The Diverted Profits Tax (DPT), known by many as the “Google Tax”, is intended to stop large groups diverting profits from the UK by seeking to avoid creating a UK permanent establishment or using arrangements or entities which lack economic substance to exploit tax mismatches.
Tax mismatches occur where intra-group expenditure is created, or income is diverted intra-group, in circumstances where it is reasonable to assume that in the absence of a tax benefit the expenditure would not have been incurred or the income would have been within the charge to UK corporation tax.
The fact that transactions or arrangements may comply with transfer pricing principles (i.e. prices have been calculated on an arm’s length basis) does not prevent the DPT from applying – the important question is whether there is a tax benefit.
DPT applies to diverted profits arising on or after 1 April 2015. The normal rate of DPT is 25% plus any interest but this rises to 55% plus any interest if the taxable diverted profits are ring-fence profits or notional ring-fence profits in the oil sector.
In many ways the DPT is seen as being as much about deterrence as it is about revenue raising. Unlike most taxes DPT is not self assessed and companies are required to notify HMRC within three months of the end of an accounting period (for accounting periods ending on or before 31 March 2016 the notification period is six months) in which they are potentially within the scope of the tax and do not meet certain conditions for exemptions. A failure to notify attracts a tax-geared penalty.
Determining the amount of any taxable diverted profits for DPT purposes is very complex. The assessment predominantly relies upon transfer pricing principles, but in certain circumstances there is a requirement to recharacterise the relevant arrangements for tax purposes and determine the DPT charge by reference to the recharacterised arrangements.
Who does it apply to?
The rules are intended to apply only to large enterprises and not to small or medium sized enterprises (SMEs) in any accounting period. SMEs broadly comprise enterprises employing globally fewer than 250 persons and which globally have an annual turnover not exceeding EUR 50 million and/or annual balance sheet not exceeding EUR 43 million.
Does HMRC see it as relevant to insurance?
Although known as the “Google Tax” it is very clear from HMRC guidance and the wording of the legislation that the rules are targeted widely and catch numerous industries including insurance.
HMRC guidance sets out particular circumstances in which the DPT could be relevant in the context of insurance.
In the example given a UK company is a large insurance subsidiary which employs its own actuarial and underwriting staff and can write insurance business within generous limits without seeking approval from the parent.
As part of its business the UK insurer reinsures 50% of its written business to a group reinsurer that is based in a low tax jurisdiction.
The group reinsurer also provides reinsurance to the other major subsidiaries in the group (located in other jurisdictions) and as a result of the reinsurance the group’s capital requirement has been reduced by 30%.
Whether the DPT applies in this scenario is said to depend on whether it can be established that the more efficient capital structure is a quantifiable non-tax financial benefit that is greater than the tax saving.
Provided the capital efficiencies outweigh the tax saving there should be no DPT charge.
In this scenario a multinational group that specialises in high value plant and equipment negotiates a group wide insurance policy for product indemnity with a policy limit of EUR 500 million. Cover is effectively increased to EUR 550 million by the UK subsidiary placing an additional EUR 50 million of risk with a group captive insurer located in a low tax jurisdiction.
Once again HMRC says the question to ask is whether the non-tax financial benefits referable to the insurance transactions outweigh the financial benefit of the tax reduction.
The conclusion in this example is that the DPT does apply because the risk has not been insured externally and the group had sufficient liquid assets to meet any claim with the result that the tax saving is the motive.
The above examples make it clear that it will be important for insurance companies to take stock of arrangements, particularly in the case of group structures that have sought to ensure that there is no UK permanent establishment or that result in payments to entities located in low or no tax jurisdictions. In the post-DPT environment it will be even more important to consider the non-tax justifications for the way in which arrangements are structured.
Currently there is no ability to obtain any sort of formal advance written clearance regarding the application of DPT (although in practice clients with a Client Relationship Manager may be able to obtain some sort of informal comfort).
Obtaining an Advanced Pricing Agreement (APA) with HMRC may also offer a degree of comfort going forward as it is expected that HMRC will give consideration to the
application of DPT as part of the process although of course this may not help if the arrangements are such that they need to be recharacterised as part of the DPT process.