Diverted profits tax
The draft legislation published on 10 December 2014 (see here) devotes almost 30 pages to the new “diverted profits tax” (DPT), which from 1 April 2015 will introduce a new tax at a rate of 25% to profits generated by those multinational corporate groups who, in the eyes of the Government at least, use aggressive tax planning techniques to divert profits from the UK.
Although the draft legislation has been released for consultation (and no doubt those taxpayers likely to be affected will have much to say on the subject) the following can be gleaned from the draft:
- the tax is an entirely new tax, rather than a higher rate of an existing tax. It has been suggested that this is so that the new DPT falls outside the scope of the UK’s existing double tax treaty network
- a charge to DPT will arise in two cases:
- case 1: a non-UK resident company (C) uses a person (P) to supply, in the UK, goods or services of C to UK customers. It must be “reasonable to assume” that the activity of C and/or P is designed to ensure that C does not have a UK permanent establishment. It must also be reasonable to assume that either there is a tax avoidance main purpose behind the arrangements OR the arrangements were implemented to achieve a tax “mismatch”
- case 2: a UK-resident company (C) and another, connected, person (P) enter into a provision which results in a tax “mismatch” and one or more of three “insufficient economic substance” conditions are met (meaning, broadly, that the financial benefit of the tax saving exceeds any other financial benefit of the transaction)
- in both cases (except Case 1 where a tax avoidance main purpose is established) it is required,for DPT to arise, for there to be a tax mismatch. This means that there is a tax decrease for C which exceeds any corresponding tax increase for the person being used to supply its goods/services by at least 20%
- there is to be a “sales threshold exemption”: no DPT charge will arise to a company unless the company’s sales to UK customers exceeds £10m in any given accounting period
- the DPT will also not apply to small and medium-sized companies (adopting the EC definition)
- it would appear that arrangements purely involving loans will be excluded from the scope of the DPT.
It is to be hoped that, if nothing else, the consultation has the effect of making the draft legislation less complex and unwieldy in places. There are also a number of presently unanswered questions as to whether the new DPT would survive a challenge by a disgruntled (new) taxpayer on the grounds that the DPT is subject to the UK’s double tax treaty network as a tax “similar” to existing UK taxes. There is also a potential argument that the DPT could prove incompatible with EU law. The place of the DPT within the post-BEPS world will also require careful consideration.
Disguised fee income of investment managers
The draft legislation brings within the charge to income tax any “disguised fees” arising to an individual from one or more collective investment schemes (CIS), with effect from 6 April 2015.
For these purposes a “disguised fee” arises to an individual if:
- the individual performs investment management services in respect of the CIS (directly or indirectly)
- at least one partnership is involved
- a “management fee” arises to the individual from the CIS (directly or indirectly)
- some or all of the fee is untaxed (ie not taxed as employment income under ITEPA 2003, or as profits of a trade).
The tax charge will apply to the portion of the management fee that is otherwise “untaxed”.
Specifically excluded from being a management fee for these purposes is any sum that constitutes “carried interest”, or which constitutes a “commercial return” on an investment.
There is then a purported definition of “carried interest”, being any sum arising:
- out of profits on the investments made for the purposes of the CIS after all (or substantially all) of the investments in the CIS made by the participants have been returned to the participants and each participant has received a “preferred return” on all (or substantially all) of the participant’s investments in the CIS, or
- out of profits on a particular investment made for the purposes of the CIS after all (or substantially all) of the investments in the CIS made by the participants and attributable to that particular investment have been returned to the participants and each participant has received a “preferred return” on all (or substantially all) of the participant’s investments in the CIS attributable to that particular investment.
This attempt at prescriptively defining “carried interest” has caused some concern amongst the investment management industry, not least as “preferred return” is itself defined as a return at least equal to compound interest of 6% on an investment.