The UK will create a new extra-territorial royalty withholding tax charge targeting low taxed overseas royalties paid in connection with sales of goods or services to UK customers, the first of a broader range of measures targeting the digital economy
The Chancellor of the Exchequer announced in his Autumn Budget speech today that the UK's royalty withholding tax rules will be extended, yet again, to target situations where royalties are paid to a low-tax foreign IP company by a foreign principal company in connection with its sales of goods or services to UK customers, where that foreign principal has no taxable presence in the UK. The 20% withholding tax charge will be subject to the eligibility of the foreign IP owner to claim relief under a double tax treaty concluded by the UK.
The new measure will be introduced in the Finance Bill 2018-19, and will come into effect from 1 April 2019. The Treasury will publish a consultation paper on 1 December 2017 to refine points of detail. The Treasury expects the new measure to raise £800m by March 2023, but it has not yet revealed its projections.
The proposal is not confined to businesses in the digital economy, but this has been positioned as the first of a broader range of more radical measures that will target that sector. The Treasury considers that the measure is necessary to maintain confidence in the international tax framework and avoid competitive distortion in local markets - it being "crucial that multinational groups are prevented from being able to realise profits in low-tax entities that are not justified by local economic substance". The Treasury states that this action will help to "prevent groups achieving unfair competitive advantages in the UK market in which they operate" and, with an eye to broader changes on the future tax framework for the digital economy, "ensure that the discussion on where value is created by the users of certain digital businesses starts from a more sustainable basis".
The 2016 reforms
This announcement comes little more than a year after the last major overhaul and extension of the UK's royalty withholding tax and diverted profits tax ("DPT") rules in the Finance Act 2016.
To recap, those reforms:
- broadened the scope of UK royalty withholding tax from payments in respect of copyright, designs and patents to include brands and trademarks, secret formula or processes and other proprietary information;
- expanded the territorial nexus of UK royalty withholding tax by deeming royalties paid by a foreign principal in connection with a trade carried on by that company through a UK permanent establishment to have a "UK source" and therefore became subject to the charge;
- introduced a new DPT charge at the rate of 25% on royalties paid by a foreign principal in connection with an avoided permanent establishment of that company for DPT purposes, subject to the availability of a credit for the treaty relief that the recipient would be entitled to; and
- enacted a new domestic law treaty override, restricting the availability of relief from UK royalty withholding tax under a double tax treaty in respect of royalties paid to a connected party, where the payment is made as part of an arrangement which has a main purpose of obtaining a tax advantage which is contrary to the object and purpose of the treaty.
These measures were accompanied by a raft of anti-forestalling measures and other anti-avoidance measures enabling HM Revenue & Customs to disregard or recast supply arrangements which were implemented with a main purpose of avoiding the effect of the new rules.
Impact and behavioural change
Despite their breadth, the 2016 changes had no discernible impact on supply chain arrangements involving a base-eroding royalty where a foreign principal was selling goods or services to UK customers directly, with no UK-based support, or where a foreign principal was selling goods or services to a related distributor in the UK, for example acting on a limited risk basis.
The Treasury highlights the first of these examples as a target of the legislation, but there seems to be no immediately obvious basis on which to differentiate the latter from a policy perspective if the objective of the new measure is to target base eroding royalty payments ultimately generated from sales to customers in the UK.
The introduction of the 2016 reforms prompted many groups to consider moving from UK sales support and marketing operations or commissionaires to a buy/sell distribution model, to mitigate the risk of a 25% DPT charge on royalty payments. Indeed, whilst acknowledging the effect that the BEPS outputs have had on groups' international structures, there is a recognition by the Treasury that "while there may be transparency benefits in large digital businesses booking revenues generated from the UK into a local company, that does not necessarily equate to an increase in UK tax revenues …". Having observed the behavioural impact of the 2016 changes, the Treasury appears to consider that further action is required which will be much broaderreaching and radical in its scope and effect.
Whereas the 2016 changes were focused exclusively on royalties paid in connection with an actual or deemed UK permanent establishment, or in other words, activity in the UK which contributed to the generation of sales of goods or services to customers, those customers could be based either in the UK or overseas. The Treasury's announcement today appears targeted exclusively at royalties attributable to sales to UK customers, irrespective of whether the activity contributing to the generation of those sales is actually taking place. The Treasury does not appear to be targeting royalties arising from sales to non UK customers where functions in the UK have contributed to those sales.
The Treasury states that it will respect the international obligations in the UK's tax treaties in applying the new measure.
Further focus on the digital economy
This measure forms part of a broader raft of announcements by the Treasury today focused more specifically on the digital economy, which included support for:
- broad-reaching multilateral reform of the international tax framework to ensure that the value created by the participation of users in certain digital business models is recognised and taxed where those users are based; and
- potential interim options to raise revenue from such digital businesses, such as a new UK tax on the revenues that they generate from the UK market, with the Treasury expressing agreement and willingness to work with the European Commission and other EU Member States to take coordinated action, or failing that, taking further unilateral measures alone.