The UK is proposing to introduce a unilateral, non-OECD co-ordinated anti-BEPS provision, referred to in the media as the “Google Tax”, with effect from 1 April 2015. The draft provision is very complex, and it will be time consuming to assess its potential impact on many common cross-border business structures. The question of its applicability is heavily fact-based, so that even those unlikely to be affected may need to incur significant time and effort in reaching that conclusion.
The essence of the provision is that it has two targets: (i) UK companies reducing taxable profits through deductible payments made under tax motivated structures which lack economic substance, and (ii) non- UK companies selling into the UK, with related UK activity but without a taxable UK permanent establishment (“PE”), with an intended fiscal benefit. Diverted profits are to be taxed at 25% (as opposed to the main UK corporation tax rate of 20%).
In very general terms, based on the proposed legislation (which may be amended before implementation), a charge to the DPT may arise:
- Base Eroding Arrangements with Insufficient Economic Substance: where a company which is UK resident or has a UK PE reduces its profits through related party arrangements with insufficient economic substance, and as a result the tax paid across all relevant jurisdictions is less than 80% of the tax which would have been payable had the profit not been reduced (an “effective tax mismatch outcome” or “ETMO”). Substance will be insufficient where the fiscal benefit exceeds either (i) the economic contribution of the staff of any entity involved (a problem for any SPV), or (ii) any other financial benefit of the relevant transactions, where in each case the entity or transactions are part of a design intended to achieve that fiscal benefit. DPT is charged on the profits which would have arisen were the related party arrangements replaced with the arrangements which would have been made but for the ETMO, and which do not themselves give rise to an ETMO; or
- Avoided Permanent Establishments: where a non-UK resident company has designed the structure of a trading activity so as to avoid creating a UK PE, despite there being UK customers of that trade and UK activity (through agents or otherwise) related to that trade. In such circumstances, the profits that would have been taxable in the UK had the entity undertaking the relevant activity in the UK been a UK PE (an “avoided PE”) may be subject to DPT. The DPT charge may arise if either (i) the arrangements have a main purpose of tax avoidance, or (ii) if the non-UK resident company is making deductible payments to a connected entity in circumstances where there is insufficient economic substance, and as a result of those payments, there is an ETMO. In the latter case, the profits attributable to the avoided PE for DPT purposes may need to be adjusted in a manner similar to that relating to the insufficient substance provision, described above.
The obvious examples of affected structures are (i) a UK resident company paying a royalty, perhaps indirectly, to a tax haven IP company, and (ii) a non-resident selling to UK customers from outside the UK, with contracted UK customer support, perhaps itself also paying a royalty to a tax haven. However, the potential scope seems to be much wider.
The term “it is reasonable to assume that” is used liberally, to lower the evidential threshhold required to fall within many of the DPT’s requirements.
There are exemptions for small and medium-sized enterprises (“SMEs”), and where a non-resident company has UK sales below £10m annually. There are also exemptions from the avoided PE provision for independent agents which are unconnected or benefit from the Investment Manager’s Exemption, and a limited exclusion where ETMOs result from loans.
The threshhold for businesses’ engagement with the DPT rules is lowered by a notification obligation which is based on a hypothetical application of a simplified and broadened form of the actual DPT rules. As such, notification may be necessary even where the actual rules do not in fact apply. In essence, notification under the avoided permanent establishment provision is required if there are UK customers and activity in the UK, but no UK PE. For the purposes of the economic substance provision, for notification purposes, the requirement for it to be a reasonable assumption that arrangements have been designed to achieve a fiscal benefit is suspended, and the presence of an ETMO is made more likely by requiring the fiscal benefit to be “significant”, rather than a saving of more than 20%. This effectively requires notification of arrangements giving rise to any material fiscal benefit, whether intended or not.
If HMRC considers that a DPT charge arises, then after issuing a preliminary notice against which the recipient can only make limited representation, it can issue a charging notice which triggers an immediate DPT liability. A 12-month period for internal HMRC review follows, after which the recipient may appeal. The design of the charging structure is clearly intended to discourage taxpayers from risking a dispute with HMRC over the application of the DPT. Unpaid DPT liabilities can be enforced against related entities.
HMRC clearly believes that double tax treaty beneficiaries won’t be protected from DPT charges, presumably on the basis that the DPT is not specifically referred to in any current treaties, although that seems a difficult conclusion to draw. There are also concerns about the compatibility of the DPT with the EU principles of freedom of establishment and the movement of goods and services. Further, the interpretation of many aspects of the draft provisions is likely to be unclear, and the determination of the level of “diverted” profits (if any) to be charged to the DPT a difficult question, in each case giving large scope for argument. However, whether these legal points are of practical assistance to many potentially affected businesses, given the current climate of hostility to tax avoidance, is another matter.