tax mismatch, and it’s cheap to imagine that with out the tax profit the earnings wouldn’t have been diverted from the UK; or
a overseas firm artificially avoids having a everlasting institution in the UK.

The place the principles apply, a tax cost at 25 per cent applies to the quantity of income that will in any other case have been taxed in the UK. Within the case of the prevented everlasting institution, the DPT guidelines additionally cost to tax any royalties that will have been deemed to be payable had there been a UK everlasting institution. The principles don’t apply:

to SMEs (i.e., the place, with sure related individuals there are fewer than 250 staff and both the annual turnover doesn’t exceed €50 million or an annual stability sheet doesn’t exceed €43 million;
the place a everlasting institution is prevented and UK gross sales don’t exceed £10 million and UK-related bills don’t exceed £1 million in a 12-month accounting interval; and
the place the ‘diverted income’ are taxed by an quantity equal to not less than 80 per cent of the UK tax that will have been payable.

iv Anti-avoidance

It’s clear that there would, within the absence of guidelines on the contrary, be important scope for tax planning as the character of IP property implies that they’re simple to maneuver throughout borders.

The historic method to judicial intervention in tax avoidance circumstances could be seen in IRC v. Duke of Westminster,109 when Lord Tomlin mentioned: ‘Each man is entitled if he can to order his affairs in order that the tax attaching underneath the suitable Acts is lower than it in any other case can be.’ This method gave rise to a literal interpretation of tax laws, permitting buildings to be simply devised that circumvented the related laws. Nonetheless, fashionable jurisprudence, following a line of circumstances, together with Ramsay (WT) Ltd v. IRC,110 Furniss v. Dawson111 and Barclays Mercantile Enterprise Finance v. Mawson,112 has taken a extra purposive interpretation of tax laws. As Lord Nicholls says in Barclays Mercantile Enterprise Finance v. Mawson:

The essence of the brand new method was to provide the statutory provision a purposive development to find out the character of the transaction to which it was supposed to use after which to resolve whether or not the precise transaction (which could contain contemplating the general impact of a lot of parts supposed to function collectively) answered to the statutory description.

The courts are due to this fact not ready to take a blinkered have a look at every transaction however will think about a tax avoidance scheme as an entire. An instance of the present method in overcoming a tax avoidance scheme could be seen in Astall & One other v. HM Income & Customs.113 An instance of the boundaries of such an method, the place it was not potential to interpret the aim of the laws, could be seen within the case of Mayes v. HMRC.114

Any tax planning and structuring in respect of franchising preparations and IP licensing buildings ought to due to this fact at all times think about whether or not what’s deliberate falls inside the related laws after taking a purposive interpretation of that laws.

Additional particular anti-avoidance guidelines have been developed to catch the extra apparent schemes which were devised. In any given state of affairs, all related particular anti-avoidance guidelines, generally referred to as focused anti-avoidance guidelines (TAARs), will should be thought-about. As this isn’t a tax textbook, we won’t think about all potential TAARs on this chapter. There are additionally guidelines whereby sure kinds of tax avoidance schemes need to be notified to HMRC.115

Moreover, the UK has a basic anti-abuse rule (GAAR) that might apply to any given transaction and would should be thought-about critically by anyone looking for to implement any tax planning. The main points of the GAAR are set out in Half 5 Finance Act 2013. The GAAR applies to counteract tax benefits arising from tax preparations which can be abusive.116

‘Tax preparations’ for the needs of the GAAR are preparations of which it might be cheap to conclude, having regard to all of the circumstances, that the acquiring of a tax benefit was the primary objective or one of many principal functions. Such preparations are abusive if they’re preparations the getting into into or finishing up of which can’t moderately be considered an inexpensive plan of action in relation to the related tax provisions having regard to all of the circumstances, together with whether or not:

the substantive results of the preparations is in line with any ideas on which the provisions are based mostly and the coverage aims of the provisions;
there are contrived or irregular steps; and
the preparations are supposed to take advantage of shortcomings within the provisions.

Examples of issues that may point out that tax preparations are abusive embody income being considerably lower than financial income, deductions considerably higher than financial prices or claims for tax credit regarding taxes which can be unlikely to be paid. In distinction, compliance with HMRC apply is indicative that preparations will not be abusive.

Quite a lot of taxpayer safeguards are constructed into the GAAR, together with:

requiring HMRC to determine that the preparations are abusive;117
making use of a ‘double reasonableness’ take a look at. This requires HMRC to indicate that the preparations ‘can’t moderately be considered an inexpensive plan of action’;118
permitting the courtroom or tribunal to consider any related materials as to the aim of the laws that it’s prompt the taxpayer has abused, or as to the kind of transactions that had grow to be established apply on the time when the preparations had been entered into;119 and
requiring HMRC to acquire the opinion of an unbiased advisory panel as as to if an association constituted an inexpensive plan of action, earlier than they’ll apply the GAAR.120

The laws can also be supported by detailed steering guidelines issued by HMRC. In respect of worldwide tax planning the steering notes state:121

B5.1 There’s a community of treaties between States setting out guidelines that govern the taxation of funding and enterprise actions involving a couple of State. These treaties (that are sometimes based mostly on an OECD Mannequin Treaty) are normally known as ‘double-tax treaties’, and their objective is to keep away from subjecting such investments or actions to tax in a couple of State and to stop tax evasion. The UK has entered into over 100 such treaties, and they’re given impact in home tax regulation.
B5.2 Lots of the established guidelines of worldwide taxation are set out in double-taxation treaties. These cowl, for instance, the attribution of income to branches or between group corporations of multinational enterprises, and the allocation of taxing rights to the completely different States the place such enterprises function. The truth that preparations profit from these guidelines doesn’t imply that the preparations quantity to abuse, and so the GAAR can’t be utilized to them. Accordingly, many circumstances of the type which have generated a substantial amount of media and Parliamentary debate within the months main as much as the enactment of the GAAR can’t be handled by the GAAR
B5.3 Nonetheless, the place there are abusive preparations which attempt to exploit specific provisions in a double-tax treaty, or the best way by which such provisions work together with different provisions of UK tax regulation, then the GAAR could be utilized to counteract the abusive preparations.

The BEPS venture has additionally modified the worldwide method to worldwide tax planning and the MLI (see Part III.viii) has considerably decreased the scope for treaty procuring.122

As well as, the EU adopted the Anti-Tax Avoidance Directive (ATAD), which has been in drive since 1 January 2019. The ATAD imposes a minimal normal for a lot of the issues set out on this chapter, to be relevant at EU degree, together with exit taxation (i.e., tax on property transferred throughout borders); an EU-wide GAAR; and minimal requirements of CFC guidelines. Moreover, the EU is seeking to impose a standard company tax base underneath which company tax is calculated in every Member State on the identical algorithm; adopted by a standard consolidated company tax base underneath which tax might be payable on an EU-wide foundation after which apportioned to related Member States. The UK is unlikely to be topic to those guidelines following its departure from the EU.

v Firm residence

As acknowledged, the place an entity is established in any jurisdiction to carry IP rights or perform another perform, it’s more likely to require the requisite substance commensurate with its capabilities. Such substance necessities might come up because of a lot of elements:

native legal guidelines might require particular substance necessities to fall inside beneficial tax regimes or to profit from tax treaties or EU directives;
switch pricing evaluation might be undertaken on the premise of a purposeful evaluation that in flip would require continued substance commensurate with such evaluation;
residence underneath native regulation and tax treaties will normally depend upon the place the corporate is managed; and
if the corporate doesn’t perform its capabilities within the native jurisdiction, there’s a danger that it might be taxable elsewhere by means of a everlasting institution.

HMRC will apply these exams to find out whether or not an entity established offshore is definitely resident in the UK. It’s normally greatest apply to make sure that an entity is appropriately managed in its dwelling jurisdiction to make sure that it meets any required substance exams domestically and to make sure that it isn’t resident in the UK (or one other taxable jurisdiction).

As acknowledged above, an organization that’s not included in the UK may very well be handled as resident in the UK underneath UK home regulation whether it is centrally managed and managed in the UK. The which means of central administration and management will not be outlined in UK statute and has as a substitute been decided based on UK case regulation ideas. Broadly, the central administration and management take a look at is a query of reality that appears at the place the very best degree of management (i.e., the general strategic administration construction, versus the day-to-day administration) of an abroad firm is bodily performed. As acknowledged in UK case regulation,123 the query is determined by the place the ‘actual enterprise is carried on’ and that is ‘the place the central administration and management truly abides’. Additionally it is acknowledged that ‘it’s the precise place of administration, not that place by which it should be managed, which fixes the residence of an organization’.124 If that is in the UK, the corporate is UK tax-resident (within the absence of any tax treaty provision on the contrary). Instances have connected significance to the place the place the corporate’s board of administrators meet, though this isn’t essentially conclusive. HMRC units out detailed steering in its manuals as to the which means of central administration and management, together with a replica of the Assertion of Apply,125 which units out its view of the elements related to figuring out residence underneath the widespread regulation take a look at.

In some circumstances, central administration and management could also be exercised by a single particular person. This will likely occur when a md or managing director workouts powers formally conferred by the corporate’s articles and the opposite board members are little greater than ciphers, or by cause of a dominant shareholding or for another cause. In these circumstances, the residence of the corporate is the place the controlling particular person workouts these powers.

