The United Kingdom is a major area for international trade. Several foreign companies are operating here and, according to the United Nations, it is the first country for direct investment from French companies.
STARTING A BUSINESS
Agent, branch or subsidiary
The first choice will depend on the expected volume of business. If it is low and the entrepreneur prefers to manage the structure from France they can hire someone to act as a representative in the UK. The advantage is that the formalities required for this set up are limited. However this structure has some disadvantages from a tax point of view. Thus, if it is possible to consider that the representative’s responsibilities go beyond the mere administration of sales, the UK tax authorities might decide that a permanent establishment (PE) taxable in the UK has been formed.
Creating a PE such as a branch will avoid this uncertainty, since the PE will automatically be taxable in the UK. A PE does not have its own independent legal identity and the parent company is therefore fully liable for the business carried out by the branch.. It is rather easy to set up since it is sufficient to file a copy of the memorandum and articles of association of the French company with Companies House and to register it with the UK tax authorities. PE can however present some difficulties from a taxation point of view, notably in the area of computing taxable profits.
The third option, which is the most frequently used, is incorporation (of a company for example). The company will be taxed in the UK according to UK tax legislation.
The incorporation process
Various types of companies/entities can be chosen. The main ones are:
– Incorporated partnerships: mainly the LLP.
– Limited companies: the limited company and the Plc, a company that may invite the public to subscribe for shares.
The most commonly used structure is the limited company. It can be created very quickly thanks to the ‘off the shelf company’ mechanism. Thus, most legal and accounting firms have companies already incorporated, with a very wide object clause, pro forma articles of association and having not traded yet. When an investor wants to incorporate a company he simply buys one of these companies and tailor it by changing the name, the directors and shareholders. This is done by simply filing the changes at Companies House and updating the legal registers. It is possible to have a company within less than three days.
Of the various structures mentioned above only the Plc. requires a minimum issued share capital, currently £50,000.
Taxation of companies
Limited companies are subject to corporation tax. The main features are as follows:
– The current large company rate is 20%.
– It is possible to benefit from generous research and development tax relief. It is possible to deduct 230% of qualifying expenses for small and medium sized businesses (130% for large companies) or to obtain a refund of the expenses in case of a loss (subject to a maximum limit).
– Large companies are able to claim an “above the line” credit of 11% of their qualifying R&D costs.
– Capital gains, computed after allowing for indexation, are subject to the relevant rate of corporation tax.
– National insurance contributions are rather straightforward since a single rate of employers contributions of 13.8% applies to the part of wages and salaries in excess of £8,112 per annum.
– There is no levy based on wages and salaries except for national insurance contributions and employees income tax, which is withheld at source.
All companies must file their tax return within 12 months of the end of the accounting period. For companies with taxable profits below £1.5m, the tax is settled in one payment within 9 months of the end of the accounting period. Companies with profits in excess of £1.5m must pay in 4 instalments, the first one being due 6.5 months after the beginning of the accounting period.
Every company with a turnover in excess of £82k must register for VAT. The main rate is 20%. A reduced rate of 5% applies to some goods and services such as energy saving items. Most food products and children clothes benefit from a 0% rate.
MERGERS AND ACQUISITIONS
Purchase of assets or shares
When a target has been identified the buyer has to choose between buying some of its assets such as intangible assets, tangible fixed assets or commercial agreements, or buying the whole business via a purchase of the shares of the target company.
The first approach is slightly more difficult since it implies slicing the business and ensuring that no element needed for the trade is omitted. It also often implies obtaining the agreement of third parties in order for the transfer of ownership of some items to be effective. This approach can however be interesting when future risks that are difficult to assess or to cover with warranties and indemnities exist. Thus, the responsibility for such risks will remain with the company, even if it has been stripped out of most of its assets.
The completion of detailed due diligences covering accounting, legal and taxation matters is crucial in the UK. This is because British legislation is far less protective for the buyer than French law. There is no obligation for the parties to negotiate in good faith and the general rule is that the buyer is supposed to care himself about his own interests. Consequently he could not claim damages for a prejudice that he should have been able to detect during the negotiations. The due diligence review will therefore imperatively encompass all past and future finance matters, but also include a review of the main contracts and other commercial and operational matters. It is the responsibility of the buyer to set up a proper process in order to know exactly what he is buying.
The only limitation relates to listed companies since confidentiality is essential to avoid an adverse impact on the share price. However the practice in such situations is that the management allows access to the main items for a short period under the ‘data room’ procedure. In the existence of such a procedure it is crucial that the buyer appoint a team of accountants and lawyers sufficient enough to ensure that all information available is properly reviewed and analysed during the time allowed.
British purchase agreements in essence do not differ significantly from French ones, but they are significantly more detailed. It is also important to pay great attention to the warranties and indemnities and to an item specific to British law; the disclosure letter.
Warranties & indemnities
Warranties are included in two different documents: the warranties and the indemnities.
The first document is a long list of general warranties, covering virtually all aspects of the business. If it later appears that a warranty given was false the buyer will be able to obtain compensation as long as he can prove that the warranty was incorrect, that he suffered a direct prejudice as a result and that he was not aware of the problem at the time of the acquisition. The buyer is also supposed to take all relevant actions in order to mitigate his loss. When all these conditions are met compensation might be obtained, usually via a reduction of the consideration paid.
