The UK Government intends to introduce a 25% “diverted profits tax” (“DPT”) from 1 April 2015. The tax is designed to catch the artificial erosion of the UK corporate tax base by multi-nationals that avoid establishing a fixed place of business here in the UK (a “permanent establishment” or “PE”) or that divert UK profits to related parties in lower-tax jurisdictions. In its current form, the DPT could catch multi-nationals which implement conduit arrangements (such as the “double Irish” structure) or supply chain management structures that shift profits out of the UK. Certain sectors are most likely to be impacted, including multi-national groups operating in the technology, distribution, media & entertainment, advertising, gaming, retail and hospitality sectors. Many of those groups will ultimately be owned in the USA. Existing structures will need to be reviewed before 1 April 2015 and where appropriate, corrective action taken. The draft legislation has been released for public consultation, so multi-nationals should take the opportunity to make representations to the UK Government.


In his 3 December Autumn Statement, the Chancellor announced that the UK would introduce a 25% DPT with effect from 1 April 2015. The target of the announcement was large multi-nationals that artificially move profits from the UK to lowertaxed jurisdictions. The Government has now (as of 10 December) published for public consultation draft legislation to implement the DPT. We give our initial thoughts on the draft legislation below.


The DPT comprises over 25 pages of new legislation drafted in opaque and often impenetrable terms. For example, to determine whether the DPT applies because a foreign company has avoided creating a UK PE (the first case described below), five conditions must be satisfied. One of those (the mismatch condition) itself comprises a further six tests. Simply understanding the draft legislation, let alone applying it, presents a considerable challenge. The accompanying explanatory notes and 50 page guidance document provide little insight. As many questions arise as do answers.

The DPT will only apply to large companies and groups. A company will not be subject to the DPT unless it (and its connected companies) have total annual UK sales revenues of at least £10 million. In addition, the DPT will not apply to companies that qualify as a "small enterprise" or "medium-sized enterprise" (as defined in European Commission Recommendation 2003/361/EC).

There are three cases where the DPT will apply. The first is where a foreign company, via another person operating in the UK (other than an entirely independent sales agent - ie a genuine third party), supplies goods or services to UK customers without creating a UK PE. This might occur where the foreign company stops short of concluding contracts in the UK. It must be objectively reasonable to assume that the arrangements are designed to avoid creating a UK PE for the foreign company. It must also be reasonable to assume that the arrangements have a main purpose of avoiding UK corporation tax (the "tax avoidance condition") or were implemented to achieve a tax mismatch (see below). Unhelpfully, "goods and services" are not defined. One might assume that it is limited to goods and services ordinarily supplied to customers. However on a wider interpretation - for example equivalent to the meaning used in a VAT context - the first case could theoretically apply, for example, to many UK real estate activities that involve off-shore entities.

The second case is where a UK company creates a tax mismatch by using entities or transactions that lack economic substance. The third case is an extension of the second in that it essentially applies the same provisions to a foreign company that trades in the UK via a UK PE.

Pure financing arrangements largely fall outside the scope of the DPT. Arrangements limited to loans are excluded from the second and third cases and cannot give rise to a tax mismatch - so will fall outside the first case unless the tax avoidance condition is met.

Where a company considers that it is reasonable to assume that it will have diverted profits for an accounting period, the company must notify HMRC within three months of the end of the accounting period. Provided the company has given notice, HMRC has two years from the end of the relevant accounting period to issue a preliminary notice explaining why the DPT applies, the amount of tax payable, the person liable for the tax and when it is due. If the company does not notify HMRC, HMRC has up to four years to issue a preliminary notice. 

Upon receiving a preliminary notice, a company has 30 days to make written representations to HMRC on certain matters - eg whether there is an error in HMRC's calculations or whether an exemption applies. Having considered any representations, HMRC then has a further 30 days to issue a formal charging notice. DPT is due within 30 days of that notice.

The due date for payment of DPT commences a 12 month review period, though this can be ended earlier by mutual agreement between HMRC and the company. During this review period, HMRC must conduct an internal review of the formal charging notice already issued and the company can make further representations. If HMRC is satisfied that the amount of DPT levied has been excessive or insufficient, HMRC can issue a further notice, making appropriate adjustments to the original charge. However, a notice increasing the DPT charge cannot be issued within the last 30 days of the 12 month review window - presumably to give the company sufficient time to lodge an appeal. Companies can appeal to the tax tribunal up to 30 days after the end of the review period.


