BACKGROUND AND INTRODUCTION
The UK Government has announced the introduction of the Diverted Profits Tax (or 'DPT') - a new tax which will have effect from 1 April 2015. The tax is intended to target two types of arrangements:
- a non-UK person may have an arrangement with another person which is intended to prevent the non-UK person from having a UK permanent establishment ('PE'). The new tax can apply where the arrangement is designed to avoid tax or creates a tax 'mis-match'. Where the tax applies, the non- UK person may be taxed as if it had a UK PE. In this publication this will be referred to as the rules dealing with the "avoidance of a UK taxable presence"; and
- a person that is subject to UK corporation tax (i.e. a UK company or a non-UK company with a UK PE) may have an arrangement with a connected person outside of the UK where that arrangement has the effect of reducing UK taxable profits. The rules apply where there is insufficient "economic substance" in the arrangements. In this publication this will be referred to as the rules dealing with "a lack of economic substance".
EXEMPTIONS FROM THE NEW TAX
The new rules will not apply in a number of situations:
- if both of the persons involved in the relevant arrangement are SMEs (i.e. small or medium sized enterprises under EU law) then the new tax will not apply to that arrangement;
- the rules dealing with the avoidance of a UK taxable presence will not apply in any 12 month accounting period during which the non-UK person (and other members of its group) has total sales revenue from UK customers of less than GBP 10M;
- the rules dealing with the avoidance of a UK taxable presence will also not apply where the person who operates in the UK (and prevents the non-UK person from having a UK PE) is an agent of independent status that is not connected with the non-UK person; and
- the rules should not apply to any arrangements which solely result in the creation of debts (between the connected entities) which are subject to the UK's loan relationship rules.
APPLYING THE NEW RULES
The new rules are complicated and, due to their nature, potentially apply to transactions which are not the primary target of the rules. There has been some recognition from HMRC that certain parts of the rules require improvement so those aspects may need to be changed or further guidance issued. Accordingly, we are presently in a period of uncertainty.
In addition, there are concerns in the UK that:
- parts of the rules may be contrary to EU law and inconsistent with a number of the UK's double tax treaties; and/or
- the UK Government has 'jumped the gun' by trying to implement BEPS principles without first waiting for general consensus as to how the relevant BEPS issues should be tackled.
Despite these concerns, the rules appear to have the support of the main UK political parties and are likely to be enacted. It would be appropriate for substantial multi- national groups to begin to consider how the rules may impact on their UK operations.
This publication is not intended to provide a full and technical summary of the conditions that must be met for the new rules to apply and the way in which any tax liability may be calculated. Instead, the following sections of this note provide headline comments as to the possibility of the rules applying to a number of standard arrangements operated within multi-national groups. The list of arrangements below merely provides examples of where the new tax may apply - it is not intended to be an exhaustive list of arrangements that are at risk or tailored to any specific circumstances.
THE RULES DEALING WITH THE AVOIDANCE OF A UK TAXABLE PRESENCE
- Sales and marketing support agreements
- A UK group entity may carry out sales and market support functions for a non-UK entity. The UK entity would not conclude any contracts but may negotiate contracts and carry out other functions. The non-UK entity would then enter into the contracts.
- These types of arrangements may be at risk under the new rules particularly if (a) the non-UK company carries out little activity, especially in relation to the negotiation of contracts; and/or (b) the non-UK company has little economic substance.
- Undisclosed agent ('commissionaire') arrangements
- A UK group entity may operate in the UK as an undisclosed agent for a non-UK entity. The UK group entity may operate as an agent of independent status so as to avoid the creation of a UK PE for the non-UK entity.
- Under the new rules, no tax charge will arise if the agent is of independent status and is not connected with the non-UK entity. However, if they are connected then the new rules will potentially apply.
- UK distributor
- A non-UK entity may sell goods to a UK entity with the UK entity then on-selling to UK customers. The UK entity would operate on a limited risk basis and hence would receive only a small taxable margin from its activities.
- The new rules should not, generally, apply to such this structure although the position should be considered on a case-by-case basis.
THE RULES DEALING WITH TRANSACTIONS LACKING ECONOMIC SUBSTANCE
- IP licensed to the UK where the UK company was involved in the creation of the IP
- A UK group entity may have a role in the creation of IP (or, indeed, may have previously owned the IP). The IP ownership is in a low tax jurisdiction and is licensed to the UK entity. The UK entity pays royalties that are tax deductible.
- The new rules would appear to be targeting this type of arrangement and may apply. If the level of royalties payable is consistent with transfer pricing principles then the new rules may not result in any adjustment to the level of deductible expense (and hence taxable UK profits) unless HMRC apply the rules so as to treat the IP as owned in the UK. In this situation the new tax charge would apply to the additional UK profits that would arise if there were no deductible royalty expense (although the UK company may be given credit for tax amortisation that would be available had it owned the IP in the UK).
- IP licensed to the UK where the UK company was not involved in its creation
- IP is owned in a low tax jurisdiction and is licensed to the UK entity. The UK entity pays royalties that are tax deductible. The UK entity had no involvement in the creation of the IP.
- The breadth of the new legislation would suggest that this type of arrangement may be caught unless the relevant IP owner has substance and carries on real activity in relation to the ownership and management of the IP. However, even if the rules were to apply, it is possible that no additional tax would be payable anyway if the royalties payable are consistent with transfer pricing principles.
- Equipment leasing to UK company
- A UK group entity requires new plant and machinery. A non-UK group company in a low tax jurisdiction is funded to purchase the plant and machinery which it then leases to the UK entity for leasing payments which are tax deductible in the UK company.
- The rules would appear to be targeting this type of arrangement and may apply. Unless there is real substance in the non-UK company (in terms of its activities relating to the plant and machinery) then HMRC may apply the rules so as to treat the plant and machinery as owned by the UK entity. In this situation the new tax charge would apply to the additional UK profits that would be treated as arising if there were no deductible leasing payments (although the UK company should be given credit for tax depreciation allowances that would be available if it had directly owned the plant and machinery).
- Intra-group funding to a UK company
- A UK group entity may borrow from a group company in a low tax jurisdiction.
- If the arrangement solely results in the creation of a debt subject to UK tax under the UK's loan relationship rules then the new tax should not apply. Instead, the level of tax deductible interest would be subject to restriction under transfer pricing principles and under other existing UK tax legislation dealing with interest deductions (such as the world wide debt cap rules).
- Captive insurance
- A UK group entity may insure (or if it is itself an insurer, reinsure) risks with a "captive" group insurance company in a low tax jurisdiction.
- The breadth of the new legislation would suggest that this type of arrangement may be caught unless the captive has substance and carries on real activity in relation to its underwriting activities. However, even if the rules were to apply, it is possible that no additional tax would be payable anyway if the premium payable to the captive is consistent with transfer pricing principles.
ADDITIONAL POINTS TO NOTE
The rules have been designed to encourage relevant multi-national groups to both (a) ensure full compliance with transfer pricing principles; and (b) to disclose to HMRC arrangements that may fall within the rules.
In particular, the rate of tax will be 25% (rather than the standard 20% UK corporation tax rate applying from April 2015) and a penalty may be payable if the taxpayer has not notified HMRC of the potential liability within 3 months of the end of the relevant accounting period.
Overseas jurisdictions will need to consider whether credit will be given for payment of the new tax. For example, it is understood that the US Treasury is currently considering the creditability of the DPT for US foreign tax credit purposes.