On the contrary, indemnities are a commitment to indemnify the buyer if a specific loss materialises. As opposed to warranties, the buyer is then fully reimbursed for the whole of the loss suffered, even in the absence of a direct prejudice and if he was aware of the problem. He also does not have to try to mitigate his loss. Indemnities are therefore much more efficient for the buyer but the vendor will obviously be less willing to grant them.
Lastly, in the case of a purchase of shares, the indemnities relating to tax matters are compiled in a specific document, the Tax Deed.
There is in British law relating to acquisitions a document with no equivalent in French law: the disclosure letter. The purpose of this document, prepared by the vendor and provided to the buyer prior to the signature of the purchase agreement, is to detail potential risks known to the vendor and likely to contradict warranties given.
It is important to analyse carefully this document and to fully take its consequences into account when deciding whether to or not invest and when negotiating the purchase price. Thus, the buyer will not be able to obtain later compensation for a prejudice resulting from an item properly detailed in the disclosure letter, even if it is covered by a warranty.
Absence of merger process
As opposed to French law, there is no real merger between the companies involved. The acquired company is not absorbed in the accounts of the buying company: only its assets and liabilities might be transferred and the target, likely to be no more than an empty shell, will remain.
Taxation of acquisitions, group relief
From a tax point of view share purchases are generally more favourable. Thus the acquirer has to pay a stamp duty limited to 0.5%. He will also be able to use tax losses, unless he brings substantial changes to the activity.
Purchases of tangible and intangible assets are subject to higher duties and might, in some instances, be submitted to VAT. Losses incurred prior to the acquisition cannot be used by the acquirer.
Lastly, if the acquirer has other entities in the UK, group regimes are significantly more flexible than in France and do not require percentages of ownership as high as the French ones.
Joint ventures are a common way of carrying out jointly with a partner a trade in the UK.
Incorporated or unincorporated joint venture
Joint ventures are either set up via a mere contractual agreement or via the incorporation of a specific entity.
Under the first approach an agreement is set up stating the role and responsibilities of each partner. Since there is no specific entity to carry out the trade each partner is fully liable for damages incurred by a third party and might be able to recoup a share of the cost borne from the other party. It is important to note that the agreement can be deemed to represent a partnership which results in specific legislation to apply, notably as far as responsibility is concerned.
Under the second approach the partners subscribe to the share capital of a company created specifically to carry out the trade. Usually two categories of shares are created, one for each partner, in order to allow different rights to be granted to each of them if required. The partners become therefore shareholders in a company where major items such as management, assets and liabilities and profit sharing can be clearly defined.
The choice between the two approaches will usually be dictated by the duration and the level of complexity of the partnership. A contractual agreement is interesting for simple and short term projects where ownership of the assets used for the joint activity can be clearly established. On the other hand setting up a company is clearly preferable in other instances. Moreover the possibility of opting for a limited company has also the merit of limiting the liability of each partner.
Incorporated joint venture: articles of association and shareholder agreement
A key feature of British law is that it gives significant freedom to the shareholders to decide how to operate the joint venture company whereas this is generally rigidly dictated by the type of company chosen in France.
The company will be regulated by two elements: its articles of associations and a shareholders’ agreement. The first document will contain general aspects of the management of the company and usually does not include any specific item. The shareholders agreement on the other hand will include all specific matters, whether relating to the management of the company, its financing or disputes between partners and all other elements considered confidential. The reason for this is that articles of association are in the public domain since they are filed at Companies House, which is not the case of the shareholders agreement.
When a simple contractual agreement is chosen the document will have to be very detailed since the entire management of the business will depend on it.
When a company is set up the shareholders agreement will include all the clauses relating to the management, notably allocation of voting rights between partners, procedure for appointment and removal of directors representing by each shareholders, powers of the directors and situations when shareholders consent must be obtained. Usually directors will not be allowed to contract new loans, acquire assets not budgeted for or enter a new activity without prior shareholders’ approval.
It is important to note that each director is legally bound to ensure that the interests of the joint venture company prevail against those of the shareholders who appointed him. Failing to do this would result in his personal responsibility being engaged.
The shareholders agreement will also includes numerous clauses aimed at addressing any dispute between shareholders in order to prevent the joint venture company from being unable to operate.
Taxation of unincorporated joint ventures can prove cumbersome. Since there is no specific entity each partner will be taxed on his share of profits. The French partner is likely to be treated as having a permanent establishment in the UK and may be taxed in this country, depending on their residence status and the type of income or where the income has arisen.
Matters are easier where the trade is carried out via a company. The company will be subject to the standard rules of UK corporation tax and partners will be mainly remunerated via dividends. Should the activity be loss making and the shares in the incorporated joint venture company be held by a company, it will normally be possible to transfer a share of the losses to this company or another company member of the same group.
The UK offers numerous opportunities for a business willing to expand internationally. It is however crucial to keep in mind that the legal, financial and taxation environments are sometimes very different. Whether setting up a structure, acquiring a company or setting up a joint venture the Beavis Morgan team can efficiently assist you and its expertise can prove a key element of the success of your project.
This document has been prepared for the use of clients, partners and staff of Beavis Morgan. It is designed to give some general information to those contemplating doing business in the UK and is not intended to be a comprehensive document. You should consult us, therefore, before taking further action. Beavis Morgan cannot be held liable for any action or business decision taken on the basis of information in this booklet.
Information in this document is considered to be accurate as at 06/04/2015.
Please contact Ravi Hungsraz to see how we can assist you.