Usually, the place of administrators’ conferences is important solely insofar as these conferences represent the medium by means of which central administration and management is exercised. Within the case of Wooden and one other v. Holden126 the Courtroom of Attraction held that an abroad included firm, managed by an abroad belief firm, which acquired recommendation from skilled advisers in the UK, couldn’t be thought-about to be UK-resident for tax functions purely as a result of the belief firm acted on the suggestions of the skilled advisers. This case confirmed that there should be clear proof that the central administration and management of a non-UK included firm is carried out by its administrators, and that the authority of the administrators has not been usurped by anyone (similar to UK-based administrators or advisers) in the UK.

The place a treaty tiebreaker applies, residence is the place the corporate is ‘successfully managed’, though, following implementation of the MLI, that is more likely to change in lots of treaties to the jurisdiction agreed by the related tax authorities underneath a mutual settlement process. It’s normally very troublesome to see how the place of the ‘central administration and management’ of an organization’s enterprise for the needs of figuring out its residence underneath UK home regulation won’t be the identical as the situation of its ‘place of efficient administration’ for the needs of the double-tax treaty. A helpful case, which thought-about intimately an organization’s residence, was that of Laerstate BV v. HM Income & Customs.127

In addition to residence points, an organization might be eager to not have taxable everlasting institutions in a jurisdiction outdoors its place of residence. In addition to guaranteeing that the corporate doesn’t have an abroad workplace or different mounted administrative center, it shouldn’t have dependent brokers concluding or considerably negotiating contracts on its behalf outdoors its jurisdiction of residence. Ideally the corporate also needs to not have any staff outdoors such a jurisdiction.

As a sensible matter, corporations ought to observe clear tips to make sure their decision-making processes don’t inadvertently imply they’re resident in a unique jurisdiction from that supposed – or for that matter commerce by means of a everlasting institution in such a jurisdiction. Examples of issues that may very well be contained in such tips would possibly embody:

having a majority of native administrators with the mandatory requisite ability and data;
holding a minimal variety of board conferences annually within the related jurisdiction;
making all strategic and different choices of efficient administration at these board conferences;
not holding board conferences in another jurisdiction;
guaranteeing that there is no such thing as a or restricted participation in board conferences by phone and no written resolutions;
approval of key contracts must be at board conferences and all contracts must be accredited and entered into by native administrators;
not considerably negotiating contracts with out enter from the board. The board shouldn’t merely ‘rubber stamp’ contracts;
having an area firm secretary, or comparable officer, from which all key paperwork emanate; and
holding all obligatory books and data on the native registered workplace.

vi Tax points arising from company structuring

In addition to the above points that come up from tax-driven structuring, many tax points for franchisors can come up from extra commercially pushed company structuring. For instance, franchisors might search fairness participation of their franchisees for financial advantages but in addition to offer the franchisors with a level of company management. The tax implications of such joint-venture preparations will depend upon the exact circumstances however might contain:

the impact of any management preparations on the tax residence standing of the franchisee;
whether or not the management preparations make the events related for any tax functions (e.g., switch pricing);
the power to say consortium aid for tax losses and the necessity to take care of surrenders of tax losses underneath the related documentation;
whether or not the curiosity acquired by the transferor is adequate to acquire any tax aid (e.g., exemption from chargeable good points in the UK underneath the substantial shareholdings exemption); and
the tax therapy of any financing preparations.

VI Franchisee tax place

Whereas franchisors will usually be corporations (and we’ve got due to this fact focused on the company tax guidelines for corporations), franchisees could also be a lot smaller companies and may very well be run as corporations, partnerships or unincorporated small merchants. It’s past the scope of this guide to debate the final tax surroundings for all such merchants. We set out under, nevertheless, the tax therapy of the possible funds by company franchisees underneath franchising preparations. That is usually the reverse of the franchisor therapy. Particularly, a franchisee will need to know:

whether or not funds are deductible for tax functions; and
whether or not it will likely be required to deduct tax at supply from funds underneath any franchise agreements.

For the franchisee, a higher diploma of research will usually be required as the character of the funds will fluctuate extra dramatically.

i Preliminary price

The essential query for the franchisee might be whether or not the preliminary price (or charges) payable by it are earnings or capital in nature. Because the charges might be incurred wholly and solely for the franchisee’s commerce, then if earnings in nature the charges must be deductible as a part of the franchisee’s buying and selling income. If capital in nature, the charges wouldn’t be so deductible. The tax therapy will depend upon the character of the price and the circumstances of the franchisee. Particularly, for company franchisees:

If the cost is an acquisition of intangible property (together with goodwill), this may for UK company franchisees fall inside the intangible mounted asset guidelines (until the intangible property are pre-April 2002 IP, which would be the case whether it is pre-April 2002 IP for the franchisor and the franchisor and franchisee are related). If the intangible mounted property guidelines apply, the franchisee ought to, aside from within the case of acquired goodwill (or comparable IP), acquire a tax deduction for the accounting amortisation of the IP or, if it elects, a set writing-down deduction of 4 per cent every year. For goodwill, customer-related intangible property and unregistered logos, the franchisee might be handled as having made an election for a set writing-down deduction of 6.5 per cent every year. The franchisee can also qualify for rollover aid in respect of previous good points underneath Chapter 7 of Half 8 or Part 898 of the CTA 2009.
Funds not coated by the intangible mounted asset guidelines will should be analysed on a case-by-case foundation and analysed as earnings or capital relying on the information (see above for a evaluate of what constitutes earnings or capital expenditure). Usually, franchisors’ preliminary prices are more likely to be capital in therapy on the rules set out. HMRC confirms this in its manuals on the premise of S Ltd v. O’Sullivan128 and Atherton v. British Insulated and Helsby Cables Ltd.129 The prices are to be break up as follows:

Capital cost for goodwill or franchise rights – for people and corporations not inside the intangible mounted asset guidelines, goodwill might be an asset for capital good points tax functions and due to this fact the acquisition price will kind a part of the bottom price of the asset however won’t give rise to any earnings tax aid on acquisition. It might be potential to roll over a acquire into the expenditure underneath the principles in Part 152 of the TCGA. Nonetheless, HMRC takes the view that the quantity paid by a franchisee will not be for goodwill however for franchise rights, which whereas being property for capital good points tax functions will not be property to which rollover aid applies, and if the licence settlement is lower than 50 years, the asset acquired might be a losing asset for capital good points purposes130 the impact of which might be to not solely stop rolling any good points into the asset but in addition to depreciate its base price for chargeable good points functions. However, a franchisee can subsequently generate its personal goodwill131 such that it is ready to apply rollover aid on a subsequent sale of its franchised buy. This was the case in Balloon Promotions and HMRC’s view of that is set out in its Capital Positive factors Guide CG68270. Nonetheless, on this case the Particular Commissioners accepted that there was substantial goodwill within the precise enterprise as run by the franchisee and never within the franchisor’s model (Pizza Specific) at the moment. It was additionally a pertinent proven fact that the franchise settlement had a six-month termination proper for both get together such that the courtroom held that there have been not substantial priceless rights within the settlement.
Capital cost for know-how or patents – to the extent that any of the preliminary price may very well be attributed to patents or know-how then capital allowances must be out there underneath Components 7 or 8 Capital Allowances Act 2001.
Deferred income expenditure – simply because an preliminary lump-sum cost is made, it doesn’t imply that that is essentially capital and basic ideas ought to apply to find out if expenditure is earnings or capital in nature. For instance, a prepayment for ongoing employees coaching could also be earnings in nature albeit paid up entrance (c.f., an preliminary one-off coaching, which is more likely to be capital in nature). Such funds for deferred income expenditure may very well be written off within the accounts up entrance or over a interval of years. The accounting therapy might be vital on this respect132 however not conclusive.133
Acquisition of logos and copyright – these rights can be capital good points property – presumably losing property – and there are not any capital allowance guidelines for such rights.
Prices of premises are more likely to be capital in nature and match out prices might qualify for aid underneath the capital allowances code.

HMRC states in its revealed guidance134 that:

Whether or not an apportionment between capital and income expenditure is acceptable is determined by the information. The information might present that no a part of the preliminary lump sum charges could be attributed to providers of a income nature supplied by the franchiser as a result of such providers are individually charged for within the annual charges.
In apply, franchisees might put ahead an apportionment regardless of the franchisor. An apportionment of this sort could also be troublesome to justify in relation to the providers supplied. As an example, some franchisors are unwilling to barter particular phrases with particular person franchisees and the identical lump sum is payable irrespective of the particular providers required from the franchisor; for instance, the variety of employees needing coaching could also be irrelevant.
If the settlement phrases are such that no a part of the preliminary price is particularly attributed to income gadgets, then the declare for apportionment might should be critically examined.

ii Capital allowances

A deduction for capital expenditure is on the market underneath the capital allowances regime to cut back income for company tax (underneath the pre-April 2002 regime) and for earnings tax functions. Usually, expenditure should be labeled as capital and should be incurred on specified property. Particular guidelines present for expenditure on R&D, know-how and patents to be relieved.

The quantum of capital allowance that may be claimed by a taxpayer is supplied at a specified price for every tax 12 months and is determined by the kind of capital asset and the kind of entity incurring the expenditure.

