What is Diverted Profits Tax?
The Diverted Profits Tax (DPT) is a new tax, introduced by the Finance Act 2015. It is an anti-avoidance measure targeted at multinationals trading in, or at least with, the UK.
The rate of DPT is 25 per cent of the diverted profit. The current UK corporation tax rate is 20 per cent, so DPT is intended as a penal tax to encourage businesses to restructure relevant arrangements so that profits are not diverted from the UK and instead the arrangements are taxed at the lower 20 per cent rate.
The objective of DPT
The rationale does not appear to be to raise money. The legislation was announced in 2014 in response to the news that some internationals, such as Google, were paying little or no UK tax, and with a General Election on the near horizon. As this briefing will show, the notification requirements alone are so draconian that the Government hopes that multinationals trading in the UK will be deterred from entering into diverted profits arrangements. As such, the primary intention of the legislation appears to be to influence international corporate behaviour. If governments in other countries follow suit – and they may well feel a political imperative to do so (Australia, for example has already taken steps in a similar direction) – then the global tax approach of multinationals could be forced to change.
When will DPT apply?
DPT will arise in either of two situations:
- a UK company has arrangements with a connected entity (UK or non-UK, but normally non-UK) which "lack economic substance" and the purpose of which is to exploit tax mismatches.
- This is potentially relevant to all UK companies making tax-deductible payments to foreign affiliates where either directly or indirectly the monies are moved to a low tax jurisdiction. For example, where a UK trading company pays a (tax-deductible) royalty for intellectual property which is ultimately located in a low tax jurisdiction for tax purposes.
- a non-UK company trades with the UK but for tax reasons avoids having a fully taxable presence (or "permanent establishment") in the UK.
- This is potentially relevant to all foreign companies selling goods and/or services to the UK. For example, where a lender provides services via the internet to UK consumers and provides support services to UK customers through a UK-based call centre.
There are some exceptions; notably, DPT will not apply to SMEs or where UK-related sales are below £10 million in a 12-month accounting period or UK-related expenses are below £1 million. Generally the DPT will not apply if it can be shown that all related profits bear tax at a rate of 16 per cent or higher.
When must I notify?
The notification requirement is capable of applying in a wider range of circumstances than the actual charge applying, suggesting that the priority for the Government is information gathering as opposed to revenue collection.
Companies must notify if they potentially fall within the scope of DPT. This is unusual legislative drafting. Ordinarily tax legislation is precise; here it is the opposite, with the onus being placed on companies to consider for themselves whether or not they may be liable to DPT. Indeed, it could well be argued that the notification provisions are more onerous than the charging provisions.
Broadly speaking, and subject to the exceptions below, an obligation to notify will arise where there is a significant risk that a charge to DPT will arise and where HMRC does not know about the arrangements. However, the tests for determining whether a notification obligation arises are detailed and not co-extensive with the provisions for determining whether a liability to DPT arises.
In view of the complexity of the legislation concerning the notification obligation and the uncertainty of key terms – for example, there may be differences of opinion as to what is meant by "significant" – it will be sensible to take advice on whether your related party transactions fall within the DPT notification provisions.
There are considerable advantages in this advice being covered by legal professional privilege
The deadline for notification is approaching fast:
- for accounting periods ending on or before 31 March 2016, notification must be made six months after the end of the relevant accounting period; and
- for accounting periods ending after 31 March 2016, notification must be made three months after the end of the relevant accounting period.
The DPT applies to diverted profits arising on or after 1 April 2015.A company whose accounts are made up to 30 April 2015, for example, must notify by the end of this month; a company with a 31 May year end, by the end of November, etc.
Failure to notify can result in a penalty.In addition, HMRC has a period of two years from the end of the accounting period to issue a preliminary notice setting out the DPT charge; this is extended to four years should the company fail to notify. (Strikingly, in contrast to the fairly leisurely period afforded HRMC to issue the preliminary assessment, companies will only have 30 days following the issue of the notice in which to make representations!)
There are a number of exceptions to the notification obligation:
- it is reasonable for the company to conclude that:
- no DPT charge would arise (ignoring any further transfer pricing adjustments); or
- the company (or a connected company) has provided sufficient information to HMRC for it to determine whether a preliminary notice should be issued and HMRC has examined that information;
- before the end of the notification period, HMRC has informed the company that it does not need to submit a notification because the company (or a connected company) has provided sufficient information for HMRC to determine whether a preliminary notice should be issued and HMRC has examined that information; or
- it has given notification in the preceding accounting period and it is reasonable for the company to assume at the end of the notification period that there has been no change in circumstances that is material to whether a DPT charge may arise in the current accounting period.
There is a standard form for notification.
HMRC will not give any formal written clearance regarding the application of the DPT to an arrangement or transaction although it may be possible to have an informal dialogue.
What you should do next
Multinationals trading in or with the UK should review related party transactions and consider whether they are likely to be caught by the DPT's notification regime, remembering that it is a "potential" rather than an "actual" liability that is being identified. This may involve some somewhat speculative interpretation of how HMRC might view the transaction in question.