Every year, countless UK startups set their sights on the American dream, envisioning growth, opportunity and success across the Atlantic. For many, the journey to the US market begins with a pivotal step: the Delaware Flip. In our previous article, we discussed the Delaware flip, including the reasons and timing for undertaking this restructuring process. The following article will delve into the tax and accounting considerations associated with the Delaware flip. We will explore key tax implications in both the UK and the US, providing essential insights for startups planning this strategic move.

Tax Considerations in the UK

HMRC clearance requirements

The Delaware Flip can be structured without triggering a Capital Gains Tax (CGT) charge for UK shareholders. If there are no investors under the Enterprise Investment Scheme (EIS), Seed Enterprise Investment Scheme (SEIS) or Venture Capital Trust (VCT) in UKCo before the flip, seeking pre-transaction tax clearance from HMRC is strongly advisable, though not mandatory. However, if EIS, SEIS, or VCT investors are involved, obtaining pre-transaction tax clearance is essential to meet the conditions required for preserving these tax reliefs.

To ensure compliance, the UK company must apply for clearance under Section 138 of the Taxation of Chargeable Gains Act 1992 (TCGA 1992). This clearance confirms that the transaction aligns with tax regulations and is not part of a tax avoidance scheme. HMRC will not grant clearance if the flip does not appear to be affected for bona fide commercial reasons and/or forms part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of tax. If it can be clearly demonstrated to HMRC that the flip is due to genuine commercial reasons, such as securing US investment or growing in the US market, then receiving approval from HMRC should not be a problem, rather just an additional planning event to fit within the overall flip timeline.

SEIS/EIS Restrictions

Many UK startups may have raised initial investment under the UK’s EIS or SEIS venture capital relief schemes, and preserving this qualifying status is a priority for existing EIS/SEIS investors during any US expansion. When a company undergoes a structural change, such as a Delaware flip, maintaining EIS/SEIS relief requires careful tax and legal planning to ensure the new structure complies with the qualifying criteria for UK tax relief, such as the new Delaware parent entity having a permanent establishment in the UK. While a Delaware flip does not automatically disqualify a UK company from EIS/SEIS eligibility, advanced planning is essential to meet the necessary requirements post-restructuring.

Qualifying for Stamp Duty Relief

Stamp duty costs, typically 0.5% of the transaction’s value, applies to the transfer of shares in UK companies, which can affect Delaware flips. The additional stamp duty costs could significantly increase the overall expenses of the flip, potentially impacting the startup’s financial health.   

However, the flip transaction can often be structured to qualify for UK stamp duty relief under Section 77 of the Finance Act 1986. The conditions to be eligible for stamp duty relief under Section 77 are more strict and limiting than Section 138 TCGA 1992, but with the appropriate planning and structuring such a relief will normally be available, particularly where the flip involves a mirroring of the shareholders between the UK and new Delaware company pre and post flip.

To avoid any complications, it is crucial to think through any post flip investment plans at the outset. Addressing any ownership changes or new investors coming on board from the outset can ensures that the transaction is structured to maintain eligibility for stamp duty relief.

UK Permanent Establishment

In the context of a Delaware Flip, maintaining continuity of SEIS or EIS treatment for existing shareholders in UKCo is often desirable. To achieve this, HMRC requires the US holding company (USCo) to have an established a UK permanent establishment immediately post flip.

To satisfy this requirement, USCo will need to implement several practical measures, including:

1. Registering a UK establishment with Companies House, referred to as a ‘UK branch’ of the USCo.
2. Securing permanent office space in the UK to ensure the UK branch has a fixed place of business in the UK
3. Ensuring the UK establishment performs some economic activity for the group, which will usually entail employing someone from the UK branch entity who works from the UK office.

It’s important to note that USCo would be subject to UK corporation tax on any profits attributable to its UK permanent establishment. The UKCo, now a subsidiary of USCo post flip, is not sufficient to maintain SEIS or EIS treatment for shareholders.