Acquisition of know-how

The place a taxpayer incurs expenditure for the aim of buying know-how from an unconnected individual, a capital allowance deduction could also be out there if the know-how is utilized in a commerce.135

Know-how is outlined as ‘any industrial info or methods more likely to help in manufacturing or processing items or materials; working a supply of mineral deposits; or finishing up any agricultural, forestry or fishing operations’.136

HMRC takes the view that this definition doesn’t prolong to business know-how (similar to market analysis, buyer lists and gross sales methods) as a result of this isn’t ‘industrial info or methods more likely to help within the manufacture of products or supplies’.137 As such, know-how allowances are unlikely to be of relevance in lots of franchising conditions.

The speed of allowance is determined by the tax 12 months by which the aid is sought. The place aid is sought, the allowance is:

all years (besides the 12 months by which (b) applies) – 25 per cent of the surplus of obtainable qualifying expenditure (AQE) for the pool of property topic to capital allowance deduction over complete disposal worth (TDV); and
last tax 12 months (e.g., when commerce discontinued) – quantity by which the AQE exceeds the TDV.138 If the TDV exceeds AQE then an assessable balancing cost will come up to the taxpayer.139

Broadly talking, AQE is capital expenditure on know-how that’s incurred for the needs of the commerce and TDV is the web proceeds of sale (which consists of capital sums).

Acquisition of patent rights

A capital allowance deduction is on the market for capital expenditure incurred to accumulate patent rights for the aim of a commerce inside the cost to UK tax140 (or for patent rights that give rise to UK taxable earnings).141

Patent rights are outlined as rights to do or authorise the doing of something that will, however for that proper, be an infringement of a patent.142

There’s a separate pool of expenditure for every commerce and a pool for non-trading expenditure. The writing down allowance out there is 25 per cent of the surplus of the AQE over complete disposal receipts143 every tax 12 months with comparable guidelines for balancing costs or allowances as know-how. The place the patent rights will not be used for a commerce, any allowance is given towards patent earnings solely.

iii Ongoing charges

Ongoing funds will nearly at all times represent deductible bills for the needs of calculating the franchisee’s buying and selling income as they need to be earnings in nature and wholly and solely incurred for the needs of the commerce. The important thing query for such bills might be whether or not they’re topic to deduction of tax at supply – which can even be a query for some capital expenditure included within the preliminary price (e.g., if patents have been acquired). Whether or not or not this is a matter for the franchisee will depend upon whether or not or not the settlement features a gross-up clause, pursuant to which the charges are elevated such that the franchisor stays in the identical after-tax place.

In addition to the above points which can be particular to the settlement, franchisees must take care of all the identical tax points as many different small companies must take care of. For instance, it must think about:

If it’s a start-up, ought to the franchisee set up itself as a sole dealer, a partnership or an organization?
How are its actual property prices handled? Can it be sure that its rental funds are deductible?
Will it acquire tax deductions for depreciating capital gadgets (e.g., underneath the capital allowances guidelines)?
Are curiosity bills tax deductible for the franchisee? Will it need to deduct tax at supply?
Can the franchisee appeal to traders by providing tax-incentivised fairness (e.g., underneath the UK enterprise funding scheme guidelines or the seed enterprise funding scheme)?
Can it minimise VAT in respect of its provides to the general public?

VII Switch pricing

The place transactions happen between associated, related or related corporations, there may be an incentive for income to be ‘moved’ from an organization with a comparatively excessive tax price to a different firm with a comparatively low tax price. This may very well be achieved, for instance, within the context of a trademark licence, by an inflated royalty being charged by a licensor in a low-tax jurisdiction to a licensee resident in a high-tax jurisdiction (thus stripping taxable income out of the high-tax jurisdiction).

The switch pricing regime seeks to stop the sort of apply by requiring an arm’s-length worth to be paid (within the above case, an arm’s-length royalty to be paid by the licensee). This can be a basic rule, which is analogous to the precise guidelines, which impose market worth costs on transactions between related individuals (e.g., for capital good points tax, TCGA 1992, Part 17 and for chargeable intangible property, CTA 2009, Part 845).

Many international locations have a switch pricing regime and, though the exact mechanics fluctuate from nation to nation, many are based mostly on the OECD’s switch pricing tips, which had been most not too long ago up to date in 2017 to deliver them into line with the BEPS motion factors. The UK’s switch pricing guidelines are in TIOPA 2010, Half 4. Broadly talking, the provisions search to regulate the tax return of an individual who obtains a possible UK tax benefit from its non-arm’s size coping with one other individual. The tax return is adjusted as if the transaction had been at arm’s size. SMEs could also be exempt from switch pricing guidelines underneath Part 166 TIOPA until the transaction is with a celebration in a non-qualifying territory (broadly talking, a tax haven), though HMRC might by discover, within the case of medium-sized enterprises (and the place the UK Patent Field applies, small enterprises), disapply the exemption. The definition of an SME follows the final EU definition.144

The regime applies the place provision has been made or imposed between two ‘affected individuals’ by a transaction or sequence of transactions, the participation situation is met, and the precise provision differs from what would have been the precise provision between unbiased enterprises dealing on arm’s-length phrases (the ‘arm’s-length provision’). The UK guidelines apply even the place the transactions are between two UK events.

To satisfy the participation situation, one individual should management the opposite or they should be underneath the management of the identical individual. ‘Management’ means voting management or management by advantage of powers conferred by the articles of affiliation or different doc regulating the powers of an organization whereby the corporate’s affairs are performed in accordance with the needs of the controller.145 Within the context of a partnership, management means the suitable to a share of a couple of half of its property or earnings. The definition is prolonged in sure circumstances (e.g., to incorporate rights held by related individuals, rights that might be acquired sooner or later or individuals who personal 40 per cent or extra of the controlling shares in an organization the place there may be one other such 40 per cent or extra shareholder).

The place the provisions apply, penalties could also be assessed to the extent of tax misplaced due to fraud or negligent conduct. Nonetheless, HMRC signifies that the place the taxpayer makes an sincere and cheap try to adjust to the laws, HMRC won’t impose a penalty.146

In apply, figuring out the arm’s-length worth, significantly one that’s acceptable to the income authorities of two international locations, is a troublesome train. That is significantly the case for intangible property similar to IP, which are sometimes distinctive to the corporate or group involved.

The OECD Switch Pricing Guidelines147 describe valuation strategies which can be usually acceptable to tax authorities across the globe and which were accepted by HMRC. These are divided into conventional transaction strategies and transactional revenue strategies.

i Conventional transaction strategies

Comparable uncontrolled worth

The comparable uncontrolled worth (CUP) methodology merely compares the value charged between the related events (the ‘managed transaction’) with the value in a comparable uncontrolled transaction (i.e., a comparable transaction between unconnected third events – an ‘uncontrolled transaction’). The value within the uncontrolled transaction might should be substituted for the value within the managed transaction if the 2 are comparable. The 2 transactions must be comparable if:

there are not any variations between the transactions being in contrast or between the enterprises getting into into the transactions, which might materially have an effect on the value charged within the open market; and
the place there are variations, moderately correct changes could be made to remove their impact.

Whereas the CUP methodology is probably the most dependable methodology for switch pricing, figuring out good, dependable comparable uncontrolled transactions could be troublesome in apply, as was demonstrated within the case of DSG Retail Ltd and others v. HMRC.148

Resale minus (resale worth)

This methodology is most helpful the place an organization purchases items for distribution from a related get together (the minus successfully corresponds to a fee and represents the quantity out of which the reseller would search to cowl its bills and, within the gentle of its capabilities (bearing in mind property used and dangers assumed), make an acceptable revenue).

Value plus

This methodology is most helpful for providers or the place semi-finished items are transferred between associated events (e.g., a producing firm promoting to a distribution affiliate), or the place joint facility agreements have been concluded. It’s in impact the alternative of resale minus, prices incurred and stating that an unbiased third get together would anticipate to make a set revenue along with such prices. The start line is due to this fact the prices incurred by the provider of the products or providers. A share is then added to this to provide the provider a revenue acceptable to the capabilities carried out and the market situations. The revenue aspect is set by comparable uncontrolled transactions carried out by the provider with unbiased third events (an ‘inner comparable’). If the provider doesn’t enter into comparable uncontrolled transactions, the mark-up that will have been earned in comparable transactions by an unbiased enterprise (an ‘exterior comparable’) must be thought-about. As cost-plus usually provides rise to a low mounted revenue, it’s extra appropriate to low-risk, low-value capabilities and is more likely to be challenged the place the capabilities or danger concerned ought to give rise to a variable and doubtlessly excessive degree of income. A danger and purposeful evaluation of what the provider truly supplies is due to this fact key as to the applying of this (and all switch pricing methodologies). In comparables, it’s due to this fact vital to reveal comparable danger allocations in comparable circumstances. Value plus will also be used for R&D providers, supplied that the purposeful evaluation and allocation of danger justify this system and any realistically out there choices or various buildings in pricing the transaction. On this sense it’s generally obligatory to contemplate not simply who contractually takes the entrepreneurial danger however who would take the entrepreneurial danger had been the events unbiased.

ii Transactional revenue strategies

There are two additional strategies supported by the OECD tips that don’t look a lot at every transaction undertaken by a celebration however at what degree of revenue must be allotted to the get together. These two strategies are the revenue break up methodology and the transactional internet margin methodology.

