Dubbed the “Google tax”, due to the nature of international tax structures the tax is looking to challenge, the new tax is charged at 25%. It applies to large multinational businesses with activities in the UK but with arrangements intended to divert profits away from the UK.
The Diverted Profits Tax (“DPT”) legislation will not apply to SMEs or businesses with annual UK sales of less than £10m or where the UK related expenses do not exceed £1m in a 12 month accounting period.
The DPT charge will apply in two cases;
- where there is an avoidance of a UK permanent establishment (The “Avoided PE”); and
- where intra-group arrangements lack economic substance and exploit a tax mismatch.
The Avoided PE
The legislation will apply where foreign companies make substantial sales through activity in the UK whilst avoiding a UK PE. This may apply where there is significant sales activity in the UK but the sales are not taxed here because the contracts are concluded overseas.
A charge will arise under the DPT legislation where:
- there is a non-resident company (“Foreign Co”) and another person (“A”), who carries on activity in the UK in connection with the supply of goods, services or other property by Foreign Co;
- it is reasonable to assume that the activity of A, or Foreign Co is designed to ensure that Foreign Co has no UK PE; and
- it is reasonable to assume that either or both of the following are met:
the “Mismatch” condition; or
the “Tax Avoidance” condition as described below.
The “Mismatch” condition is met where Foreign Co and A are connected, the transaction between Foreign Co and A results in an effective tax mismatch (the increase in one party’s tax liability is less than 80% of the reduction in the other party’s tax liability) and the “Insufficient Economic Substance” condition is met.
The “Insufficient Economic Substance” condition is met where the financial benefit of the tax reduction is greater than the total other financial benefits and it is reasonable to assume that the arrangements are designed to reduce tax.
The “Tax Avoidance” condition is met if: in connection with the supply of goods, services, or other property, arrangements are in place where one of the main purposes is to avoid a charge to tax in the UK.
The legislation does not define what is meant by “main purpose” or “one of the main purposes” so these terms are given their normal meaning as ordinary English words.
The tax office are likely to apply this where the company has separated the substance of its activities from where the business is carried on.
Arrangements caught by these new rules include the “double Irish structure” which involves, typically, US groups locating their Intellectual Property (“IP”) in a Bermuda/Ireland dual resident company and routing sales to UK customers from Ireland. However, where a group decides to take advantage of lower tax rates by establishing the whole of the economic activity in that lower taxed jurisdiction, the DPT is unlikely to apply.
A charge to DPT will not arise where the Foreign Co and A are not connected. Therefore agents of independent status transacting with a foreign company will not cause a charge under the DPT legislation to arise.
Intra-group arrangements which lack economic substance
A charge will arise under the DPT legislation where there are intra-group expenses (or a diversion of income) which lack economic substance.
This will occur where:
- a provision is made between a UK resident company (“C”) and another person (“P”);
- the participation condition is met (i.e. C and P are connected);
- the provision results in an “effective tax mismatch outcome”; and
- the insufficient economic substance condition is met.
An effective tax mismatch outcome arises where C has an increased tax deductible expense or decreased taxable income, there is a reduction in UK tax which is greater than the increase in P’s tax liability and the amount of tax paid by P is not at least 80% of the tax reduction of C.
The insufficient economic substance condition is met where the financial benefit of the tax reduction is greater than the total other financial benefits and it is reasonable to assume that the arrangements are designed to reduce tax.
Where a charge arises under the DPT legislation the company must notify the UK tax authorities, (“HMRC”) within three months of the end of the accounting period where the charge arises. HMRC will issue a “preliminary notice” within two years of the end of the accounting period and the company will then have 30 days to send written representations to HMRC.
HMRC will consider the representations and either issue a “charging notice” or confirm that no charging notice will be issued within 30 days of the end of the representation period. The company must pay the tax set out in the charging notice within 30 days of issue. There is no postponement or right of appeal at this stage.
HMRC then have a 12 month review period during which a supplementary or amended charging notice may be issued. The company may appeal within 30 days following the end of the
The Diverted Profits Tax has been introduced into UK law with remarkable haste. When originally announced in December 2014 the Government’s stated intention was to “introduce a new tax to counter the use of aggressive tax planning techniques used by multinational enterprises to divert profits from the UK”.
The DPT achieves its objective of countering the use of aggressive tax planning but goes further than just taxing profits which have been diverted from the UK.
HMRC state that the DPT legislation is not designed to catch bona fide commercial arrangements where there is sufficient economic substance offshore and where intra-group pricing is at arm’s length.
However, the legislation is widely written and its application is potentially very broad. Businesses should therefore review their international arrangements to understand if they are within the scope of the new tax.
This is a high level summary of the provisions relating to DPT. For more information, please contact Nilesh Shah at firstname.lastname@example.org.