Doing Business in the U.K.

Doing Business in the U.K.

GO BACK TO INDEX

SECTION 1: INTRODUCTION

SECTION 2: ESTABLISHMENT IN THE U.K.

SECTION 3: DOING BUSINESS IN THE U.K.

3.1 Value Added Tax (VAT)
3.1.1 Chargeable Supplies
VAT is a tax which is much misunderstood in the U.S., as was apparent when the idea of introducing it was floated by the Clinton Administration in 1993, as a way of paying for health care reforms. Firstly, it is technically not a tax but a duty and it is therefore administered by HM Customs and Excise rather than HM Inland Revenue. Furthermore, it is a tax not only on the sale of products but on the provision of services in the widest sense of the word (collectively a "supply"). For example, landlords have the right to charge VAT upon the rent payable by commercial tenants. Finally, there is no real measurement of the value added except in the most notional sense, since it is really a tax on gross revenues. Every member of the EU is obliged to charge VAT, since the EU is principally funded by a proportion of the VAT receipts of each member state. The current rate in the U.K. 17.5%.
3.1.2 Operation of the Tax
VAT is chargeable on the gross invoice price of the product or service supplied, at every state of production and distribution ("output"). That is to say, the supplier of raw materials must charge it to a manufacturer, who must charge it to a wholesale distributor, who charges it to a retail distributor, who charges it to the retailer, who charges it to the consumer. However, every commercial enterprise having taxable supplies in excess of the registration threshold, (ś45,000 per annum from December 1, 1993) is required to register for VAT (and to charge VAT on its outputs) and is therefore entitled to deduct from the VAT collected on its income, the VAT which it has paid on its expenses ("inputs"). Only the net amount is required to be paid to Customs and Excise. In theory, for registered businesses, VAT should only have cash flow implications, with the only person who really bears the cost being the retail customer. If a business only has "exempt supplies", e.g. the sale of residential real estate, then it is not entitled to register and neither charges VAT, nor recovers any VAT paid on its expenses.
On the other hand, businesses which are primarily involved in exporting from the U.K. may have a particular cash flow advantage. Such exports are "zero rated" which means that although they are technically required to collect VAT, the applicable tax rate is zero. Such businesses are still entitled to register for VAT, (as opposed to a business only engaged in exempt supplies, which is not entitled to register; see above) and will, accordingly, be able to reclaim the input VAT which they have paid on all of their expenses. This means that every time they file a VAT return rather than paying VAT, they will receive a refund from Customs and Excise.
3.1.3 Accounting for VAT
VAT requires a completely separate accounting system for each business, since it does not go through the usual books of account and does not appear in the profit and loss account (any liability for VAT will, of course, appear on the balance sheet). This can be an enormous administrative burden particularly for small companies, as well as a financial one. Most accounting in the U.K. is done on an accruals basis, which means that the business has to account for VAT based on the date of the invoice not the date of payment. Small businesses in particular may experience major cash flow problems if they are not receiving timely payments from their customers. Accordingly, businesses having annual sales of less than ś250,000 are entitled to cash account for VAT and only pay it to Customs and Excise once they have been paid.
3.1.4 Exports within the EU
Following the implementation of the single market in the EU on January 1, 1993, the situation with regard to dealings with businesses in other member states has become more complex. The system is still in a transitional stage and currently requires an enormously increased amount of paper work by each of the companies involved, since there are no longer border controls at which import and export information can be collected. Furthermore, VAT is payable by the registered enterprise which is receiving the supply upon importation (referred to as an "acquisition" in this context) and at a rate prevailing in its own jurisdiction. Previously, sales to businesses in other member states were simply zero rated (see above). There are plans to simplify the procedure but it is believed that this will take some years.
3.1.5 Temporary Imports
When certain classes of goods are imported into the U.K. on a temporary basis and are then re-exported within a short period, relief from duty and VAT may be available. Security is usually required in the form of a cash deposit, guarantee or bond. In addition, if goods are held in bonded warehouses or imported into one of the five free zones, then no VAT is payable unless and until they are moved out of the warehouse or free zone into the U.K. market. Most import controls and duties do not apply in such cases and to a certain extent, such goods may even be processed and bought and sold whilst within the warehouse or free zone.
