Service: Taxation 

Topic: Coronavirus 

Corporate tax implications of Covid-19

By Sonal Shah

12 May 2020

The ripple effects of the Covid-19 pandemic are difficult to model and assess. Whilst entities are primarily focused on managing their condensed supply chains, borrowing opportunities and workforce immobility, we continue to support businesses by highlighting and advising on various tax implications which can be easily overlooked. 

The corporate tax effect following international travel restrictions

We discussed in an earlier article, ‘Covid-19: Impact on UK tax residency’, the impact that international travel delays would have on the residency status of individuals currently unable to leave or return to the UK. However, we ought to now highlight that the Chancellor in his recent letter to the Treasury confirmed that the Statutory Residence Test (SRT) will be subject to temporary changes. This means that between 1 March and 1 June 2020, time spent in the UK by individuals working on Covid-19 related activities (i.e. from anaesthetists to engineers) will not count towards the UK residence tests. 

Whilst on the subject of international travel restrictions, businesses should also factor in the tax effects caused when employees and consultants with international roles are not able to return home. The accumulation of months spent working in a foreign jurisdiction could trigger further tax liabilities, such as: additional social security, withholding taxes on earnings, etc. These will highly depend on the bilateral agreements between the countries and any temporary amendments made in light of Covid-19.  Thus, in order to avoid unexpected charges and liabilities, entities should actively monitor the status of their employees.

Companies are subject to different rules. Generally, if a company is incorporated or it’s central management and control is exercised in the UK, then it will be deemed to be UK resident; hence subject to UK corporation tax. Unfortunately, the current travel restrictions raise concerns in scenarios where directors are not able to fly out for board meetings or where there are not sufficient staff or resources present in the company’s usual jurisdiction. These could restrict the company to meet the economic substance test and its tax resident status in a particular jurisdiction. 

We have seen that jurisdictions such as Guernsey and Jersey have relaxed their economic substance and residency rules. This is so long as the adjusted operating practices are required to mitigate threats from the outbreak and are of a temporary nature. Although HMRC published guidance on its approach to corporate tax residence in light of the Covid-19 pandemic, it has not gone as far as to relax the rules. Therefore, there is a concern that different jurisdictions may take different stances on adjusted corporate practices resulting from Covid-19. Due to such complexities, further advice should be sought and all amended practices should be documented and reasoned accordingly.

Eligibility for claiming reliefs

Numerous reliefs available in the UK are based on the trading eligibility criteria. For instance, the entrepreneurs relief can be claimed on sales of shares in a trading company or the holding company of a trading group. For the purpose of this test, however, an entity is deemed to be trading so long as its non-trading activities are not more than 20% of its total activities. The 20% test can be based on various factors such as: asset base, income streams, costs incurred, time spent on activities, etc. 

Given the trade restrictions imposed by the government to suppress the Covid-19 pandemic, there is a likelihood that these will compromise the level of reliefs shareholders, especially in the hospitality and airlines industries, could claim on disposals of their shares. As such, no matter what the temporary adjustments are, companies should keep track of all their operations and have evidence to support that there is an intention to continue to be trading once the conditions revert to normal.

Loans and exempt distributions from overseas subsidiaries

Due to Covid-19, multiple group companies may re-assess their finances and consider further opportunities to restructure. However, in the short-term, liabilities could be funded via intra-group loans and distributions.

When loans are made available to UK companies by foreign group entities, there are circumstances when a withholding tax is applied to the interest paid on such loans. One such instance is when a loan is issued which is short term but, due to liquidity issues, there is a risk that short term loans would not be settled in time and, therefore, rolled forward for longer than 12 months. Such delay will, unfortunately, give rise to an additional administrative burden. It is possible to evaluate whether the entity will avoid the withholding tax by reviewing the relevant Double Taxation Treaty. As such, more detailed assessments should be made when intercompany loans are arranged with non-UK resident entities.

In contrast to loans, dividends received by UK companies are generally exempt from UK corporation tax. However, the conditions of the exemptions largely depend on whether the recipient company is either “small” or “large”. A company is small if in an accounting period it has fewer than 50 employees, and an annual turnover and/or total balance sheet of less than EUR 10 million. Given the temporary financial support received by the government such as the furlough scheme, it is anticipated that the employee headcount will not be significantly affected. However, due to the cut-off date of this scheme, there is a likelihood that several firms will have to resort to redundancies; hence resulting in a group becoming “small”. Given the eligibility conditions, it is possible that the transition of a “large” company to “small” would bring in a tax charge on dividends received from overseas subsidiaries (i.e. if the issuer is located in a non-qualifying territory). Although a reduction of 19% in the dividends received may seem significant at this point, this may not be of relevance and may not apply since the thresholds should be breached for two consecutive accounting periods in order for a company to charge status from “large” to “small” and vice versa.

The above is just a flavour of what should be considered. If you require any further advice on this matter or wish to discuss your personal case, please do not hesitate to contact us.

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