Revenue break up

This methodology seeks to find out the division of income that unbiased enterprises would have anticipated to grasp from the related transactions. It’s a ‘two-sided’ methodology because it appears at each (or all of the) events to the transaction. The opposite strategies are ‘one-sided’ in that they solely take a look at the suitable return for a single get together with out contemplating the impact on the return of the opposite get together. The strategy is beneficial for complicated buying and selling relationships the place it may be troublesome to guage transactions individually. The newest OECD Tips clarify that utility of a revenue break up methodology ought to break up the income on an economically legitimate foundation, which approximates the division of income that will have been anticipated and mirrored in an settlement made at arm’s size. This a part of the OECD Tips was up to date because of the BEPS venture to offer extra steering and examples on when this is perhaps probably the most acceptable methodology to make use of and the way it must be utilized.

Transactional internet margin methodology

The transactional internet margin methodology appears on the internet revenue relative to a selected base (e.g., prices, gross sales, property) {that a} taxpayer realises from a managed transaction. On this sense it’s much like price plus or resale minus. So on this sense inner comparable must be thought-about within the first occasion adopted by exterior comparables. The OECD Tips emphasise discovering comparable transactions based mostly on purposeful evaluation.

Making use of switch pricing ideas to transactions involving intangible property, together with disposals of such property and royalty funds, is a very troublesome space due to the individuality of most IP and due to this fact the shortage of comparables. There’s a particular chapter of the OECD Tips devoted to intangible property. Equally, there are particular chapters devoted to intra-group providers, price contribution preparations and enterprise restructurings – all of which can should be thought-about within the context of franchising preparations. The chapter regarding intangible property was rewritten as a part of the BEPS venture.149 This supplies new steering on defining intangibles, figuring out transactions involving intangibles and for figuring out arm’s-length phrases for transactions involving intangibles. In a key change ensuing from this venture, it has been highlighted that IP earnings ought to accrue to entities that carry out value-creating capabilities regarding the event, enhancement, upkeep, safety and exploitation of the intangible asset (referred to as the ‘DEMPE capabilities’). The web impact of that is that it will likely be tougher for multinational enterprises to argue that an organization in a low-tax jurisdiction that merely funds IP improvement (e.g., R&D or advertising bills) can accrue the earnings from the ensuing IP, because it won’t have adequate substance when it comes to folks capabilities.

Whichever valuation methodology is chosen, proof might be wanted to justify the worth given. Documentation must be stored to show the related relationship, nature, phrases and costs of the related transactions, the valuation methodology used (significantly how the arm’s-length worth was decided, together with any purposeful evaluation or comparable examine). The idea for any computational adjustment required to succeed in an arm’s-length worth must be retained, and the phrases of related business preparations with each third-party and affiliated prospects. Such documentation must be stored for not less than six years from the tip of the chargeable interval to which it relates.

The extent of documentation must be such ‘as is cheap given the character, measurement and complexity (or in any other case) of their enterprise or of the related transaction (or sequence of transactions) however which adequately demonstrates that their switch pricing meets the arm’s-length normal’.150

It also needs to be borne in thoughts that the place switch pricing is related to any transaction, a taxpayer might apply pursuant to Part 223 of the TIOPA for an advance pricing settlement to hunt readability on the phrases of a transaction for switch pricing functions. Such agreements could be unilateral (i.e., solely agreements with HMRC) or bilateral (i.e., the place the settlement pertains to a cross-border transaction looking for settlement with HMRC and the tax authority within the different jurisdiction).

VIII Worth added tax

Broadly talking, VAT is an oblique tax, chargeable on shopper expenditure. Within the EU, it’s based mostly on the EU VAT Directive.151 VAT is applied underneath the VAT Directive and varied different EU rules thereunder in addition to native implementing legal guidelines in every jurisdiction. In the UK, the primary implementing regulation is the Worth Added Tax Act 1994 (VATA).

Underneath the UK guidelines, VAT applies to any provide the place:

there’s a provide of products or providers (together with something associated to that provide);
the availability is made in the UK;
the availability is a taxable provide;
the availability is made by a taxable individual for (financial or non-monetary) consideration (albeit sure provides could be deemed to come up even with out consideration); and
the availability should be made within the course or furtherance of a enterprise carried on by the taxpayer.152

There are at current separate import VAT costs the place items are ‘imported’ into the UK from outdoors the EU and, from 1 January 2021, items shifting to Nice Britain from outdoors the UK (together with from any EU Member State) may even be handled as imports, moderately than as an intra-EU ‘acquisition’ (business-to-business (B2B)) or ‘distance sale’ (business-to-consumer (B2C)) of products underneath present VAT guidelines.153

VAT is collected and payable by the provider or by the individual making the importation or (when relevant) acquisition. The final word ‘price’ of VAT is meant to be borne on the finish of the availability chain by the tip consumer or shopper (who can’t get well the VAT price), however the tax is collected at completely different levels within the provide chain.

A VAT-registered individual should cost VAT (output tax) on its VATable provides and might get well the VAT it pays (enter tax) on provides acquired by it to the extent that this may be attributed to its onward taxable (i.e., VATable or zero-rated) provides. At intervals, when a return is made to HMRC, the VAT-registered individual provides up all of the enter tax and all of the output tax and deducts the enter tax from the output tax; and if there’s a optimistic stability, it pays to the UK tax authority, HMRC, (usually on a month-to-month or quarterly foundation) the distinction between its output and enter tax (or it receives a reimbursement the place enter tax exceeds output tax).

Enter tax is mostly solely recoverable to the extent it’s attributable to taxable provides. Subsequently, the place a VAT-registered individual makes each taxable and non-taxable (i.e., exempt, non-business, or sure different outdoors the scope of VAT) provides, solely a proportion of his or her enter tax might be recoverable.

Companies that make taxable and exempt provides are usually known as ‘partially exempt merchants’, typical examples of that are banks and insurance coverage corporations. The restoration of enter tax attributable to ‘outdoors the scope’ provides varies. Nonetheless, restoration will not be blocked within the case of exports of providers that will be taxable if made in the UK.

VAT data should be stored by VAT-registered individuals for as much as six years and a VAT bill should usually be issued to help a buyer’s VAT restoration, exhibiting the variety of the bill and the date, the date of provide, the provider’s title, deal with and VAT registration quantity, and the shopper’s title and deal with. As well as, the kind of provide (e.g., sale or rent) should be proven, with an outline adequate to establish the products or providers provided, the amount and quantity payable (excluding VAT), the speed of any money low cost supplied and the speed and quantity of VAT charged.

There are not any particular VAT legal guidelines for franchising in the UK, or within the EU VAT Directive, so basic VAT ideas apply to franchising preparations. UK VAT legal guidelines have continued to be aligned with EU VAT legal guidelines through the Brexit transitional interval ending 31 December 2020. Nonetheless after this era, Nice Britain (and the UK in respect of providers) will not be a part of the EU’s customs union and VAT system, so it might then unilaterally introduce particular UK VAT legal guidelines for franchising preparations. Additionally it is proposed that distinctive guidelines would apply in respect of actions of products between Northern Eire and EU Member States pursuant to the phrases of a Protocol on Eire/Northern Eire, agreed in precept between the UK and the EU as a part of settling the Withdrawal Settlement, and whose precedence is to keep away from a tough border between Eire and Northern Eire. In keeping with HMRC, which means Northern Eire will stay aligned with the EU’s VAT guidelines for items shifting between the EU and Northern Eire, and in any other case Northern Eire will stay a part of the UK VAT system, so UK VAT guidelines associated to transactions in providers will apply throughout the entire of the UK. HMRC may even proceed to be chargeable for the operation of VAT and assortment of revenues in Northern Eire, whereas import VAT might be due on items that enter Northern Eire from Nice Britain. The result’s a particular, twin VAT regime in Northern Eire and a brand new course of would apply for figuring out Northern Eire merchants utilizing a particular VAT identification prefix for EU VAT functions and enabling them to reclaim EU VAT by means of current processes. Nonetheless, on the time of writing, important points stay excellent on the implementation and utility of the Protocol, together with with regard to respecting Northern Eire’s place in the UK’s customs territory and inner market, and supporting the graceful stream of commerce. Subsequently, settlement continues to be required on the sensible options obligatory for merchants similar to supermarkets and franchises in relation to the Protocol and on the right way to set up which items are at a real and substantial danger of getting into the EU market.

i Taxable individual

VAT applies to provides made by a taxable individual. Subsequently, an individual who’s a taxable individual should cost VAT on taxable provides made by her or him on the acceptable price and an individual who will not be a taxable individual should not cost VAT in respect of any provide.

