A new section 1305A of the UK Corporation Tax Act 2009 (CTA 2009) has been introduced by the UK Finance Act 2014 that applies to payments made from March 19, 2014 under avoidance schemes involving the transfer of corporate profits within a group.
This new measure applies if:
- two companies (“A” and “B”) are members of the same “group”;
- A and B are party to “arrangements” (whether or not at the same time);
- the arrangements equate to, in essence, A (directly/indirectly) paying B “all or a significant part” of A’s profits (the “profit transfer”); and
- one of the main purposes is to gain a “tax advantage”.
If applicable, the profits of A are reassessed for corporation tax on the basis that the profit transfer did not occur.
HM Revenue & Customs (HMRC) released amended guidance on the section on July 24. Groups should examine any arrangements with UK based members to ensure they are not caught by this new anti-avoidance measure.
This new measure follows the announcement of section 695A of the CTA 2009 in December 2013, which was intended to close down schemes where a company enters into a total return swap derivative contract with a group company, generally located in a tax haven, under which profits of the company are paid away in return for much smaller payments back. A deduction is claimed for the payment under the contract, leaving little or no profit chargeable to tax.
HMRC subsequently became aware of avoidance schemes not involving derivatives that could achieve the same outcome, that is, to try and obtain a deduction for a payment designed in substance to move profits earned in the UK to a tax haven, or otherwise to divert profits to generate a tax advantage, and s. 1305A blocks those schemes.
Arrangements that are, or have similar effects to, insurance, reinsurance, guarantees provided for services provided by another, profit swaps, derecognition, non-recognition, or profit transfers through skewed partnership profit shares are potentially within scope of the rule if these arrangements are being used to achieve a profit transfer, and a tax avoidance purpose is present. However, HMRC guidance indicates that most will not.
Main aspects of the legislation
S. 1305A of CTA 2009 applies where:
- two companies in the same group are party to any arrangements;
- the arrangements result in what is in substance a payment from one group company to another of all or a significant part of the profits of the business of A; and
- the main purpose or one of the main purposes of the arrangements is to secure a tax advantage for any person involving the profit transfer.
Where the section applies, profits are to be calculated for corporation tax purposes as though the profit transfer had not occurred. This can involve denying a deduction or adding a sum back to profits where an amount that is pure income profit has been transferred. Unlike s. 695A, s. 1305A contains no provision to exempt from tax any credits or receipts that correspond to disallowed amounts. Where a sum paid to another group company is partly a transfer of profits, but contains other components, then the add back will be limited to the amount of the profit transfer.
The measure will deny tax deductions for amounts that in substance represent distributions of the profits of a company, because they are paid after profits have been earned rather than being deductions incurred in the making of profits. Payments genuinely incurred in earning profits, on commercial terms, will not result in a profit transfer since these expenses need to be deducted in determining what the profits are.
Where the payments concerned are, for example, genuinely payments in respect of goods, services, or the use of tangible or intangible assets, the section will not apply, as the payments were made in arriving at the profits of A rather than being a transfer of part of A’s profits.
Transfer of profits
The new measure targets payments (as with s. 695A) that are in reality distributions of profits, as well as other arrangements where profits are diverted from a company with the intention of avoiding corporation tax, such as where a UK company that is due to receive a lump sum of pure income profit on which it will be taxed, and arranges for it to be paid instead to a group company.
The tax advantage must, however, involve a profit transfer. It would not therefore apply because of indirect effects of the transfer, for example, where profits were distributed as a non-deductible dividend.
Main purpose and tax advantage
The legislation does not define what is meant by “main purpose” or “one of the main purposes”. These expressions are to be applied objectively, having regard to the full context and facts and given their normal meaning as ordinary English words.
"Tax advantage” takes the broad definition in s. 1139 of the Corporation Tax Act 2010, which includes, among other categories, a relief from tax or increased relief from tax, a repayment of tax or an increased repayment of tax, the avoidance or reduction of a charge to tax or an assessment to tax, and the avoidance of a possible assessment to tax.
While HMRC will give clearances on whether a “profit transfer” has occurred, it will not do so on the question of whether the “main purpose” test is satisfied (although it would be willing to provide a view on whether there is considered to be a low risk of the provision applying).
The guidance issued in July 2014 includes the following examples:
1. Securities and financing arrangements
A securitisation company covered by the Taxation of Securitisation Companies Regulations 2006 will only be liable to tax under those regulations on the fee or margin received from the securitisation transaction. Thus there is no deduction for which relief could be denied under s. 1305A. The company will be subject to the anti-avoidance test in those 2006 regulations.