3.1.6 Prices
Finally, it is most important to note, that contrary to the common presumption with regard to sales tax in the U.S., any price quoted is deemed to include VAT, unless expressly stated to the contrary. This generally applies in retail establishments and makes life easier for the consumer. However, in the commercial context, it is usual to discuss prices "ex VAT". In that case, the practitioner and the business person must ensure that the contract specifies that prices referred to are "exclusive of," or "plus" VAT.
3.2 Premises - Leasing and Buying
In general, the commercial considerations governing the decision whether to buy or lease premises in the U.K. will be the same as in the U.S.A. From the tax point of view, as in the U.S.A., both rental payments and interest on loans by a business to purchase a property are deductible against income, for U.K. tax purposes. This section will, therefore, be limited to a review of some of the differences in the economics and legal procedures involved in leasing and buying real property in the U.K. (Real property law being significantly different in Scotland, this review will deal primarily with the situation in England and Wales).
3.2.1 Leasing
There are fundamental differences in the way in which U.K. commercial leases deal with the prime issues of rent and rent reviews (escalations), service charges (payment for operating expenses), property taxes and renewals.
3.2.1.1 Rent
A typical English lease will set an initial rent, subject to periodic, upward only rent reviews to the open market rent prevailing at the date of the review (e.g. a nine year lease with reviews in the third and sixth years). Accordingly, the rent is only agreed until the date of the first rent review. This contrasts with typical U.S. leases, in which the amount or calculation of all future escalations are agreed at the outset.
At each review date, the landlord proposes a new rent, based on the rent recently agreed for new lettings or reviews under leases of comparable premises in the area. If the parties do not agree the new rent, the lease will normally provide for arbitration by one or more Chartered Surveyors or Licensed Valuers (who carry out all real estate appraisals in England). Rent is payable at the previous rate under the lease, until the amount of the review is agreed or determined, when the accrued deficiency is payable, usually with interest from the effective date of the review.
3.2.1.2 Service Charges
Rent is generally not inclusive of any expenses incurred in the management and operation of the property. Accordingly, most commercial leases will require the payment of a service charge in addition to rent, representing a proportion (based on area) of all of the landlord's expenses in operating the building and not merely the increase in expenses over a base year, as is often the case in the U.S.
The main exception is a "Full Repairing & Insuring Lease" (an "FRI Lease"), under which all of the obligations for repair and maintenance of the building are assumed by the tenant and accordingly, the landlord has no operating expenses. Generally this will only arise where the lease is of an entire building, for a relatively long period, say in excess of fifteen years.
3.2.1.3 Taxes
Property taxes are almost universally paid by the tenant, in addition to rent. The property tax regime in the U.K, was completely revised under the Thatcher government. Under present law, each unit of ownership, whether an entire building, or the area demised under a particular lease will be separately valued by the District Valuer. The local authority (city or borough) then applies to the valuation the Uniform Business Rate (rate of tax), which is set by the U.K. government for each fiscal year (April 1 through March 31) and payments are made to the local authority. It is possible to pay taxes in ten equal, interest free installments, during the relevant fiscal year.
In addition, a water rate is payable to the local water company, for the provision of fresh water and sewage services.
3.2.1.4 Renewals
Commercial leases are subject to the security of tenure provisions of Part II of the Landlord and Tenant Act 1954. Most commercial tenants have the right to a renewal of their lease on the same terms, subject only to payment of the then open market rent.
In summary, the procedures are as follows. Prior to the end of the lease, the landlord is entitled to serve a notice stating that it accepts or opposes the tenant's right to a new lease. The tenant is entitled to serve a notice stating that it wishes or does not wish to exercise its right to a renewal of the lease. In only limited circumstances is the landlord entitled to object to the grant of a new lease, the most common instances being where the landlord requires the premises for its own use or for a substantial reconstruction of the whole building. In the event of a dispute, either party is entitled to commence proceedings for a judicial determination under the statutory provisions.
Since strict compliance with the statutory provisions is required by both landlord and tenant, in order to preserve their respective rights, each party should take detailed advice on their positions at least one year before the expiry of the term. Furthermore, since either party can commence the procedure by service of notice and service of the first notice triggers a statutory timetable, the tactics of who does what and when need to be very carefully considered.