A ‘taxable individual’ is basically an individual (together with an organization or a partnership) who makes taxable provides in the UK within the course or furtherance of a enterprise carried on by her or him and the combination worth of the provides which were made by her or him within the earlier 12 months or much less, or are anticipated to be made within the forthcoming 12 months (or within the subsequent 30 days alone), exceeds the prevailing registration restrict (that is at the moment £85,000 in the UK). This threshold has, nevertheless, been eliminated with impact from 1 December 2012 for all non-UK merchants and not using a UK institution who make taxable provides for VAT functions of any worth in the UK (similar to provides regarding UK land or provides of inventory saved within the UK). Companies can also register voluntarily for VAT (thus turning into taxable individuals).

ii Provide of products and providers

A ‘provide of products’ means the availability of the entire property in items however the switch of an undivided share in property or of the possession of products is a provide of providers (until possession is transferred underneath a sale settlement or in sure different circumstances (e.g., rent buy agreements). Moreover, sure different provides are particularly handled as provides of products (e.g., provides of energy or sure provides of land).154

A ‘provide of providers’ may be very broadly outlined as something that’s not a provide of products however is completed for a consideration (together with, if that’s the case executed, the granting, project or give up of any proper).155 Granting IP rights will usually be provides of providers for VAT functions.

iii Time of provide

Broadly, for items, the time of provide is when they’re eliminated or in any other case made out there. If the products are eliminated earlier than it’s recognized whether or not they’re to be provided, the time of provide is when the availability turns into sure or, if sooner, 12 months after elimination.156

The ‘time of provide of providers’ is when the providers are carried out.157 An exception to this basic rule is the place there’s a steady provide of providers, by which case the time of provide is the sooner of when the cost is acquired by the provider and when the provider points the bill.158 Within the case of royalties, the time of provide is the sooner of when the royalties are acquired or a VAT bill is issued.159

For each items and providers, it’s potential to speed up the time of provide by the problem of a VAT bill or receipt of cost (e.g., deposit or prepayment on account).160 Additional particular time-of-supply guidelines apply in respect of reverse cost providers acquired by UK companies from outdoors the United Kingdom161 and, till 31 December 2020, in respect of intra-EU acquisitions of products to the UK (post-January 2021, this must be restricted to Northern Eire).

iv Taxable provide

A taxable provide is a provide of products or providers made in the UK aside from an exempt provide.162 There are three charges of UK VAT on taxable provides, 20 per cent, 5 per cent (on a restricted class of provides) and nil (on zero-rated provides). Provides of sure providers or kinds of inventory could also be exempt or topic to a decreased (for instance, zero) price of VAT, however this may depend upon the character of the providers or items in query and whether or not they kind a part of a combined or composite provide with different items or providers.

An exempt provide in the UK is a provide laid out in Schedule 9 of the VATA. Exempt provides embody monetary and insurance coverage providers, however provides of IP will not be usually exempt. Zero-rated provides are set out in Schedule 8 of the VATA and embody, topic to detailed situations, meals, youngsters’s clothes, and medicines prescribed by pharmacists.

There are two different classes of provide, that are vital for VAT functions: ‘outside-the-scope’ provides and different provides handled as not involving a provide of products or providers with the end result that VAT will not be chargeable. Examples of such provides embody non-business provides, the availability of sure worldwide providers (e.g., a switch of IP to a buyer outdoors the UK) and a switch of a enterprise as a going concern (TOGC). UK TOGC guidelines can cowl IP provides or licensing, or each. The expression ‘going concern’ usually refers to a enterprise that’s nonetheless in existence, stay or working and has all components and options essential to maintain it in operation, as distinct from being solely an inert aggregation of property. A enterprise scaled down due to monetary difficulties or in anticipation of a sale, and even in liquidation, receivership or chapter, can nonetheless be a going concern.

TOGC guidelines will not be applied in a harmonised means throughout Europe, and completely different native issues will apply. In the UK, TOGC therapy for transfers of franchise companies could be out there supplied a number of situations are met, together with that the identical sort of enterprise is transferred from a franchisor to a franchisee and that the brand new franchisee intends to hold on the identical sort of enterprise, and not using a important break in buying and selling after the switch, and the switch won’t be adopted by different instantly consecutive transfers of the enterprise (e.g., to a different new franchisee). The place solely a part of a enterprise is offered, it should be able to separate operation. HMRC inner guidance163 notes the significance of creating whether or not a franchisor has truly operated the enterprise being transferred. If that’s the case, it’s able to being a TOGC. In any other case, merely granting a franchise will not be a TOGC, as such a grant will not be the identical sort of enterprise as making provides of products and providers underneath a franchise settlement. TOGC for VAT functions can also be out there in circumstances the place a franchisee provides up a franchise and the franchisor ‘installs’ one other franchisee within the premises. In these circumstances, one must study whether or not the brand new franchisee was shopping for the premises, inventory or fixtures and fittings from the previous franchisee and that what was being transferred was the possession of a enterprise as a going concern that may very well be carried on by the brand new franchisee on an enduring foundation. The truth that the permission of the franchisor could also be obligatory for the property to be offered shouldn’t stop the transaction from being a TOGC. As well as, the place the transferor is a taxable individual (i.e., UK VAT registered), the transferee should be a taxable individual (VAT registered) already or instantly grow to be one as the results of the switch (with the VAT registration normally being in place by and with impact from completion).

The place land is transferred as a part of a TOGC, there are specific further situations that will need to be met for the switch of the land or lease, and many others. to be given TOGC (non-VAT) therapy. One such situation is that the transferee might need to make an election (known as an ‘choice to tax’) and notify HMRC of this determination to elect earlier than completion (or an earlier cost) to waive any VAT exemption regarding a switch of the property in query, and likewise notify the transferor that this selection won’t be revoked underneath sure anti-avoidance guidelines.

v Place of provide

The complicated ‘place-of-supply’ guidelines decide by which nation, if any, a provide of products or providers must be taxed. The result’s that UK VAT is simply chargeable the place the place of provide underneath these guidelines, as applied domestically, is the UK. UK VAT will not be chargeable if the place of provide is outdoors the UK, even when made by a taxable individual. If the place of provide is one other Member State of the EU, that Member State has the jurisdiction to cost its native equal of VAT on the availability. If the place of provide is outdoors the EU, no Member State has the jurisdiction to cost VAT on the availability though VAT or gross sales tax could also be chargeable outdoors the EU.

There are detailed guidelines for each items and providers and the principles fluctuate relying on whether or not provides are to ‘taxable individuals’ (broadly talking, companies) or not. Within the context of franchising we’d assume that almost all provides by franchisor to franchisee are B2B provides of providers.

Provide of providers

The place of provide of providers finally is determined by varied elements, similar to the character of the providers, whether or not or not the recipient is a taxable individual, and the place the service is carried out. Nonetheless, topic to future legislative adjustments in the UK taking impact after 1 January 2021, in abstract, the current place is that the final place-of-supply rule for providers is as follows:

for B2C provides, the final rule is that the availability is made the place the provider belongs, with the provider being liable to account for the VAT due on the availability; and
for B2B provides, the final rule is that the availability is made the place the recipient belongs and a UK VAT-registered recipient would usually be liable to account for the UK VAT due on the availability by accounting for the VAT through the UK reverse cost accounting process.

So, in a franchising context, B2B provides of providers by a franchisor to a related enterprise individual are usually handled as provided within the nation by which the recipient belongs. For this objective, a related enterprise individual is an individual registered for VAT in the UK, Isle of Man or EU or any one that independently carries out in anyplace any financial exercise and the place in any case the providers are acquired aside from wholly for personal functions.

It must be famous that the final guidelines acknowledged above are topic to many exceptions.164 For instance, for broadcasting, telecommunications and electronically (BTE) provided providers, the availability is handled as made the place the recipient belongs, regardless of whether or not the recipient is in enterprise or not, with the provider liable to account for BTE provides to non-business recipients, and VAT-registered enterprise recipients being liable to account utilizing a reverse cost process. The VAT Mini One-Cease Store (MOSS) scheme, an digital registration and cost system, was launched throughout the EU to facilitate suppliers’ VAT administration for his or her BTE provides to non-business recipients or shoppers within the EU the place the provider was not established. Nonetheless, because of the UK’s exit from the EU, from January 2021, the UK MOSS system will not be out there to be used by UK suppliers making cross-border BTE provides to EU-based shoppers, and an area UK VAT registration might be required of any non-UK suppliers to account for UK VAT on their BTE provides. For IP royalty earnings, both the final B2B rule applies for UK VAT place-of-supply functions (so VAT is chargeable the place the enterprise buyer belongs) or, the place relevant, a particular rule listed in VATA 1994, Schedule 4A, Paragraph 16 applies for UK outbound IP (and different skilled) provides to non-business shoppers outdoors the EU (which is anticipated to be amended to incorporate non-business shoppers in EU Member States (see under)), in order that such provides to each EU and non-EU personal prospects underneath UK VAT legal guidelines from 1 January 2021 won’t be topic to UK VAT. For sure provides, such because the rent of products, the UK at the moment applies a use and pleasure rule override towards the final guidelines. The use and pleasure guidelines are supposed to ensure taxation takes place the place providers are consumed if providers are both consumed inside the UK however would in any other case escape VAT or they’d be topic to UK VAT when consumed outdoors the EU. Efficient use and pleasure takes place the place a recipient truly consumes providers regardless of the contractual preparations, cost or helpful curiosity. In these circumstances, the place of provide of the related service is the place their efficient use and pleasure takes place. The place that is the UK, the providers are topic to UK VAT and the events would wish to contemplate who’s chargeable for accounting for the VAT relying on the related rule or provide and VAT standing of the recipient. The use and pleasure rule as adopted in the UK (e.g., for the rent of products in the UK) is anticipated to use in respect of EU lessees because it does for non-EU lessees from 1 January 2021, in order that UK VAT could also be chargeable on the rent of products in the UK by EU-based residents. The EU’s personal use and pleasure guidelines may even have extra relevance for the UK, with it turning into a non-EU jurisdiction for all intents and functions from 1 January 2021.

