Diverted profits tax (DPT) (informally known as "Google tax") was first announced on 3 December 2014 as part of the Autumn Statement by the UK's Chancellor of the Exchequer (Finance Minister). In great haste it became law on 26 March 2015, due partly to the desire to rush it through before the UK’s General Election.
HM Revenue & Customs (HMRC) has provided interim guidance which provides some assistance in interpreting the new rules, but there are many aspects of the legislation that remain uncertain. The legislation is not primarily aimed at real estate transactions, although it has now been confirmed by HMRC that DPT does indeed apply to UK property transactions. However, neither the legislation nor the guidance really helps taxpayers understand the full scope of what types of real estate transactions will be caught.
DPT is charged at a rate of 25 per cent on relevant profits from land transactions after 1 April 2015. It applies to existing and new structures. It is deliberately set at 5 per cent above the UK corporation tax and income tax rates, currently 20 per cent. Although not explicit in the legislation or guidance, it is considered that DPT is intended to apply to trading transactions (ie where UK real estate is bought to be sold at a profit, or when UK real estate is developed to be sold), rather than to apply to investment transactions (ie where UK real estate is acquired with the aim of generating UK rental income and capital growth). However, even this issue may not be beyond doubt.
The legislation targets two situations:
- First, a non-UK person may have an arrangement with another person which is intended to prevent the non-UK person from having a UK permanent establishment (PE). DPT can apply where the arrangement is designed to avoid tax or creates a tax "mis-match". Where the tax applies, the non-UK person may be taxed as if it had a UK PE. This will be referred to below as the rules dealing with the "avoidance of a UK taxable presence"; and
- Second, a person that is subject to UK corporation tax (ie a UK company or a non-UK company with a UK PE) may have an arrangement with a connected person outside of the UK where that arrangement has the effect of reducing UK taxable profits, for example, by channelling the profit offshore by means of a subcontract that results in a tax deductible payment by the UK taxpayer. The rules apply where there is insufficient "economic substance" in the arrangements. This will be referred to below as the rules dealing with "a lack of economic substance".
Exemptions from DPT
The new rules are targeted at large groups or companies, and will not apply in a number of situations:
- If both of the persons involved in the relevant arrangements are SMEs (ie small or medium sized enterprises under EU law) then DPT will not apply to that arrangement;
- The rules dealing with the avoidance of a UK taxable presence will not apply in any 12-month accounting period during which the non-UK person (and other members of its group) has total sales revenue from UK customers of less than £10 million;
- The rules dealing with the avoidance of a UK taxable presence will also not apply where the person who operates in the UK (and prevents the non-UK person from having a UK PE) is an agent of independent status that is not connected with the non-UK person; and
- The rules should not apply to any arrangements which solely result in the creation of debts (between the connected entities) which are subject to the UK’s loan relationship rules.
On the basis of current guidance there may be a particular risk in the following real estate scenarios:
- An example in the HMRC interim guidance indicates a risk of DPT applying where property is transferred from a UK company to a non-UK vehicle with which the UK company is "connected", unless there is significant substance in the offshore vehicle and a good commercial reason for the transfer. This situation may, for example, apply to a sale and leaseback transaction.
- A non-UK company procures a development on UK land with an intention to sell. The company has an employee based in or who visits the UK and/or appoints a connected UK person to assist with the development. The greater the role of the employee/connected person in the UK, the greater the risk that this creates the "avoidance of a UK taxable presence".
- A non-UK company buys UK real estate to sell on as trading stock, and has an employee based in or who visits the UK and/or a connected UK person that assists with the buying and selling process and negotiations. The greater the role of the employee/connected person in the UK, the greater the risk that there is the "avoidance of a UK taxable presence"
In addition to the above areas of concern, there is a wider concern within the property industry that standard Propco/Opco structures that involve a non-UK property owning company and a related UK operator company may also be caught by the DPT rules. The better view may be that this is unlikely but this is an area where further analysis may be appropriate.
What to do if you have an "alarm bell" structure?
Please get in touch with your tax advisers as soon as possible. Although there is no formal clearance mechanism there is an informal consultation process. Otherwise formal notification must be made, as discussed below, and there is a tax geared penalty for non-compliance.
If it is decided that there is likely to be a DPT liability, notification to HMRC must be made in writing to HMRC within three months of the end of the accounting period (extended to six months in relation to accounting periods ended before 1 April 2016). A notification may lead to HMRC issuing a "provisional notice" stating that payment of DPT is due "on the basis of the best estimate that can reasonably be made at that time". There are very few grounds, other than arithmetical error, to challenge this. HMRC may then issue a "charging notice" requiring actual payment which must be made within 30 days. No postponement is possible. After payment, the DPT is then reviewed by both sides, leading to possible adjustments, in the light of all the DPT provisions.
If a structure is within DPT, it may make sense in certain cases to ensure that the relevant property interest is held by a UK taxpayer. This would make a UK tax charge inevitable but such charge would be at a rate which is 5 per cent below the DPT rate. In other cases, it may make sense to boost the substance of the offshore structure or ensure that activities within the UK are carried out by independent agents rather than employees or related parties.
Challenge to the legislation?
The EU Commission is currently considering DPT and its compatibility with EU law, so it is possible some changes may be made. Questions have been raised over DPT's interaction with freedoms of establishment and provision of services granted by Articles 46 and 59 of the Treaty on the Functioning of the European Union (TFEU), but HMRC would no doubt respond that in the context of anti-avoidance any restriction on freedoms is justifiable and proportionate and that a certain lack of precision is inevitable when drafting anti-avoidance legislation in order to make it wide enough to be effective. However, the UK Government has pre-empted the Base Erosion and Profit Shifting (BEPS) process by introducing DPT unilaterally, and there could be an unacceptable level of uncertainty in cross border transactions if other countries followed suit. Australia in particular has decided not to introduce its own legislation in relation to this issue. If the BEPS project results in an agreed international solution whereby each jurisdiction would receive its "fair share of tax", DPT may be quickly confined to the history books but until that time it is a real and present danger to offshore structures.