Many people work in the UK on an ongoing basis, but are employed by foreign enterprises – foreign companies without any formal presence in the UK or foreign embassies, for example. So what obligations – if any – arise for such foreign enterprises from a UK perspective with regard to the deduction of income tax and National Insurance contributions under the PAYE system? Do such enterprises need to register for PAYE and National Insurance? And if so, under what circumstances? Further, are there any obligations for employees? What are these and when would they apply?
The position for employers
The obligations for employers can depend upon a number of factors and the answers to questions including:
a) Is there a UK subsidiary? Has a permanent establishment (or similar taxable presence) been created in the UK?
b) Is the overseas employer based in the EU? Here, the EU includes Switzerland and the European Economic Area (EEA) countries of Norway, Iceland, Liechtenstein.
c) Would the UK employees be caught by ‘the agency regulations’ for off-shore employees?
d) Are there ‘political’ or wider business and human resources factors?
e) Does the person work for a foreign embassy in the UK?
UK subsidiaries and permanent establishments
If there is a UK subsidiary entity employing individuals this will always create a UK payroll obligation. If there is not a subsidiary it will be necessary to consider whether there is a permanent establishment in the UK. This can often be straightforward. For example, if there is a UK production facility or a sales office leading on negotiations and the like with clients, there should be no doubt that there is a permanent establishment in the UK. If there is a UK permanent establishment, there is a clear obligation for the entity to register in the UK and to account for PAYE income tax and National Insurance for the UK-based employees.
However, in some cases, the position in this regard can be less clear-cut. For example, there may be a UK sales office but it undertakes only ‘preparatory activities’ and these, for example, may be undertaken from the homes of individual employees rather than in any fixed office or similar.
Further, double tax agreements would suggest that the following are, in effect, not permanent establishments for corporate tax purposes:
- a buying office in the UK for an overseas business;
- a warehouse in the UK for a foreign business used for storage or display purposes;
- a branch operation – say for marketing and market research support to the overseas entity; and
- a building project which is designed to last for fewer than 12 months (or six months according to some double tax agreements).
As such, if these are not permanent establishments, what is the position on registering for payroll withholding in the UK? Is there any obligation for these businesses to register? As with many things in tax, the answer can be: ‘It depends.’
HMRC accepts that, based on Clark v Oceanic Contractors  STC 35, PAYE registration is required only if there is a taxable presence in the UK. As with any assessments linked to case law rulings, the precise facts and circumstances of each situation can alter depending on whether an employer has a ‘taxable presence’ here. However, if one looks at the HMRC guidance in its PAYE Manual at PAYE81610, which gives its view of the case law, this says:
‘For there to be a tax presence, we need to show there is something in the UK similar to a branch or agency, office or establishment. Essentially, we need a UK address where we can contact the employer, send PAYE literature and, if necessary, enforce compliance.’
As such, HMRC would accept, for example, that staff simply working from their private homes (including sales-related staff), should not, in the absence of any branch or office-like presence in the UK, represent a taxable presence for payroll registration purposes. However, the UK warehouse of an overseas company, a UK building site or a formal buying office operating from a specific location would, I suggest, be sufficient for HMRC to argue that there is a taxable presence and payroll reporting requirement.
Employers based in the EU
The position for employers based in the EU, EEA or Switzerland is potentially further complicated by the EU Social Security Regulations SI 883/2004. In practice, if there is a clear taxable presence here, there is no issue – PAYE income tax and National Insurance are both due innately under UK law.
However, if there is no taxable presence in the UK as in Oceanic Contractors, EU employers are still obliged to register for National Insurance withholdings in the UK under the EU regulations if they have UK-based employees. This is the case, even if such employees are not creating any formal UK presence. For example, an IT support worker working from his garage in Luton for a German or French entity would be subject to UK National Insurance withholding (primary and secondary contributions) on their salary. If the German or French entity does not automatically register for such withholdings in the UK, HMRC can request that the German or French authorities automatically ‘demand’ such contributions from the overseas company.
It is important, however, to note that the regulations apply only to National Insurance (social security). They do not impose any legal obligation on EU employers to also register for PAYE income tax withholding in the UK. In practice, many EU employers that are registering for National Insurance withholdings will also register for PAYE because:
- HMRC is understandably happy to have foreign employers register for PAYE withholding in the UK on a ‘voluntary basis’;
- registering for PAYE as well as National Insurance will, realistically, not create any additional payroll compliance costs for the EU-based company – because payroll providers typically charge the same fee for the service whether it is only National Insurance or tax and National Insurance that is being deducted and paid; and
- accounting for PAYE withholding in the EU can help reduce the employees’ UK tax obligations – for example, UK self-assessment tax returns would not be required in most cases, whereas they would be, if PAYE was not withheld.