Along with these particular guidelines and exceptions, an important query to find out the place of provide in respect of providers is generally the place the provider or recipient ‘belongs’. For a related enterprise individual, it’s broadly the place the place that individual has its enterprise institution or another ‘mounted institution’ or (in the UK not less than), if it has a couple of enterprise institution, the institution that’s most straight involved with the availability of providers in query. How these provisions must be interpreted, in addition to the which means of phrases similar to ‘mounted institution’, has been topic to a considerable physique of UK and EU case regulation. Non-business individuals are handled as belonging within the nation of such an individual’s standard place of residence.165

Provides and imports of products

The start line underneath United Kingdom home regulation is Part 7 VATA, which units out a precedence for the place of provide of products. If a provide doesn’t contain the elimination of the products to or from the UK, they shall be handled as provided in the UK if they’re in the UK. There may be then a sophisticated hierarchy of guidelines that observe this to find out the place of provide. If, for instance, the availability includes their importation by the provider and onward provide in Nice Britain, UK VAT might be due. Equally, if items are to be put in or assembled within the UK, UK VAT might be due. Provides of products to EU registered companies are at the moment UK VAT zero-rated as dispatches supplied the products are faraway from the UK inside three months of the availability. Nonetheless, intra-UK–EU commerce in items from January 2021 might be topic to VAT guidelines on imports and exports and customs supervision and UK companies might require native fiscal illustration to offer commerce (together with offering providers) inside the EU. EU distance promoting guidelines for UK VAT functions will not be related.

Accordingly, from January 2021, shipments from the EU to Nice Britain will grow to be imports, and UK import VAT will grow to be chargeable along with relevant duties or tariffs (besides the place HMRC’s new import mannequin applies). As famous, separate preparations will apply in respect of products shifting from Nice Britain to Northern Eire, however the particulars of those preparations are nonetheless underneath dialogue with the EU. As well as, from 1 January 2021, provides involving the export of products outdoors the UK, together with to EU Member States, could be VAT zero-rated.

Given the time of writing, we’ve got outlined under some additional element on the proposed UK reforms for commerce in items, in addition to the EU’s future reforms derived from its Motion Plan on VAT (see under)166 and subsequent proposals (regardless of Brexit). These guidelines for items are, nevertheless, extra sophisticated than the principles for providers and we solely define them right here on the idea that the center of a typical franchising association is the licensing of IP and the supporting providers. However, there could be related agreements for the availability and cross-border motion of products, so the complicated VAT guidelines on items would then need to be thought-about rigorously, significantly in gentle of Brexit for franchisors buying and selling inside Europe. For UK franchise preparations involving actions of products to Europe, customs valuation guidelines might grow to be extra important, provided that underneath present EU and UK customs guidelines (that are more likely to be retained initially from 1 January 2021), royalties and licence charges in respect of IP rights included in imported items and payable to a vendor are to be included within the customs worth for import VAT and customs responsibility functions. This is applicable, broadly, the place such charges each relate to the imported items (i.e., embodied within the items) and are paid as a situation of the sale (even when they aren’t stipulated within the worth paid or payable). In-scope preparations might embody the manufacture or sale for export of imported items (incorporating, for instance, patents, designs, fashions and manufacturing know-how and logos) or the use or resale of imported items (particularly, copyright, and manufacturing processes inseparably embodied within the imported items). For instance, if the imported items incorporate a trademark underneath which the products are marketed and for which the licence price is paid, this must be thought-about to be associated to the imported items, significantly if the licensee will not be free to acquire such items from different unrelated suppliers. Helpfully, EU steering signifies {that a} franchising licence settlement that includes cost of a royalty or licence price in return for the availability of providers such because the coaching of the licensee’s employees within the manufacture of the licensed product or in using equipment or plant, and technical help within the areas of administration, administration, advertising, accounting, and many others. shouldn’t be included within the customs worth for the related items. Nonetheless, all of the circumstances and contractual preparations surrounding the sale (and the import of the products and funds to 3rd events) might should be examined, together with potential hyperlinks between sale and licensing agreements and different related info.

Additional adjustments

In gentle of Brexit, HMRC has revealed a brand new proposed Nice Britain (GB) Border Working Mannequin and a brand new import mannequin will apply from 1 January 2021, whereby UK import VAT and duties will not be due on the GB border in respect of a consignment of products valued at lower than £135 (excluding, for instance, excise items). As an alternative, UK VAT might be charged on the products to be imported as in the event that they had been already provided in the UK, with such VAT accountable to HMRC on the UK VAT return. Which means companies (whether or not or not in the UK) promoting these low-value consignments of products to be imported into Nice Britain might be required to register for UK VAT and cost and accumulate any VAT due on the level of sale. In circumstances the place companies promote these low-value consignments to shoppers by means of a web-based market, the net market might be required to register for UK VAT and to account for the VAT due on its VAT return. UK VAT registered companies importing items in a consignment valued at lower than £135 might be required to account for VAT on their VAT return underneath the reverse cost methodology.

For consignments of products exceeding £135, regular UK import VAT and customs duties and tariffs will apply. To help companies’ money stream, the UK might be introducing postponed VAT accounting from January 2021 for UK VAT registered companies that act because the importer, in order that UK import VAT could also be declared and reclaimed on the identical UK VAT return, with out truly having to be paid to HMRC. Nonetheless, HMRC can also be insisting that the proprietor of the products on the time of import should act because the importer of file for the products when bringing them to the UK, as solely the proprietor might be allowed to make use of postponed VAT accounting and reclaim the UK import VAT through the VAT return. There are a only a few exceptions to this (e.g., utilizing a qualifying undisclosed agent to import the products as a substitute). HMRC is due to this fact advising companies to make sure that there may be readability in provider buying and selling phrases on the proprietor of products on the time of their import, on the duty for customs checks, tariffs, duties and border formalities, and on who might be financially accountable within the occasion of any points.

No matter Brexit, additional adjustments proposed by the EU will have an effect on all suppliers buying and selling in items inside the EU and must be famous. These embody reforms that may take impact in EU Member States from 1 July 2021, whereby a brand new low €10,000 threshold will substitute all current distance promoting guidelines for intra-EU provides of products B2C and when this threshold is exceeded VAT might be due and accountable on the products gross sales within the EU nation of supply. On-line marketplaces facilitating gross sales might be handled as deemed suppliers for EU VAT functions in sure circumstances and liable to account for any such VAT that’s due. To mitigate the necessity for a number of EU VAT registrations for on-line suppliers, a brand new digital One Cease Store (OSS) VAT registration (simplification) service might be launched. Just like the UK’s new import mannequin, EU VAT may even grow to be due on the level of sale (moderately than at import) from non-EU sellers or on-line marketplaces in respect of gross sales of low-value items to be imported (i.e., valued at lower than €150), and a brand new digital Import One Cease Store might be developed to help importers with their import VAT accounting obligations. These adjustments kind a part of the EU’s VAT e-commerce package deal reforms, which themselves kind a part of a wider set of EU VAT proposals to implement a ‘definitive’ EU VAT system from July 2022. These latter proposals would finish the EU’s present apply of permitting an EU provider to zero-rate intra-EU B2B gross sales and the EU purchaser to self-assess and account for (acquisition) VAT on intra-EU purchases, and as a substitute would create a single destination-based VAT system for all cross-border transactions, underneath which provides can be taxed within the vacation spot Member State or the place the transport of the products ends, on the VAT price relevant in that Member State, along with an OSS for all B2B EU merchants to take care of their VAT accounting. Ultimately this VAT therapy could also be prolonged to all imported, cross-border providers, the proposals for which might be applied at a later date. Because the Motion Plan on VAT, the European Fee has additionally adopted a Tax Motion Plan that features modernising EU VAT guidelines and tackling VAT fraud. The EU’s 2022 reforms will not be but lastly decided and the relevance of those proposals to UK companies (as non-EU companies) will depend upon the UK’s relationship with the EU following Brexit (e.g., whether or not they may very well be required to nominate an EU-based middleman to make use of the OSS).

vi Importation of providers from different international locations

It has been famous above that the place a provider belonging outdoors the UK makes a provide to a taxable individual in the UK and that provide is handled underneath the above guidelines as happening in the UK, the ‘reverse cost’ guidelines apply. Underneath the reverse cost, the recipient of the providers (moderately than the provider of the providers) is required to account for VAT on the price relevant within the Member State by which she or he belongs to the related tax authority. The principles additionally enable the recipient an enter tax deduction in respect of purchases associated to taxable outputs. The impact of the reverse cost in the UK, due to this fact, is to deal with providers introduced in from outdoors the UK in the identical means as providers which can be truly provided in the UK if the recipient of the providers is VAT registered however with the recipient making use of the related VAT formalities. The reverse cost process can also be used on sure imports to Nice Britain from 1 January 2021 and for sure home provides (e.g., B2B wholesale telecommunications provides in the UK).

Usually, reverse costs don’t have any impact on recipients who will not be taxable individuals.