These statutory rights of renewal can be excluded by agreement, subject to approval by the County court. Such exclusions, commonly referred to as "taking the lease outside of the 1954 Act", are generally only agreed in special, short term situations, e.g. a sublease for less than three years.
3.2.1.5 Delapidations
One feature of English leases can prove very expensive to the unsuspecting tenant and is often the subject of lengthy negotiations and litigation. Under most leases, apart from detailed repairing and maintenance obligations on the part of the tenant, the tenant will also have an obligation to reinstate the premises at the end of the term, to the condition which existed at the commencement of the lease. The landlord is entitled by statute to serve on the tenant a "Schedule of Delapidations", setting forth in great detail all of the construction work and repairs that landlord considers necessary for tenant to comply with its obligations. Compliance could cost the tenant hundreds of thousands of Pounds.
Accordingly, Schedules of Delapidations are frequently served prior to the end of the term as a negotiating tactic, in order to give the landlord additional leverage in the negotiations for the renewal of the lease. Careful drafting of the lease is needed to mitigate or limit the effect of the repairing and reinstatement clauses.
3.2.2 Purchase
A majority of real estate transactions in England and Wales involve registered land. Pursuant to the scheme first introduced by the Land Registration Act of 1925, title to registered land has been investigated by the Land Registry for the district in which the land is located and a government guaranteed Land Certificate is issued to the owner for each parcel of registered land. Title insurance, as commonly used in the U.S.A. is unknown in the U.K. and, indeed, unnecessary in the case of registered land. Since land is only required to be registered when it changes hands, land which has been held by the same owner since before the 1925 Act, remains unregistered. The transfer of unregistered land involves detailed title investigation and therefore the procedure on sale is entirely different. This section will only deal with sales of registered land.
3.2.2.1 Pre-contract Enquiries & Searches
The normal progression of a real estate transaction involving registered land, would be as follows. Once the vendor and purchaser have agreed terms, they will instruct solicitors to prepare the sale contract. As in the U.S., a contract for dealing in any interest in land is unenforceable unless recorded in writing.
The vendor's solicitor will prepare the contract and obtain from the Land Registry an office copy of the Land Certificate. The purchaser's solicitor will review the contract and the Land Certificate. The Land Certificate will show the present owner of the property, any charges registered against the property (e.g. mortgages and other liens) and restrictive covenants affecting the property. However, the purchaser's solicitor also needs to ask the vendor various questions regarding the use and other detailed legal and practical matters relating to the property, which will not be registered (e.g. leases or underleases, occupants other than the vendor who may have certain rights, boundary disputes and so on).
In addition, the purchaser's solicitor will carry out a Local Authority Search, in order to disclose the planning (zoning) situation. This would reveal any major forthcoming adverse developments, such as the construction of a highway through the area and any enforcement notices (violations) which may be recorded.
3.2.2.2 Exchange of Contracts
Once the contract has been agreed and the purchaser is satisfied with the results of all enquiries and searches, the parties may proceed to "exchange contracts". It is only at this point that the parties are legally committed to the transaction and specific performance can be sought to enforce the contract. Both parties sign one part of the contract and deliver it to their solicitor. The purchaser also provides the contract deposit, usually ten percent of the purchase price. The solicitors will generally deal with exchange by a telephone call, in which they agree that the contract is exchanged (or effective) and undertake to send a copy of the contract signed by their client and, in the case of the purchaser's solicitor, the contract deposit, to the other party's solicitor.
Contracts are rarely conditional, so that all matters which could affect the purchaser's decision to proceed must be resolved prior to exchange. Any physical inspection report (always required where financing is involved) and an unconditional mortgage offer (loan commitment) must be obtained before exchange of contracts.
3.2.2.3 Completion
Completion (closing) will normally take place one month later. In the case of registered land, a simple two page Transfer document in statutory form is used to convey title to the property. Mortgage documents are also generally simple forms and the solicitor for the purchaser will often act for the bank, except in the case of complex or large commercial loans.
