When American work starts costing a British business tax

Effectively connected income is US-source income connected with a US trade or business carried on by a foreign person. The IRS sets out the test, which starts with whether that trade or business exists at all.

That is the first and hardest question behind effectively connected income. The IRS says a foreign person generally must be engaged in a US trade or business during the tax year for income to fall into this category, so everything turns on that threshold rather than on where the customer sits.

Selling into a market is not the same as operating in it.

A UK company with no American people, premises or operations rarely qualifies.

So the analysis starts with what happens inside the United States, not with who pays the invoice.

In our practice most British exporters never reach it. The useful outcome of the analysis is usually a documented no rather than a filing.

It sets the bar above the occasional and the one-off. The IRS uses that phrase about the activities required, which rules out a single trip, an isolated sale or an experiment that went nowhere.

Frequency matters as much as scale.

A small operation running all year can qualify where a large one-off does not.

So the pattern of activity carries more weight than the money involved.

Nobody has reduced it to a day count, which frustrates people who want a number. The question stays one of fact, judged on the pattern over a year.

They are the clearest route in. The IRS says foreign persons generally are engaged in a US trade or business when personal services are performed in the United States, subject to those activities meeting the threshold.

That reaches consultants, engineers and performers.

It reaches a British team on a long American project.

So where the work happens matters far more than where anybody signed the contract.

Keep a record of who travelled, when, and for how long. Three years later that record is the only thing capable of answering the question.

Effectively connected income is taxed on profit, at ordinary rates. The IRS taxes income in this category after allowable deductions, at the graduated rates that apply to US citizens and residents, so costs come off before the tax calculation.

That is a net basis rather than a gross one.

For a business with real costs the difference is substantial.

So falling into this category is sometimes the better outcome.

So a consultancy with staff costs and travel can end up paying tax on a modest margin rather than on the whole fee.

Withholding runs on gross amounts, where effectively connected income runs on net. Passive US-source payments of the relevant kind face a flat charge taken at source, with no deduction for what it cost you to earn them.

Thirty per cent of an invoice can exceed the profit on it.

Our guide to US dividend withholding under the treaty covers one of those flat charges.

So the two regimes answer different questions and produce very different numbers.

A company can meet both regimes in the same year, on different income. One invoice can be business profit and another a royalty.

It can, in defined circumstances. The IRS treats certain fixed, determinable, annual or periodical income as effectively connected, for instance where a Code provision requires it or where investment income passes an asset-use or business-activities test.

That catches income genuinely tied to an operating business.

It does not catch a portfolio held passively.

So the label follows the connection rather than the asset type.

The practical test is whether the asset is used in the business. Cash held to fund American operations behaves differently from a portfolio held in London.

No, on its own. The IRS is explicit that trading in stocks, securities or commodities through a US resident broker or agent does not by itself amount to a US trade or business.

That carve-out is deliberate and long-standing.

It keeps foreign investors out of the regime.

So a brokerage relationship is not the thing that pulls a company in.

The same logic protects a British pension fund or family office holding American securities through an American custodian.

It raises the bar considerably. The agreement between the two countries generally protects the business profits of a UK enterprise from American tax unless it operates through a permanent establishment there, a higher threshold than the domestic test.

So a company can sit inside the American test and still enjoy protection.

Claiming that protection is a positive step rather than an automatic one.

Our guide to treaty-based return positions covers the disclosure.

Our double tax treaty relief service handles the claim and the disclosure that has to accompany it.

A fixed place of business through which the enterprise operates, broadly, with its own definition in the treaty. An office, a branch or a factory is the obvious case, and an agent with authority to conclude contracts can create one too.

Preparatory and auxiliary activities generally fall outside it.

A warehouse used only for storage often falls outside.

So the treaty asks a narrower question than American domestic law does.

Agents are where this gets argued. Somebody who habitually concludes contracts for you can create a presence even with no office at all.

It changes who pays rather than whether anybody does. A separate American company pays American tax on its own profits and files its own return, which can be cleaner than a UK company operating directly.

The group then has transfer pricing to think about.

Our guide to a foreign-owned US LLC covers one common structure.

So incorporation is a structuring answer rather than an exemption.

It also changes how profits come back to Britain. Dividends from a US subsidiary bring their own withholding question, which the treaty addresses separately.

A corporate return for a foreign company with American income. That return is where you claim deductions and where you disclose a treaty position, if you take one. Nothing else in the American system does either of those jobs for you.

Filing protects the deductions as well as reporting the income.

A late or missing return can put them at risk.

So the filing is worth making even in a year with little profit.

A short sequence for a British business with American revenue.

The first three steps are the whole exercise for most businesses. If the activity is not there, nothing after them applies.

They are the modern version of this problem. A British company employing somebody who lives and works in the United States has activity there, whatever the contract says about the company's home.

Payroll obligations can arise separately from income tax.

Our guide to a US employer with no UK payroll covers the mirror-image case.

So one American hire can change the analysis for the whole company.

State obligations can arise too, independently of the federal question, and they follow where the person sits rather than where the company does.

Establish the position before assuming the worst, because many companies in this position owe nothing. Where a return should have gone in and did not, the routes back exist and the exposure frequently turns out smaller than it looks.

In our practice the common finding is no American tax and a missing protective filing.

That is a cheaper problem than it sounds.

So get the analysis done rather than carrying the uncertainty.

Our US federal returns service deals with any protective filings once the analysis settles what, if anything, is due.

Consider a Leeds engineering consultancy that won a two-year American contract and sent four engineers to work on site for most of it.

Invoicing from Leeds did not keep the work in Britain. The engineers performed the services in the United States, continuously, over two years.

The treaty analysis mattered more than the domestic one, and the filings that followed were manageable once somebody looked at them properly.

These facts are illustrative. The shape is ordinary: the contract was British, the activity was not.

Had the same consultancy done the design work in Leeds and flown out twice for meetings, the answer would have gone the other way.

The first assumes that invoicing from Britain settles the question. The test looks at activity, not at invoices.

The second treats any American revenue as creating a US trade or business, which is equally wrong in the other direction.

The third relies on the treaty without disclosing the position on a return.

The fourth forgets that a single remote employee in America is activity in America.

We work out whether a US trade or business exists before anything else, because for most British exporters the honest answer is no and the file can close there.

Where it does exist, we take the treaty threshold next, since it frequently protects a company that the domestic test would catch.

Our business and corporate tax service covers the filings, and fees stay fixed and agreed in writing. How we work sets out the process.

If your business has people or premises in America, talk to us before the year end.