After 1 January 2021, VAT guidelines for (basic rule) providers (together with IP) ought to largely stay unchanged. For instance, the UK’s reverse cost is utilized by a UK VAT registered enterprise that buys providers from overseas and never simply the EU, so this rule shouldn’t be impacted by Brexit. Equally, for provides of B2B providers to EU enterprise prospects, the place of provide will stay the EU nation the place the enterprise buyer is predicated (invoices ought to nonetheless show the shopper’s EU VAT quantity as that is the perfect proof of the shopper’s enterprise standing).

vii Impact of the above guidelines on franchising preparations

The web impact of the above guidelines on franchising preparations is that usually:

UK franchisors will cost VAT to UK franchisees in respect of all providers and items (assuming the products are already in the UK and never being faraway from the UK) besides the place the availability satisfies TOGC guidelines such that TOGC therapy applies;
UK franchisors (assuming they aren’t VAT registered elsewhere) won’t cost VAT to non-UK franchisees in respect of providers (which incorporates IP licences). VAT on the providers must be accounted for by EU franchisees underneath the reverse-charge process in that jurisdiction. Native guidelines would should be thought-about in different non-EU jurisdictions. The VAT therapy of any items provided will depend upon the character of the availability chain and the situation and supposed motion and importation (if any) of the products;
non-UK franchisors won’t must cost VAT on providers provided (together with on the IP licences) to UK-based VAT registered enterprise recipients or franchisees, who would account for the UK VAT due underneath the UK reverse cost process. Once more, the VAT therapy of any items provided will rely in additional element on the character of the availability chain and the situation and supposed motion and importation (if any) of the products;
if there’s a disagreement over the VAT therapy of any of the provides underneath a franchising settlement then the query would then should be requested as as to if one apportions the charges between provides with completely different VAT remedies or whether or not there’s a single composite provide with VAT decided on the precept aspect of the availability underneath the ideas established in, for instance, Card Safety Plan v. C & E Comrs, and as additional utilized and developed in subsequent case regulation;167 and
to the extent a franchisee is UK VAT registered and finishing up absolutely VATable providers, it ought to have the ability to get well the UK VAT incurred on the franchising charges.

For instance, underneath (a) above, in a franchising context, the place a UK franchisor costs royalties underneath a regular franchise settlement to a UK franchisee (i.e., the royalties characterize the franchisor’s licensing of the franchisor’s IP), this may be a B2B provide of IP or providers for UK VAT functions (assuming this licence weren’t a part of a qualifying TOGC switch of the franchise) and this provide can be contained in the scope of UK VAT the place provided between two UK-established companies. UK VAT can be chargeable, accountable by the franchisor. Within the case of inbound IP provides from a non-UK franchisor to a UK franchisee or licensee, then, as underneath (c) above, UK VAT wouldn’t be charged by the abroad franchisor, however it might as a substitute be accountable by the UK VAT registered franchisee or licensee underneath the UK’s reverse-charge mechanism, though, as it is a reporting or simplification mechanism, there must be no internet VAT payable by the UK franchisee on the availability (i.e., then the availability must be cash-flow or VAT impartial for the franchisee or licensee) until it was {a partially} or wholly exempt enterprise that can’t absolutely get well UK VAT. Inside licensing of IP between sister franchisor entities can be topic to UK VAT on the identical ideas, assuming the entities weren’t a part of a proper UK VAT group (which might should be specifically registered as such) to ignore such provides. UK VAT grouping guidelines presently require group members to have a UK mounted institution.

There have been some UK VAT circumstances involving franchising preparations. One such case is Kumon Academic Firm Restricted v. HMRC,168 which checked out rewards supplied to a franchisee by the franchisor. It was held that these rewards weren’t for a separate VATable provide however had been linked to the franchise price and in impact amounted to a contingent low cost. The franchise price might due to this fact be decreased for VAT functions and VAT beforehand accounted for repaid.

In Reeds Faculty of Motoring (Sheffield) Ltd v. C & E Comrs,169 driving tuition provided to pupils was held to be made by the (franchisee) instructors as principals and never by the motoring college, the latter’s function being to offer a supporting organisation by which the instructors had been supplied with the means to provide tuition, similar to the schooling automobiles. It was held that the tight management maintained by the varsity over the instructors was a standard function of franchise agreements, the place the franchisor doesn’t keep on the enterprise in query (say for instance, one in every of a series of eating places), however as a substitute licenses one other (for reward) to take action underneath a reputation and methodology of operation which can be, or are supposed to be, distinctive and well-known. This management was held to not be determinative of the kind of relationship between the events, and it was concluded that the enterprise in query was that of the franchisee whereas the franchise settlement was in drive.

Tumble Tots UK Ltd v. Income and Customs Comrs170 concerned a franchisor of a series of play centres for youngsters. To participate in a play session, the kid would should be a member of the Nationwide Tumble Tots Membership. An annual price was payable, and this was the topic of the attraction. In return for the annual price, a member acquired varied advantages together with a T-shirt and varied newsletters and booklets. HMRC argued that there was one principal provide of membership (normal rated), entitling the youngsters to participate in exercise classes at Tumble Tots premises. All different provides had been thought-about to be incidental to this principal provide. Tumble Tots argued that the primary provides had been the zero-rated provides of printed materials and youngsters’s clothes (T-shirt), so total it was making a zero-rated provide. The tribunal concluded that the membership was the primary profit, and all different provides had been incidental other than the T-shirt that had some financial profit and significance to the kid. Nonetheless, HMRC appealed171 to the Excessive Courtroom, which dominated that the purpose of the cost made by the shopper was to safe attendance on the lessons. Different advantages such because the T-shirt had been incidental to this principal provide. The complete cost made by the shopper was due to this fact topic to VAT.

Within the joined circumstances of Air France-KLM and Hop!-Brit Air SAS v. Ministère des Funds et des Comptes publics,172 (KLM), Hop!-Brit Air SAS (Hop) supplied air passenger transport providers underneath a franchise settlement with Air-France-KLM, with Air-France being chargeable for advertising and ticket administration on the franchised routes. Within the context of the franchise settlement, Air-France acquired the ticket worth direct from passengers and paid this on to Hop in relation to every transported passenger. The place there have been ‘no-shows’ or tickets had expired, Air-France paid Hop compensation at an annual flat price calculated at 2 per cent of the annual turnover (together with VAT) acquired from the routes operated as a franchise. Hop didn’t account for VAT on these sums and the French authority issued assessments for VAT on these quantities. The query for the Courtroom of Justice of the European Union (CJEU) was whether or not or not a non-refundable cost for unused tickets was a taxable provide. The taxpayer argued that funds in such circumstances must be handled as compensation and due to this fact outdoors the scope of VAT. Nonetheless, the CJEU held that, checked out objectively, the funds had been topic to VAT as they represented consideration for a proper to profit from the airline’s obligations underneath a transport contract, even when they weren’t truly utilized by no-show passengers. It additionally held that the sums paid by Air France-KLM to Hop couldn’t be considered compensation for hurt suffered. As an alternative, the sums corresponded to the worth attributed by the events to the unused tickets issued for a transport service and had been due to this fact topic to VAT.

HMRC has not too long ago revised its VAT coverage to deal with most early termination and compensation funds payable from a buyer to a provider as additional consideration for the provider’s provides underneath the unique contract, which is topic to relevant UK VAT.173

Footnotes

1 Zoe Feller is a accomplice and Caroline Brown is a senior affiliate at Fowl & Fowl LLP. The data on this chapter was correct as at January 2021.

2 The European Union (Withdrawal Settlement) Act 2020, which acquired Royal Assent on 23 January 2020. The Taxation (Cross-border Commerce) Act 2018, and rules made underneath that Act, arrange a brand new customs and worth added tax regime for the UK, to use as soon as it has left the EU. The operative provisions of the Act, nevertheless, don’t take impact till the implementation interval supplied for within the European Union (Withdrawal Settlement) Act 2020 involves an finish (31 December 2020).

3 Company Tax Act 2010 (CTA 2010), Part 1121.

4 Company Tax Act 2009 (CTA 2009), Part 5(1).

5 CTA 2009, Sections 5(2) and (3).

6 TCGA, Part 10B(1).

7 CTA 2009, Part 14.

8 De Beers Consolidated Mines Ltd v. Howe 5 TC 198.

9 CTA 2010, Part 1143.

10 CTA 2009, Part 2.

11 CTA 2009, Part 19.

12 TCGA, Part 8(1); CTA 2009, Part 4.

13 CTA 2009, Part 46.

14 Revenue Tax (Buying and selling and Different Revenue) Act 2005 (ITTOIA), Part 33; CTA 2009, Part 53.

15 ITTOIA, Part 96(1); CTA 2009, Part 93; and Enterprise Revenue Guide BIM14060.

16 Marson (Inspector of Taxes) v. Morton 59 TC 381 at 393.

17 [1974] 3 All ER 949.