Completion is also often accomplished by a telephone call. The purchaser sends the purchase price to the vendor's solicitor in escrow, in advance of completion (generally on the morning of the completion date). Once confirmation of the wire transfer has been received, the vendor's solicitor will confirm that all necessary documents are in his possession and undertake to send them to the purchaser's solicitor. In most simple transactions, there is no closing meeting as such, or even if there is, the principals frequently need not attend.
3.2.2.4 Registration of Title
Following completion, the purchaser's solicitor must have the Transfer "Stamped" by the Inland Revenue, which evidences payment of Stamp Duty (transfer tax) of one percent of the purchase price (subject to limited exemptions). Only when the document has been duly stamped, can the new owner's title to the property (and any mortgage) be registered at the Land Registry.
3.3 Employees
Employment legislation in the U.K. has a different focus to similar legislation in the U.S. A great deal of emphasis is placed upon the protection of employees with regard to the terms and conditions of their employment and the termination of employment. As in the U.S. there is a growing body of law and precedent, much of it coming from the ECJ, intended to counteract discrimination in all forms. The government has strongly resisted further regulation by the EU, particularly with regard to limitations on hours of work and employee representation in management of the business. Indeed, John Major's government considered that it had achieved a major coup, when it negotiated an "opt-out" clause from the recent Maastricht Treaty, with respect to certain social and employment legislation. However, the U.K. is still, to a certain extent, subject to such regulation by virtue of other, preexisting treaties and legislation. The following is a summary of some of the principal areas of employee relations law, which may be unfamiliar to U.S. practitioners and businesses.
3.3.1 Terms of Employment
Under the Employment Protection (Consolidation) Act 1978 ("EP(C)A"), as amended by the Trade Union Reform and Employee Rights Act 1993 ("TURERA") most employees (excluding among others, employees who work less than eight hours per week) are entitled to written particulars of certain terms of their employment, within two months after the date on which their employment commences. They are also entitled to a statement updating the particulars from time to time.
The EP(C)A and TURERA set forth a detailed list of the matters which need to be notified. A sample statement of particulars appears in Appendix II. Apart from those particulars which state specific facts, e.g. the names of the parties, the date employment commenced, the job description, etc., the law does not mandate what the terms should be, it merely requires that the employee be informed what the terms are. For example, the rate of remuneration or the method of calculating remuneration must be stated but there is no minimum wage. Details of any pension benefits must be set forth, but there is no obligation to provide any. If there are no provisions as to any of the terms of which particulars are required, that fact must be stated.
Certain of the particulars must be given in detail, at the same time in a "principal statement"; these are indicated by an asterisk in Appendix II. Other information may be given in or by reference to other documents. For example, the employer may issue a separate handbook or memorandum detailing rules relating to disciplinary and grievance procedures, pension and retirement arrangements and agreements with trade unions. The requirements relating to disciplinary and grievance procedures do not apply, if on the date of commencement of employment, the employer has less than twenty employees.
If the employer fails to provide the required particulars voluntarily, the employee is entitled to demand them and if the employer still fails to give them, in the event of any dispute, any ambig uities in the terms will be construed against the employer.
3.3.2 Unfair Dismissal
Every employee has statutory rights not to be "unfairly dismissed". The majority of these rights only arise after two years of continuous employment by the same employer, however every employee has the right, both under UK and EU law, not to be unfairly discriminated against when seeking employment, during the course of employment or upon termination of employment. Unfair dismissal focuses on two separate aspects of termination of employment: (a) the reason for the dismissal; (b) the manner of dismissal.
3.3.2.1 Reason for Dismissal
Every employee is entitled to a written statement of the reason for his dismissal. The reason must be objectively reasonable and relate to the employee's performance and conduct of duties for his employer. The one exception is dismissal by reason of redundancy. Here, the employer must show that the job for which the employee was hired is no longer needed or available (typically for financial reasons) and that the employer has made every reasonable effort to try to find the employee an alternative position within the business (for further details regarding redundancy, see section 3.3.2.4).
