The tax planning techniques used by some multi-national groups has been subject to a great deal of attention by the press. The particular allegation is that multinational companies pay little or no tax in the countries where they make most of their sales.

The UK government has unveiled new legislation to counteract these types of arrangement and proposes to introduce a Diverted Profits Tax which will levy tax on profits diverted from the UK at a rate of 25 per cent.

Norton Rose Fulbright comments

The legislation revealed is a game changing shift in policy.The UKalready has a range of measures designed to counter-act avoidance in this area, including the transfer pricing rules designed to prevent multi-nationals manipulating the price on transactions with related parties in low tax jurisdictions to reduce their tax liabilities.

Whilst the proposals may win popular support they will be controversial in business circles and are likely to cause significant uncertainty in how companies’ operations should be taxed.

Why might this be controversial?

The UK has a large network of double tax treaties which allocate taxing rights. This legislation may afford the UK wider taxing rights than it currently has. The new provisions may have been cast as a new tax with the apparent intention that it will fall outside the scope of the treaty provisions, although if this is the intention, it is likely to be contested by taxpayers. The draft guidance, which runs to 50 pages, does not directly address this issue. It is also not clear whether this new tax will be creditable for (non-UK) foreign tax rules.

Whilst there may be a popular consensus that the arrangements targeted are unacceptable, the change will cause great uncertainty across many businesses as to whether legitimate arrangements are caught.

The basis for payment of Diverted Profits Tax is a just and reasonable assessment of the tax diverted made by government officers. The tax must be paid within 30 days but cannot be appealed for a period of 12 months.

The tax is set at a penalty rate 5 per cent greater than the normal rate of corporation tax.

The OECD has been seeking to co-ordinate an international response to multi-national tax planning through its Base Erosion of Profits (BEPS) programme. The UK has stepped in with a unilateral programme of its own which is likely to be highly controversial.

How it will work

The new rules operate in two ways. They target tax motivated arrangements designed to avoid the creation of a permanent establishment. The system of international tax established by a world-wide set of bilateral double tax agreements made between governments, generally exempts companies based in one country from tax on sales in another country unless they have a permanent establishment in the other country. The new provisions will give HMRC power to levy tax on the non–resident’s profits where arrangements have been put in place for another person to act as a disguised permanent establishment. This will target the type of arrangement where a contract for sales is negotiated in one country but formally concluded in another low tax country. A second provision will give the UK taxing powers where connected parties have entered into transactions which result in a reduction in tax in one country without a corresponding tax liability in the other country and the transactions, or one of the entities, lacks economic substance.  The scope of the targeted arrangements is potentially very broad.