18 ITTOIA, Part 34(1); CTA 2009, Part 54(1).

19 CTA 2009, Part 906.

20 CTA 2009, Part 882.

21 CTA 2009, Part 883, Company Intangibles Analysis and Improvement Guide (CIRD) 11670.

22 CTA 2009, Part 883(5) to (7).

23 CTA 2009, Part 884.

24 CTA 2009, Part 713(1).

25 CTA 2009, Part 712; CTA 2010, Part 1127.

26 CTA 2009, Part 715.

27 CTA 2009, Part 803.

28 CTA 2009, Sections 721–722.

29 CTA 2009, Part 723.

30 CTA 2009, Part 724.

31 CTA 2009, Part 725.

32 CTA 2009, Sections 733–741.

33 CTA 2009, Part 728.

34 CTA 2009, Part 729.

35 CTA 2009, Part 735.

36 CTA 2009, Part 732.

37 CTA 2009, Part 730.

38 CTA 2009, Part 753.

39 [2003] STC 117.

40 Jeffrey v. Rolls-Royce (1962) 40TC443.

41 Rustproof Steel Window Co Ltd v. IRC [1947] 2 All ER 454.

42 Coalite & Chemical Merchandise v. Treeby (HM Inspector of Taxes) 48 TC 171.

43 British Salmson Aero Engines v. IRC (1938) 3 All ER 283.

44 Murray (HM Inspector of Taxes) v. Imperial Chemical Industries Ltd (1967) 44 TC 175.

45 Margerison v. Tyresoles Ltd (1942) 25 TC 59.

46 British Insulated and Helsby Cables v. Atherton [1926] AC 205, HL.

47 Triage Providers Ltd v. HMRC Sp C 519 [2006] SCD 85.

48 [1977] STC 353.

49 See additionally Strick v. Regent Oil Ltd (1965) 43 TC1; Vallambrosa Rubber Co Ltd v. Farmer (1910) 5 TC; Solar Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337.

50 Enterprise Revenue Guide BIM35505.

51 Enterprise Revenue Guide BIM35510.

52 Enterprise Revenue Guide BIM35525.

53 Enterprise Revenue Guide BIM35545.

54 Enterprise Revenue Guide BIM35540.

55 CTA 2009, Sections 882(7) and 896.

56 CTA 2009, Sections 176–179.

57 CTA 2009, Part 178.

58 CTA 2009, Part 909.

59 CTA 2009, Part 912.

60 CTA 2009, Part 912(3).

61 CTA 2009, Part 913(1).

62 CTA 2009, Part 913(2).

63 CTA 2009, Sections 914–915.

64 ITTOIA, Part 591; CTA 2009, Sections 916–917.

65 CAA 2001, Part 468(1).

66 CAA 2001, Part 469.

67 TCGA, Part 10B.

68 TCGA, Part 275.

69 TCGA, Part 1.

70 TCGA, Part 21.

71 TCGA, Part 22.

72 TCGA, Part 29(5).

73 TCGA, Sections 37–38.

74 TCGA, Sections 17–18.

75 TCGA, Part 37.

76 TCGA, Part 171; CTA 2009, Part 775.

77 TCGA, Part 179; CTA 2009, Part 780.

78 TCGA, Part 171(1A); CTA 2009, Part 775(1)(c).

79 TCGA, Part 185; CTA 2009, Part 859.

80 TCGA, Part 186; CTA 2009, Part 860.

81 Nationwide Grid Indus BV v. Inspecteur van de Belastingdienst Rijnmond C-371/10 (NGI).

82 Council Directive 2005/56/EC and Council Directive 2009/133/EC.

83 Moss Empires Ltd v. IRC (1937) 21 TC 264.

84 Earl Howe v. CIR (7 TC 289).

85 The Revenue Tax Act 2007 (ITA), Part 900.

86 ITA, Part 910.

87 Part 917A ITA.

88 [2006] STC 1195.

89 2009 DTC 5053 (FCA).

90 2012 TCC 57.

91 Countess Shrewsbury v. Earl of Shrewsbury (1907) 23 TLR 224, CA; Turvey v. Dentons (1923) Ltd [1953] 1 QB 218, [1952] 2 All ER 1025.

92 CTA 2009, Part 747.

93 CTA 2009, Part 754.

94 CTA 2009, Part 734.

95 See Patterson Engineering Co Restricted v. Duff (1943) 25 TC 43 underneath which the courtroom will not be certain to observe contractual allocations if these don’t replicate the true nature of funds.

96 Enterprise Revenue Guide BIM57610.

97 [1962] 40TC443.

98 Enterprise Revenue Guide BIM57610.

99 British Dyestuffs Company (Blakeley) Ltd v. IRC (1924) 12 TC 586.

100 Chapter 7 Half 8 of the CTA 2009.

101 CTA 2009, Part 898.

102 For instance, Johnston v. Britannia Airways Ltd [1994] 67TC99.

103 TIOPA, Part 9(6).

104 HMRC manuals, Worldwide Guide INTM161130.

105 TIOPA, Part 112.

106 TIOPA, Part 9(7).

107 See Indofood Worldwide Finance Ltd v. JP Morgan Chase Financial institution NA London Department; see additionally the revised commentary on the which means of ‘helpful possession’ as set out within the 2014 replace to the OECD Mannequin Conference.

108 For instance, Part 140C, Part 140E(8), 140F(9) TCGA.

109 (1936) 19 TC 490.

110 [1982] AC 300.

111 [1984] STC 153.

112 [2005] STC 1.

113 [2009] EWCA Civ 1010.

114 [2009] EWHC 2443 (Ch) (8 October 2009).

115 The first laws is to be present in Half 7 and Schedule 2 Finance Act 2004.

116 Part 206 FA 2013, Part 206.

117 FA 2013, Part 211(1).

118 FA 2013, Part 207(2).

119 FA 2013, Part 211(3).

120 Schedule 43 FA 2013 and Part 211(2)(b) FA 2013.

121 HMRC’S GAAR Steering (Accepted by the Advisory Panel with impact from 28 March 2018).

122 OECD (2013), ‘Motion Plan on Base Erosion and Revenue Shifting’, OECD Publishing. See http://dx.doi.org/10.1787/9789264202719-en.

123 De Beers Consolidated Mines Ltd v. Howe 5 TC 213.

124 Unit Development Co Ltd v. Bullock [1960] AC 351.

125 SP1/90 (9 January 1990) now revealed at INTM120200.

126 [2006] STC 443 (Courtroom of Attraction).

127 [2009] UKFTT 209 (TC).

128 Irish Tax Instances 108.

129 (1925) 10TC155; Enterprise Revenue Guide BIM57620.

130 Capital Positive factors Guide CG68270 and CG76724.

131 Balloon Promotions Restricted v. Wilson SpC 524/06 [2006] STC (SCD) 167.

132 For instance, Strick v. Regent Oil Restricted (1965) 43 TC 1; Johnson v. Brittania Airways Ltd (1994) STC 763; Enterprise Revenue Guide BIM35210.

133 EEC Quarries Restricted v. Watkis (1975) STC 175; Enterprise Revenue Guide BIM35901.

134 Enterprise Revenue Guide BIM57620.

135 CAA 2001, Part 454(1).

136 CAA 2001, Part 452(2).

137 Capital Allowances Guide CA70030.

138 CAA 2001, Sections 458(1), (6); 457(4), (5).

139 CAA 2001, Sections 457(3); 458(5).

140 CAA 2001, Part 468(1).

141 CAA 2001, Part 469.

142 CAA 2001, Part 464(2).

143 CAA 2001, Part 472.

144 As set out within the Annex to Fee Advice 2003/361/EC of 6 Could 2003 (regarding the definition of micro, small and medium-sized companies).

145 CTA 2010, Part 1124.

146 Worldwide Tax Guide, INTM 483120.

147 OECD Switch Pricing Tips for Multinational Enterprises and Tax Administrations, July 2017.

148 TC00001.

149 Steering on Switch Pricing Elements of Intangibles, BEPS Motion 8: last report dated 5 October.

150 INTM 483030.

151 Council Directive 2006/112/EC on the widespread system of worth added tax.

152 VATA, Sections 1(2), 4.

153 VATA, Part 1(1)(b) and (c).

154 VATA, Schedule 4 paragraphs 1–3.

155 VATA, Part 5(2)(b).

156 VATA, Part 6(2).

157 VATA, Part 6(3).

158 SI 1995/2518, Regulation 90(1).

159 SI 1995/2518, Regulation 91.

160 VATA, Part 6(4).

161 SI 1995/2518, Regulation 82.

162 VATA, Part 4(2).

163 See: https://www.gov.uk/hmrc-internal-manuals/vat-transfer-of-a-going-concern/vtogc3500 (2016).

164 See HMRC VAT Discover 741A.

165 VATA, Part 9.

166 See, e.g., COM(2016) 148 last: ‘In the direction of a single VAT space – Time to resolve’, and the follow-up Communication, COM(2017) 566 last.

167 Case C–349/96 [1999] STC 270, ECJ (Half V11), utilized by the Home of Lords [2001] UKHL/4 STC 174.

168 [2015] UKFTT 84.

169 Reeds Faculty of Motoring (Sheffield) Ltd v. C & E Comrs (1995) VAT Choice 13404.

170 Tumble Tots UK Ltd v. Income and Customs Comrs [2007] EWHC 103 (Ch), [2007] STC 1171.

171 [2007] EWHC 103 (Ch), [2007] SWTI 293, [2007] All ER (D) 274 (Jan).

172 Air France-KLM and Hop!-Brit Air SAS v. Ministère des Funds et des Comptes publics (circumstances C-250/14 and C-289/14) (KLM).

173 See HMRC Transient 12/2020.

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