3.3.2.2 Manner of Dismissal
Although there is no statutory procedure for dealing with disciplinary problems, as a matter of practice, the Industrial Tribunal and the courts have required employers to follow a fair and proper procedure, in order to give a non-performing employee, every chance to improve his conduct. If an employer does not follow procedures laid down in any trade union agreement or in the employer's own disciplinary rules, then the employee will be deemed, prima facie, to have been unfairly dismissed. In the absence of such rules, the employer will be strongly advised to ensure that the employee was warned about his conduct, probably on more than one occasion and with at least one written warning; and that the particular reason for the dismissal was presented to the employee and that he had the opportunity to have that decision reviewed by an "independent" person in the organization, i.e. one who is not involved in the decision to terminate employment. The employee should be entitled to have someone sit in at such review whether a trade union representative, lawyer or friend, and to present his case.
3.3.2.3 Legal Recourse
If the employee is dissatisfied with the stated reason for or the manner of his dismissal, then he is entitled to apply to the Industrial Tribunal for review of the decision and redress. The Tribunal is intended to operate under a more informal procedure, and although the parties are entitled to be represented, a "legalistic" form of representation is discouraged. The normal rules of evidence are not strictly applied. As a matter of practice, it must be said that unfair dismissal cases tend to be decided in favor of the employee. The Tribunal has the power to award compensation and to require reinstatement of the employee in appropriate cases. The basic compensation payable, in the event of a decision against the employer, is limited by reference to a maximum weekly level of earnings multiplied by the number of years of continuous employment. The Tribunal is entitled to award additional compensation in appropriate cases, by reason of the conduct of the employer and to compensate for additional losses of benefits such as pension rights but this is presently ca pped at ś11,000.
However, the law in this area is now in turmoil, following the recent landmark decision by the ECJ in the case of Marshall v Southampton and Southwest Hampshire Health Authority (ECJ 271/91)[1993]. In that case the ECJ held that it was contrary to the EU's Equal Treatment Directive 76/207 for national provisions to prescribe a maximum limit on the compensation recoverable by a victim of discrimination, in respect of loss and damage sustained. At present, it seems that only employees in public sector employment can benefit from this, but the writing is apparently on the wall for this provision. Following the case, the Ministry of Defence has taken the unprecedented step of announcing that about 5,500 women were dismissed from the armed services by reason of pregnancy, in breach of the directive and that it was trying to settle these cases by paying additional compensation.
This area of the law in particular, serves as a salutary lesson to all practitioners, that even apparently wholly domestic U.K. issues, not involving any other more obvious inter-European affairs, may be dramatically impacted by EU law and decisions of the ECJ. Lawyers ignore this at their peril.
Appeal from the Industrial Tribunal lies to a specialized panel of judges of High Court status called the Employment Appeal Tribunal. From there, further appeal lies direct to the Court of Appeal and then to the House of Lords and, in appropriate cases, the ECJ.
3.3.2.4 Redundancy & Notice
Although redundancy is a good reason for dismissal, this does not mean that employees have no rights in the event of being dismissed for that reason. Apart from any internal redundancy provision that each company may make, every employee who is made redundant after more than two years of continuous employment, is entitled to redundancy pay, calculated at an equivalent level to the basic compensation for unfair dismissal (see section 3.3.2.3) Redundancy pay is separate and apart from any entitlement to pay, during the period of notice of termination, or in lieu of notice of termination. Every employee has the right to at least one week's notice of termination during the first two years of employment and thereafter, an additional week for every year of employment, up to a maximum of twelve week's notice. Such periods of notice may be increased by contract.
3.3.3 Wrongful Dismissal
3.3.3.1 Basis of Claim
Wrongful dismissal is a common law claim for breach of contract. The elements required in order to maintain a wrongful dismissal are exactly the same as for breach of any other contract. The fact that an employee may have been held to have been unfairly dismissed, is not conclusive evidence of wrongful dismissal, although it is obviously supportive evidence of such a claim. Since any damages award in a wrongful dismissal action, could be taken into account in assessing compensation for unfair dismissal, in appropriate cases, it is common for employees to pursue their rights through the Industrial Tribunal first, before commencing High Court action.
