The United Kingdom is an active participant in the Base Erosion and Profit Shifting (BEPS) project currently being undertaken by the Organisation for Economic Co-operation and Development and the G20, and has already committed to implementing several of the project’s forthcoming recommendations. Ahead of those recommendations, however, the United Kingdom recently announced its own unilateral measure to combat BEPS, known as the Diverted Profits Tax (DPT). The new tax will come into force on April 1, 2015.
Scheme of the Legislation
There are two separate charges to DPT: one on companies that are UK resident or have a UK permanent establishment (PE), and one applicable to all other companies.
The charge on a company that is UK resident or has a UK PE can apply if the company enters into a transaction with a related party that results in an effective tax mismatch and the related party has insufficient economic substance. An effective tax mismatch occurs where the transaction causes a reduction in the principal entity’s UK tax (either by increasing the entity’s deductible expenses or by reducing its taxable income) and the corresponding increase in the counterparty’s non-UK tax liability is less than 80 percent of the UK tax saved. The counterparty has insufficient economic substance if the value of the tax benefit from the transaction exceeds any other financial benefit, or where the tax benefit exceeds the economic benefit provided by the staff of the counterparty, provided, in each case, that it is reasonable to assume that the transaction was designed to secure the tax reduction.
The charge on companies not falling within the ambit of the aforementioned rules can apply where a company conducts activities in the United Kingdom in the course of supplying goods or services to UK customers without creating a UK PE, provided that it is reasonable to assume that the arrangements in question were designed to avoid giving rise to a UK PE. Under the rules, arrangements can be treated as being designed to avoid giving rise to a UK PE even if there are legitimate commercial or other reasons why they are structured in that fashion.
Companies falling within this test will be subject to DPT if it is reasonable to assume that the main purpose, or one of the main purposes, of the arrangements in question is the avoidance of UK corporation tax. Where a UK tax avoidance main purpose cannot be established, a charge to DPT will apply if there is an effective tax mismatch arising from transactions with a related party and the counterparty has insufficient economic substance.
Non-resident persons relying on the “investment manager exemption” are excluded from the application of DPT. This exemption will generally protect non-resident funds with investment managers based in the United Kingdom.
DPT does not apply to any small or medium-sized enterprises (which are, broadly, those with fewer than 250 employees and either a balance sheet total of no more than EUR 43 million or a turnover of no more than EUR 50 million). A further exemption applies to companies with sales of no more than £10 million to UK customers.
DPT also does not apply if the provision giving rise to an effective tax mismatch is a loan or other financing arrangement.
DPT is charged at a rate of 25 percent. The taxable base is, broadly speaking, the profits that would have been charged to corporation tax in the absence of the arrangement giving rise to the effective tax mismatch. The rate is higher than the standard corporation tax rate (20 percent).
The draft legislation also provides an accelerated assessment and payment timetable relative to the corporation tax regime. The application of DPT is triggered by HM Revenue and Customs (HMRC) serving a preliminary estimated notice of liability, after which the company has 30 days to make representations. HMRC then has a further 30 days to issue a final notice of liability, after which the taxpayer must make payment within a further 30 days. This triggers the start of a 12-month review period in which a designated HMRC officer must review the amount of DPT that has been charged and adjust it accordingly. The company may only appeal a charge after the end of the review period, and there are no grounds for postponement of the payment of DPT.
When HMRC calculates the liability for the purpose of the estimated and final charging notices, 30 percent of otherwise allowable expenses will be disallowed where the mismatch results from provisions that have the effect of inflating the expenses against the receipts from UK sales above what they would have been between independent persons dealing at arm’s length. This rule is explicitly targeted at “double Irish” and “Dutch sandwich” type arrangements.
The legislation includes broad provisions allowing enforcement against any group company or persons conducting activities in the United Kingdom on behalf of a non-UK company within the tax charge.
This measure is a far-reaching piece of legislation targeted at multinationals whose tax affairs have been the subject of press criticism in recent years. There is a significant possibility that the DPT is compliant with neither the United Kingdom’s tax treaties nor the right to freedom of establishment under the EU Treaty. Moreover, the DPT pre-empts the BEPS process and could encourage other countries to take their own unilateral actions. Multinational groups that may be caught by the DPT should consider their position as a matter of urgency, because it seems likely that these provisions will come into force in less than one month’s time.