Given that the threat of tariffs has now become a reality there’s no shortage of commentary on this subject. This note puts to one side the geopolitics of the tariff rates and instead focuses on the interaction of tariffs with other UK taxes such as corporation tax, income tax and VAT. 

Tariffs have a long history, and the US is not alone in imposing them. In fact, almost every country imposes tariffs of some sort, however World Trade Organization (WTO) membership and/or bilateral trade agreements impose certain boundaries. 

According to the WTO, tariffs are a type of customs duty levied on imported goods. The most common form of tariff is an ad valorem tariff which means the charge is calculated based on a percentage of the value of the imported goods. Fixed tariffs can also be imposed, for example a fixed specified duty can be charged on the quantity of a product imported. Other forms of tariffs might employ a compound rate, a mixed duty or a minimum import price mechanism. There are different policy considerations around the type of tariff levied depending on the nature of the product, how easily it can be calculated, how frequently the market price changes, and the jurisdiction from which it is imported. 

So far, the UK Government’s response has been limited, however it has announced its decision to suspend import tariffs on a range of (“everyday and summer essential”) products imported globally until July 2027. The Government has also opened a consultation with business on how to shape the UK’s response to US tariffs as it prepares for negotiations on a potential trade deal. Despite this, businesses may still be exposed to higher tariffs for some time. 

Corporation tax and income tax

For corporation and income tax purposes the key question will tend to be whether tariffs which are paid on the import of goods are deductible in determining profits. There are no specific statutory rules in relation to the deductibility of tariffs. The starting point for determining whether a tariff is deductible for UK corporation tax (or income tax for unincorporated businesses) is the normal rule of whether the expense has been incurred wholly and exclusively for the trade.

UK case law has from time to time considered whether other taxes are deductible in determining the profits chargeable to tax and it has been found that taxes based on profits are not a deductible expense because they are charged on profits of the trade after they have been earned. Tariffs, however, are not determined by the profit of a company. They are typically calculated based on the value of the good imported and the importer must pay the tariff in order for the good to enter circulation. One would therefore expect that in almost all cases a tariff would be deductible as there is no reason for paying it other than for the purposes of the business. This position is not controversial (tariffs have been around for a long time) but could come into closer focus if higher tariffs become the norm. 

Without wishing to get distracted about whether the UK’s Digital Services Tax (DST) is or isn’t a tariff (we did say we wouldn’t get political…), HMRC does offer some helpful guidance (at DST47100) on the deductibility of the DST for UK corporation tax that supports this approach. In the guidance they state “The availability of any deduction will depend on the particular facts and circumstances of the business. However, it should be noted that a company’s DST expense is directly related to the earning of its revenues and is a legal obligation of performing that trade. Therefore, in most cases it is likely the expense will have been incurred wholly and exclusively for the purposes of the trade.”

Not all businesses are considered trading. A company with an investment business will in general only be able to deduct expenses of management it has incurred in relation to managing the company’s investment business. Although tariffs are unlikely to be a major component of the expenses incurred by the business there may be instances where say, office supplies are subject to import duties. So far as these expenses can be referenced to managing the company’s investment business and not just expenses incurred by management then it should follow that the associated tariffs are also deductible. 

In conclusion, tariffs imposed on goods imported in the business are likely to have been incurred wholly and exclusively for the purposes of the trade of the person doing the importing and should be deductible. Similarly for non-trading businesses, tariffs should be deductible expenses of management if they relate to the management of the investment business. 

Naturally, the actual effect on corporation tax or income tax liabilities will depend on the extent to which tariff costs are passed on to customers or swallowed by the importer so affect their own profits.

Transfer pricing

The tariffs are being imposed on goods and not services, and therefore are likely to impact the transfer pricing policies of multinational businesses that manufacture and/or sell goods but are likely to have a lesser impact on the transfer pricing policies of service-based businesses (e.g. investment management businesses). 

Transfer pricing policies for businesses that manufacture/sell goods are complex and typically price transactions using different transfer pricing methods. For example, some intra-group transactions could be transfer priced on a cost-plus basis, others could be transfer priced on re-sale price basis, for certain intra-group transactions the comparable uncontrolled price may be adopted and the remainder being subject to a residual profit split. Given that tariffs will result in higher costs and prices, the immediate impact is that cost-plus and re-sale pricing arrangements will be impacted. Comparable uncontrolled transactions will need to be reassessed to test whether such transactions are still comparable. Furthermore, residual profit models will also need to be reassessed to test whether profits are being allocated fairly taking into account the impact of tariffs. Updating transfer pricing policies to reflect the impact of tariffs will be challenging because transfer pricing generally relies on historical financial data for comparable transactions to determine an arm’s length price and such data may no longer be comparable because it does not reflect the impact of tariffs. Furthermore, companies with varying supply chains may be impacted in a different manner which will make it difficult to draw comparisons between two companies that conduct similar activities but with a different geographical supply chain. Adjustments to reflect the impact of tariffs on an existing transfer pricing policy will require applying subjective changes due to the lack of objective data which is likely to result in an increase in transfer pricing risks for multinational groups. In the medium and long term, multinational businesses that manufacture/sell goods are likely to seek to restructure their operations to manage the longer-term impact of tariffs and therefore transfer pricing policies as a whole will need to be reassessed to ensure that the group’s transfer pricing policy continues to allocate profit/losses that are aligned with the overall value chain of the group.

Tariffs are unlikely to impact the transfer pricing policies of investment management businesses although investment managers will be affected as profits of underlying investments being managed will likely be impacted by increase in costs as a result of tariffs.

VAT

While this note does not attempt to explore the differences between tariffs and import VAT it is worth noting that they are fundamentally different (again – trying not to be political!). Import VAT will be charged on an import into the UK at the same rate (or, in some limited cases, a lower rate) as it is charged on the sale of goods manufactured and sold in the UK. The VAT charged on imports therefore serves to level the playing field between imports and domestically produced goods. Unlike tariffs, VAT (so some would argue) does not discriminate against imported goods but, rather, prevents overseas businesses from gaining a significant advantage over domestic businesses.

Customs duties (including tariffs) are added to the value of imported goods before import VAT is calculated. The result of this is that businesses effectively pay VAT on tariffs, meaning that an increase in tariffs will lead to an increase in import VAT. 

However, if the importer of record is a business that intends to sell the goods or otherwise use them in the course of its business (as will typically be the case), then subject to normal VAT recovery rules, it should be entitled to recover such import VAT. If the business operates postponed import VAT accounting (PIVA), it will simultaneously declare and obtain credit for the import VAT on the same VAT return, meaning no VAT will actually be paid to HMRC at the time the goods are imported. In such cases, accounting for any additional VAT resulting from tariff increases will have no financial consequences.

However, where the importer of goods is an end consumer with no entitlement to VAT recovery, increases in tariffs will lead to an increased VAT cost.