3.3.3.2 Damages
The key issue in wrongful dismissal cases (once a breach of the contract has been established) is the calculation of damages. Although this is based upon the usual contract measure of damages, a specific body of law has evolved with regard to damages for breach of employment contracts. Take the example of an employee who has a three year fixed term service contract who is wrongfully dismissed after one year. Prima facie, he or she would be entitled to the equivalent of two years salary and benefits under the contract, representing what they would have received had the employer performed its obligations under the contract. However, there is a strong duty on the employee to mitigate damages by trying to find comparable employment, as soon as reasonably possible. Account may be taken of unemployment benefits received. A further deduction would be made based on the fact that the employee would receive the damages reward as a lump sum, as opposed to a stream of payments over two years and an appropriate discounting factor may be applied. On the other side, the employee is entitled to claim for such additional losses as loss or diminution of pension rights, the value of lost benefits in kind, such as motor vehicles and the loss of the right to exercise any share or stock options.
3.3.4 Discrimination
Under the Sex Discrimination Act 1975 and EU legislation and case law (referred to above), every employee has the right not to be improperly discriminated against in seeking employment and during the course of and on termination of employment. This is an area with which U.S. lawyers are well familiar and although generally, the law in this area is not as developed as it is in the U.S., as can be seen from recent ECJ decisions, U.K. law is rapidly catching up.
3.3.5 Continuity of Employment
Many of the rights granted to employees under U.K. legislation are dependent upon "continuous employment". Accordingly, U.K. law has made additional provision in order to protect employees from having that continuity broken. Particular attention should be paid to the Transfer of Undertakings (Protection of Employment) Regulations 1981. Pursuant to these regulations, where an employer disposes of substantially all of the assets and undertaking of the business (as opposed to selling shares in a company) the employer changes and, in the absence of the regulations, the employee's continuity of the employment would be broken.
The regulations set forth a number of rights and obligations in such cases, as follows:
3.3.5.1 The new employer is required to offer employment on comparable terms, to all employees of the business.
3.3.5.2 The employees are not required to accept the offer of new employment and if they do not do so within one month then, subject to certain conditions, they are entitled to be treated as having been made redundant and paid compensation accordingly (see section 3.3.2.4).
3.3.5.3 Employees are treated as having continuity of employment from the date when they were first employed by the original employer. The effect of this, is that the new employer inherits a contingent liability in respect of redundancy, unfair dismissal, maternity and other rights based, on the length of employment by the seller of the business.
The parties are at liberty to apportion the impact of these rights and obligations between themselves, provided they do not affect the rights of the employees. For example, the seller could agree to indemnify the purchaser and to pay the redundancy cost of any employees who do not accept employment with the new owners. Accordingly, in any contract for the sale or purchase of a business it is most important to obtain warranted details of all employees, including their terms and conditions as to salary, notice and the date on which they commenced employment and, in appropriate cases, to make provision for dealing with the effect of the Transfer of Undertaking Regulations.
3.3.6 Payroll Costs
All employers are required to pay their employees subject to withholding tax and National Insurance Contributions ("NIC") (Social Security), under the scheme commonly referred to as "pay as you earn" or "PAYE". As in the U.S., employers are required to deduct income tax and NIC in accordance with tables and codes and to account Inland Revenue for same by the 19th of the month following the month in which the payroll occurs. In addition, employers are required to pay employers' NIC which, for the year 1994/5, is at the rate of 10.2% of gross pay. Lower rates apply in respect of lower paid workers, in order encourage employment in that sector of the labor market. Following the enactment of a series of anti-avoidance provisions, NIC will also be payable not only on wages and salary but also upon a wide range of benefits in kind, which were previously used as devices to save the amount of NIC payable.

GO BACK TO INDEX

SECTION 1: INTRODUCTION

SECTION 2: ESTABLISHMENT IN THE U.K.

Copyright 1994, THE AMERICAN BAR ASSOCIATION. Reprinted with permission.
This article was prepared by Beck & Arad, LLP, a New York-based law firm dedicated to serving the needs of domestic and international business clients. The content of this article was designed to provide general information on the subject matter covered. No legal or other professional advice or option is being rendered. Any liability or loss incurred as a consequence, directly or indirectly from the use or application of the information contained herein, is specifically disclaimed.
For further information about this article or Beck & Arad, LLP, please contact Philip Beck or Graham Arad at:
Beck & Arad, LLP
950 Third Avenue, 18th Floor
New York, New York 10022
United States of America
Telephone: +1 212 319 0800
Telecopier: +1 212 750 0101
e-mail: beck&arad@interleges.com