Corporate Tax Residence

USCo could be considered a UK tax-resident if its central management and control (CMC) is in the UK, post flip. CMC is determined by where key decisions are made and where decision-makers, like board members, are located during important meetings.

If USCo is treated as a UK tax-resident, it would be liable to UK corporation tax. An appropriate Transfer Pricing policy between USCo and UKCo can help mitigate any risk of UK corporate tax being due on the activities of USCo (unless the USCo established a UK branch to preserve EIS reliefs, in which case the UK branch will be liable to UK corporation tax).

Each case needs careful review to understand the activities of the USCo and UKCo and where key decision-makers are based to form the appropriate transfer pricing policy to mitigate any risks.

Key Tax Considerations in the US

Understanding Qualified Small Business Stock

The QSBS (Qualified Small Business Stock) exemption in the US tax code is a major benefit for investors in US companies. If the strict QSBS rules are met, shareholders of growth-stage companies can exclude up to $10 million (or 10 times the original investment, whichever is greater) from US federal income taxes when selling shares held for over five years. However, when UKCo shares are exchanged for USCo shares in a flip, those new USCo shares typically don’t qualify for QSBS benefits. QSBS would only be available for new shares issued from USCo after the flip.

For most pre-flip UKCo shareholders, who are often non-US investors, QSBS benefits don’t matter, but it can be a very attractive relief for new US investors coming in. It is worth considering if USCo will enable new investors to qualify for QSBS benefits

Understanding Simple Agreements for Future Equity (SAFEs)

Simple Agreements for Future Equity (“SAFEs”) and similar convertible tools are commonly used by growth-stage companies to raise early funding before a formal priced equity round. For example, a US investor holding a SAFE in UKCo may want the flip to be tax-free under U.S. tax rules and might also care about QSBS eligibility for their investment in USCo after the flip. Because of these factors, UK companies planning a flip into the US should carefully consider U.S. tax implications when issuing SAFEs and converting them into USCo SAFEs or stock during the flip.

CFC and PFIC considerations

A Passive Foreign Investment Company (PFIC) is a non-US company that qualifies under either the Income Test—where at least 75% of its gross income is passive (e.g., interest, dividends)—or the Asset Test—where at least 50% of its gross assets are passive (e.g., cash). While most active trading companies do not meet these criteria, companies holding large amounts of cash raised from venture capital (VC) investors may trigger the Asset Test. PFIC status is unfavourable for US investors due to the complex and strict IRS tax rules, potentially resulting in a higher tax rate on their investment compared to a non-PFIC company. By implementing a flip to establish a US entity above the UK company, VCs invest in a US company, thereby eliminating the application of PFIC rules.

A Controlled Foreign Corporation (CFC) is a non-US company controlled by US shareholders, where “control” means owning more than 50% of the company, either by voting power or share value. This control can be direct or indirect and applies collectively when multiple US shareholders each hold at least 10%. If a company qualifies as a CFC, US shareholders are subject to complex tax provisions, including GILTI, Subpart F and Section 956, which require them to report the CFC’s income and investments on their tax returns, even if no distributions are made. Due to the complexity of these rules, US investors typically avoid investing in foreign companies that might trigger CFC status. For example, if two US venture capitalists each own 30% of a UK company, their combined ownership exceeds 50%, bringing the company under CFC rules.

Conclusion

The Delaware Flip continues to be a key strategic move for UK startups aiming to access US capital, streamline operations, and enhance their exit opportunities. However, this restructuring introduces a host of tax complexities that require meticulous planning from both sides of the Atlantic.

While a flip into the US can be accomplished with careful preparation, businesses must also be aware of the restrictive anti-inversion rules in the US. A US company cannot easily reverse this process to re-establish a non-US holding company. As such, companies should be particularly cautious in deciding whether a Delaware Flip is the right path, ensuring they fully understand the long-term tax implications and business objectives.

Ready to navigate the complexities of a Delaware Flip with confidence?

Our experts specialize in cross-border restructuring and can help you develop a tailored strategy that aligns with your growth goals while minimizing tax risks. Contact us today for a consultation and ensure your US expansion is structured for success.

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