However, be aware that in some cases employees may prefer that their employer does not account for PAYE on their salary in such ‘voluntary PAYE cases’. For example, employees earning more than £100,000 a year and who are already subject to self assessment may prefer to settle their UK tax obligations by way of the self-assessment process.
Companies in this situation may be in a difficult situation – in particular if some employees are happy to have PAYE withheld and others prefer to pay under self assessment. In this regard, one should note that the Employment Rights Act 1996, s 13(1)(a) says:
‘An employer shall not make a deduction from wages of a worker employed by him unless the deduction is required or authorised to be made by virtue of a statutory provision or a relevant provision of the worker’s contract.’
Because it is questionable whether an employer has a statutory obligation to account for PAYE if the foreign company has registered for PAYE withholdings in the UK on a purely voluntary basis (and hence whether the statutory reference in the above clause is satisfied), it may be sensible for such businesses to have a provision in the employees’ contracts, making it clear that they will be deducting PAYE from their salaries, even though this is not strictly required under the legislation.
Although the UK formally left the EU on 31 December 2020, the free trade agreement between them retains the obligation for EU companies to register for National Insurance withholding in the UK. However, this arrangement applies specifically to EU companies with UK-based employees and EEA states are not part of this new agreement. Therefore, although companies from the EEA states will need to continue to account for National Insurance withholding if they have historically registered in the UK, EEA businesses employing someone in the UK for the first time after 1 January 2021 would not (at present), be part of this arrangement. So they would not be obliged to register for National Insurance withholdings if they are not establishing a taxable presence in the UK. However, it is expected that the UK will try to reach an agreement with the EEA countries in the coming months, so these states accept that there will be a need to formally register for National Insurance withholdings in the future.
In December 2013, the government started to ‘tighten’ the PAYE and National Insurance regulations for contractors and employees working through offshore intermediaries. Although, arguably, the legislation was designed to target tax (and specifically National Insurance ) avoidance in, for example, the IT contracting sector, the legislation is wide ranging and can capture genuine ‘commercial arrangements’ between UK and overseas-based operations. As an example, this might be where UK building or production work has been subcontracted to third-party providers who happen to be based overseas.
In short, these regulations can place the PAYE income tax and National Insurance obligations on:
- an associated UK company of the non-UK business; or
- if there is no associated UK company of the non-UK business, the end client in the UK of the off-shore business.
In practice, therefore, many foreign businesses that are not required to register officially for PAYE in the UK may well do so on a voluntary basis. That is, they wish to avoid any PAYE obligations (penalties) being imposed on their end client, while also wishing to avoid sharing commercially sensitive data (wage rates and the like) with that client.
Some of these other factors – such as political, human resources or business issues – have already been explored in the previous sections. For example, the need to avoid negative consequences (for payroll failures) arising for client companies in a supply chain, while keeping salary data confidential from partners and end clients can be a good reason for companies looking to voluntarily register for PAYE withholdings in the UK.
Similarly, foreign businesses involved in servicing UK government or similar public sector contracts, may feel that there is a ‘deemed obligation’ to ensure that PAYE income tax and National Insurance contributions are being accounted for in the UK, even if this is officially only being undertaken on a voluntary basis.
Foreign embassies in the UK
One should also note that the PAYE and National Insurance norms for foreign embassies (and some other ‘foreign state institutions’) in the UK are different.
In effect, and despite the fact that they have a clear presence in the UK, HMRC cannot impose a PAYE income tax or National Insurance withholding obligation on foreign embassies because they are sovereign states and hence are outside the usual regulations. Further, the position in this area can be affected by:
- whether the individuals are diplomatic staff on assignment to the embassy; or
- are UK locally employed staff; and
- whether we are dealing with an embassy (or high commission or consulate) or some other state-At the simplest level, genuine diplomatic staff will not be liable to either PAYE income tax or National Insurance in the UK. Under international law principles, they (as with UK Crown servants working abroad) should remain liable to tax and social security in their home jurisdiction.