Key to the DPT is whether there has been a tax mismatch. This is a requirement of the first case (avoidance of a UK taxable presence) unless the tax avoidance condition is met. It is also a requirement of the second and third cases (involvement of entities or transactions lacking economic substance).

In the first case, the tax mismatch (strictly, the "mismatch condition") appears targeted primarily at conduit arrangements. These are arrangements whereby the foreign company and a second related person enter into a transaction or series of transactions which results in an effective tax mismatch outcome. This is a decrease in the tax payable by the foreign company which exceeds any corresponding increase in the tax payable by the second person (or which would have been payable but for the availability of losses) by at least 20%. The arrangements must also have "insufficient economic substance". A lack of substance arises where the overall financial benefit of the tax reduction to the foreign company and second person (taken together) exceeds any other financial benefit referable to the transaction or transactions (and it is reasonable to assume that the transaction or transactions were designed to secure that overall reduction). It also arises where one of the parties contributes less by way of economic value (in terms of the functions or activities that the staff of that person perform) than the financial benefit of the tax reduction. It is entirely unclear how these other (non-tax) financial benefits and economic values should be calculated.

The "double Irish" structure is an obvious target of the mismatch condition. As many will know, that structure involves an Irish incorporated and resident operating company making tax-deductible royalty payments to a related Irish incorporated company that is resident in a low-tax jurisdiction. The reduction in Irish tax payable by the operating company would significantly exceed any additional tax payable by the second company. If there is insufficient economic substance in these arrangements, the mismatch condition may be met.

The second and third cases focus on a tax mismatch arising out of a transaction or transactions between the UK resident company (or UK PE of a foreign company) and a second related person. An example might be the payment of a royalty by the UK business to a related party in a low-tax jurisdiction or other payments commonly made as part of cross-border supply chain management arrangements. Once again, the decrease in tax payable by the UK company (or UK PE) must exceed any corresponding increase in the tax payable by the second person (but for the availability of losses) by at least 20%. The arrangements must also have insufficient economic substance. 

In the first case, the computation of taxable diverted profits essentially looks to what would have been subject to UK corporation tax had the company traded in the UK via the "avoided" PE, determined on a "just and reasonable" basis. For the second and third cases, the computation of taxable diverted profits is particularly opaque. A charge only appears to arise to the extent that the UK business would not have made a payment unless there was an overall tax reduction from doing so. The target may therefore be arrangements where groups have moved assets or functions out of the UK to a related party, only to then charge them back in (eg by way of a licence or service fee).


Questions remain as to whether the DPT will work. Currently the UK does not subject foreign companies to UK tax unless they trade in the UK through a UK PE or they have sources of UK income, such as UK rents, interest or royalties. This position is enshrined in the UK's extensive double tax treaty network. Those double tax treaties generally only apply to UK income tax, corporation tax and capital gains tax. The DPT purports to be a new and separate tax so that the UK can impose the DPT without any concern for its existing treaty network. However, the UK's double tax treaties also generally apply to all "identical or substantially similar taxes" to UK income tax, corporation tax and capital gains tax. The DPT might not be UK corporation tax, but is it a substantially similar tax? Will the DPT survive if a foreign company (or foreign government) challenges it on the basis that it is subject to an existing double tax treaty?

The European dimension also looks interesting. Companies within the EU benefit from certain fundamental freedoms, including a "freedom of establishment" - in a nutshell the right to establish and manage a company in one Member State without being subject to less favourable treatment by another Member State. On one view the DPT does not unlawfully restrict freedom of establishment as it does not actually prevent business establishing in other Member States - it merely seeks to prevent the avoidance of UK tax by companies doing so. But it does so in a way which could involve profits of entities based elsewhere in the EU being taxed by the UK at a higher rate (25%) than profits subject to UK corporation tax (20% from 1 April 2015).

Finally, it is worth keeping in mind the OECD's base erosion and profit shifting (BEPS) project. To the extent that it seeks to tackle what the UK Government considers to be an artificial erosion of the UK tax base, the DPT is a horse bolting long before the BEPS gun has gone off. Whether this will prejudice what international consensus the OECD has maintained throughout the BEPS project remains to be seen.