In other securitisations, it is likely that profits will not be transferred, but rather that different streams of payments on different assets are being exchanged. It is unlikely therefore that a transfer of profits will be involved.
In some cases, a provision for residual profits to be brought back to a parent company or member of the group may exist. Where this involves the transfer of profits to the UK, this will not amount to obtaining a tax advantage. It would seem to follow that a transfer from the UK to an overseas group member may potentially involve a tax advantage
2. Transfer pricing
Where, under genuine arrangements, a non-arm’s length price is paid for goods, services, or the use of tangible or intangible assets, s.1305A will not apply as the payments were made in earning profits rather than being a transfer of profits. UK transfer pricing rules will, however, apply to change the price of the transaction to the arm’s length price.
S.1305A may apply where transactions lack commercial substance or are artificial, and one of the main purposes of entering into them is to secure a tax advantage for any person, notwithstanding that an arm’s length price for the arrangements was determined.
Where HMRC has agreed an Advance Pricing Agreement profits are taxed in the “correct” tax jurisdiction and there is then no transfer from A to B of part of A’s profits, s.1305A will not apply.
3. Transfer of assets
S.1305A does not apply to potential profits transferred because the underlying business has been transferred, as there is no transfer of the profit away from the business that generates it.
Similarly, if as part of an unconditional arrangement an asset is transferred with the associated income stream, then this would not amount to a transfer of profits.
However, if an asset that is due to give rise to income is transferred on a temporary basis such that the temporary holder receives pure income profits, s.1305A could apply.
The legislation is also unlikely to apply to intra-group repos or stock loans in the ordinary course of a group’s business.
Reinsurance arrangements within a group as part of ordinary commercial arrangements would not normally be covered. It is only in circumstances where the normal commercial motives for reinsuring are absent from the arrangements that the measure would be applied.
A payment of premium from a group company to a reinsurer would not normally be considered in itself to be a payment of profits, but rather a price for indemnifying against insurance losses (even if taxation levels were taken into account in deciding where to locate the intra-group re-insurance company).
5. Franchise arrangements
In most cases the franchisor and franchisee would not be in the same group. However, even if they were, these payments would be payments made in earning the profits and not payments of part of the profits and thus would not be caught, provided that normal commercial arrangements were entered into, and not tax avoidance arrangements.
6. Licence payments
Payments made by a UK company to an overseas group member under a licence agreement based on a percentage of turnover would also not be profit transfer arrangements. Where there is an avoidance purpose, the anti-avoidance provision in the corporate intangibles legislation would act to counteract the avoidance.
7. Profit splits
Where a non-UK company is rewarded by a percentage of the profits arising from the exploitation of intangibles for its providing substantive and quantifiable services that enhance the intangibles, the nature of the payment is that of an expense incurred in arriving at the taxable profits of the UK company, so s. 1305A would not be considered to apply.
8. Sale of loan receivables
Sale of a creditor loan relationship and the associated interest income to a group company in another jurisdiction would not fall within s. 1305A as there is not a payment (directly or indirectly) of all or a significant part of the profits of the UK company selling the asset.
9. Contracts undertaken by non-resident companies
If an online retailer “fulfils” contracts in the UK, but the contracts are concluded with a non-resident group company, then provided that the profit arises offshore and does not involve a transfer of profits, the legislation cannot apply. If the arrangement does effect a transfer of profits, the legislation will apply if tax avoidance is involved.
10. Profits diverted
Where a company entitled to receive a compensation payment (which is in effect pure income profit) arranges for this payment to be made to a different company in the group for tax avoidance reasons, this will be caught and a sum equal to the compensation payment will be added back to the profits of the UK company.
11. Cessation of taxable payments
Where Company A receives taxable amounts from Company B, its parent, in respect of B’s use of an asset owned by A and Company A pays dividends equal to those profits back to Company B, for which it receives no tax deduction, but Company A and B then agree that A will no longer pay dividends and in return B will no longer have to pay the income; however use of the asset continues as before. This arrangement results in what is in substance a payment from A to B of a part of A’s profit: in effect A is still making these profits and paying them back to company B, but under an offsetting arrangement.
This arrangement would be caught by the legislation if there is a tax avoidance purpose. If there is no tax avoidance purpose transfer pricing will require adjustment of Company A’s profit to recognise an arm’s length payment for the use of its asset by Company B.