Agency Companies

The use of ‘agency companies’ as a structure for international tax planning is a relatively simple concept. This structure involves the establishment of an offshore company which would act as principal. This offshore company would then appoint an English company to become its agent. As the agent the English company would act for it in respect of the collecting in fees, commissions or other moneys that are due to the principal.

The English company would act as ‘agent’ on a non-disclosed basis. This means that the name of its principal would not be disclosed to the third party with whom it is transacting.

The English company acts in a normal manner and can register for VAT and is subject to the statutory requirements of company law and the UK taxation system.

The question of commission becomes a transfer pricing issue and these are usually considered on a case by case basis. In some cases the commission can be as low as half of 1% but is more usually between 5% and 10%.

The English company, as agent, accounts for its commission in the financial records of the company. From the commission it would deduct all standard and reasonable running costs with UK corporation tax levied at the prevailing rate on the resultant profits. This typically, gives rise to a UK tax liability of something in the region of 0.5% and 3%.

Principal Company

This is very similar to an agency structure discussed above. Here it is the UK company that acts as principal and sub-contracts the performance of the work to an offshore company or companies. The objective of this structure is to manage the tax liability in the UK to an acceptable level having regard to the client's wishes.

Why use the structure over the Agency Company?

There are two main reasons why a client my want to use a principal structure in preference to an agency structure.

• Firstly, if an ‘agency structure’ is used, if for example the UK Company collects fees totalling £2m, when it prepares its financial statements they contain only the agent’s commission, which is likely to be a maximum of £200,000. If however, a principal structure is used, then all of the income will be shown through the profit and loss account of the English company.
• The second reason is that obtaining treaty certification for agent companies can be problematic. This is because an inspector of taxes maybe unwilling to certify that the income of a UK agency company qualifies as income of the company for the purposes of one of the UK’s double taxation agreements. In addition an inspector is likely to be very reluctant to provide any form of certificate of UK residence for a company that has been sole established to act as an agency company. This is not withstanding the fact that the company is evidently resident in the UK for tax purposes. In using the ‘principal structure’ however, the income belongs to the UK Company and is taxed in the UK. As such an inspector is duty bound to issue either a general certificate of residence or a certifying document relating to the underlying income.

The key task in managing a Principal Company is to determine the level of profit that the UK operations will produce. This however is not an exact art and clients should take this into account.

However, from experience at ATC Solutions we are able identify the key procedural issues on a business to business level and we can then make a reasoned assessment of the level of profits that are likely to be accepted by an inspector of taxes as reasonable. As such every case is considered on its own merits and designed to reflect the objectives of the client but satisfy the UK tax authorities.

In that the objective is to arrive at an acceptable level of profits in relation to the UK tax liability this again becomes an issue of transfer pricing. Therefore, any amounts invoiced by the subcontractor to the UK Company must be considerate to the overall circumstances. Where possible though they should be calculated at a distance, ie they have to be consistent as opposed to being levied solely with a final profit figure for the principal in mind. Finally it has to be clear that the expense was incurred wholly and specifically for the carrying on of the UK company's trade.

It is obvious from the above that the level of profit attributable to the UK Company will vary on a case by case basis. As a rough benchmark we would argue that an English company acting as principal in a transaction should earn a profit above that earned by an English company acting as agent in the ‘agency structure’. Thus if agents generally earn between 5% and 10% then our starting level for a principal should be at a gross profit margin of 10%. In our detailed discussions HMRC the Inspector of Taxes has confirmed that currently this will be considered as acceptable structure for dealing with a transaction such as this.

Net profit however must also be considered in the calculation. It would not be looked on too favourably if the principal company were to produce net losses and to thus pay no taxation to the UK authorities. A situation such as this is likely to result in an inquiry, particularly if losses are incurred on an ongoing basis. In the above example the company has made a 10% gross profit and an 8.5% net profit.

If the company is likely to show a net loss then either some of the expenses should not be claimed through the profit and loss or the gross profit margin should be reconsidered as it is unlikely to be considered to have been conducted ‘at arms length’ by the tax authorities.