- Local employees will be liable to UK taxes and National Insurance (but see the example below on other state institutions). However, as mentioned above, the UK cannot impose withholding obligations on the embassies directly. In practice, though, many foreign embassies in the UK will account for PAYE income tax and National Insurance on their locally employed staff on a voluntary basis.
Other state institutions
While the regulations for embassies and high commissions is relatively straightforward, the rules for other state institutions (and similar organisations) can be slightly more complicated.
Here, one needs to note that some double tax agreements have particular rules in them. For example, the UK/German agreement says, specifically, the following with regard to German nationals employed in the UK (Article 18(1), ‘Government service’):
‘Salaries, wages … paid by a contracting state, a “land”, a political sub-division … or some other legal entity under public law of that state to an individual in respect of services rendered to that state … shall be taxable only in that state. However, such salary, wages … shall be taxable only in the other contracting state [UK], if the services are rendered in that state [UK], and the individual is a resident of that state related institution.
The above could mean, for example, that the PAYE withholding position can differ in this specific example, depending upon whether the UK-based individual is:
i) a UK national or resident;
ii) a German national or UK/German dual national; or
iii) a third-country national.
Only in (i) above, in this specific example, is there an actual need under the double tax agreement for UK taxes to be paid or withheld in the UK. Some care does, however, need to be taken when interpreting double tax agreements in this regard – say in respect of exactly what classifies as a ‘public body’.
For example, Germany has some institutions that are controlled and primarily funded by the German state, but one needs to analyse on a case-by-case basis whether the ‘some other legal entity under public law of that state’ definition is satisfied in a particular situation. Many publicly funded bodies in Germany are, in fact, ‘private institutions’ (albeit funded by the state) rather than actually being an entity under public law.
ITEPA 2003, s 301 provides similar ‘protection’ from a UK income tax PAYE liability, when one is dealing with ‘official agents’ of an overseas state – for example, state newspaper representatives or similar, semi-government related persons.
Section 301 reads as follows:
‘1) No liability to income tax arises in respect of income arising from employment as an official agent in the UK for a foreign state if conditions A and B are met.
‘2) Condition A is that the employee is neither (a) a Commonwealth citizen, nor (b) a citizen of the Republic of Ireland.
‘3) Condition B is that the functions of the employment are not exercised … for the purposes of profit…’
Finally, in this regard, it is worth noting that the relief – whether under a double tax agreement or s 301 – applies only to income tax and PAYE withholdings. The legislation or tax agreements do not exempt official agents and similar from registering for UK National Insurance withholdings if they have a clear ‘taxable presence’ in the UK.
Having assessed whether there is a PAYE and National Insurance withholding obligation for the employer, what does this mean for individual workers and employees? Clearly if the foreign employer is accounting for both PAYE and National Insurance – whether on a voluntary basis or because of a taxable presence – there is fundamentally no further action for the UK-based employees to take (though clearly they may be in self assessment, for example, because of other, personal factors).
However, what is the position for those individuals who are not suffering PAYE and or National Insurance withholdings from their foreign business?
Obligations for such individuals can be affected by whether they are:
- able to argue that they are self-employed; and
- workers and employees of the foreign business or enterprise.
When assessing whether someone is self-employed in this situation, perhaps the first points to note are:
- just because someone has a ‘foreign employer’ (or a contract with a foreign entity), should not affect their employment status; and
- employment and self-employment status under overseas law is irrelevant – that is, they could legitimately be self-employed under the law of the overseas country, while being employed under UK regulations.
As such, and as with any case where it is not clear whether someone is employed or self-employed, it is necessary to do a formal assessment of the business relationship. In other words, is it possible to argue that there is a contract for services rather than a contract of service in a particular situation? If an adviser can assess the individual as self-employed under UK law, the worker should be registered for self assessment and class 2 and 4 National Insurance contributions.
The position for employees and workers
Assuming it is not possible to treat the individual as self-employed under UK rules and the foreign company or entity has not voluntary registered for UK withholdings, the employee (or their adviser) must look at the direct collection regime in the UK. In practice, this is broken down into the following:
|Direct collection (employee only NICs)||Set up by an employee where direct payment of primary class 1 National Insurance only is due (tinyurl.com/y29o4458)|
|Direct collection (income tax only)||Set up by an employee where deduction of income tax only is due (tinyurl.com/y5h679vd)|
|Direct payment (income tax and NICs)||Set up by an employee where direct payment of primary National Insurance only and PAYE income tax is due (tinyurl.com/yyu2f2sa)|