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The UK is on course to enact a new tax (the "DPT") with extraterritorial scope which will apply to profits arising on or after 1 April 2015 and will be applied at a rate of 25%.
The UK is on course to enact a new tax (the
"DPT") with extraterritorial scope which
will apply to profits arising on or after 1 April 2015 and will be
applied at a rate of 25% (the UK's main rate of corporation tax
is expected to be 20% from the same date). The UK Government
considers the DPT to be an anti-avoidance measure aimed not only at
raising revenue directly, but also at modifying taxpayer behaviour.
The UK Revenue authority, HMRC, consider that double tax treaty
protections will not apply in the context of the DPT. Whether this
is right or not will depend on the applicable treaty wording and
the success of any mutual agreement process between HMRC and their
relevant counterpart – little comfort to potentially affected
taxpayers.
What does the DPT apply to?
Aimed primarily at arrangements involving multinational
enterprises with UK-linked profits and nicknamed "The Google
Tax", the DPT arises in the context of high-profile media
criticism of US-headquartered global businesses such as Google,
Amazon and Starbucks. However, the draft legislation appears wide
enough to catch a great many more enterprises and group structures
which would traditionally have been seen as being "on the
right side" of the tax planning/tax avoidance line, for
example:
A foreign entity
("FE") selling data analytics services
enters into a sales and marketing support agreement with a UK
company in its corporate group ("UKE")
under which UKE identifies and negotiates sales contracts up until
the point of final approval and execution, whereon the relevant
contracts are concluded by FE with the effect that FE is regarded
as having no taxable presence (i.e. a permanent establishment) in
the UK on which its profits could be subject to UK tax.
FE has a UK subsidiary
("A") which is intended to engage in
manufacturing activities, for which expenditure on plant and
machinery must be incurred. FE incorporates and capitalises another
subsidiary ("B") in a jurisdiction with
no tax. B acquires the necessary plant and machinery and leases it
to A, generating a tax deduction for A and profits for B which are
not subject to tax.
The draft legislation is deliberately cast wide enough to
potentially catch arrangements wholly within the UK and so unless
an exclusion clearly applies, all taxpayers with links to the UK
are likely to have to consider the application of the new rules to
some extent.
When will it apply?
The DPT timetable to implementation is unusually short:
Following its announcement in the UK's Autumn Statement on 3
December 2014, draft legislation was published on 10 December 2014
and an "open day" was hosted by HM Treasury and HMRC on 8
January 2014 at which it was announced that the DPT would be
introduced from 1 April 2015 in substantially the form of its
initial draft.
Whilst there remains the possibility of changes to its terms,
taxpayers must begin to prepare themselves for the application of
DPT on the basis of the draft legislation in its current form and
must keep abreast of developments in the run up to 1 April. In some
cases, multinational groups may need to consider making structural
changes to their UK-linked operations. In others, compliance
functions must be extended to deal with the DPT.
Key points and Orrick contacts
A number of articles, updates and alerts have been generated by
UK tax practitioners in the context of the DPT. The table below
seeks to highlight some of the key risk features in (and key
exclusions from) the new (draft) legislation. It does not purport
to be comprehensive. The potential application of the DPT
legislation must be considered on a case by case basis by
potentially affected taxpayers in conjunction with their
advisers.
Who is potentially
caught?
Any business which reduces the tax
which it might otherwise pay in the UK by:
arranging its UK affairs so as to come outside the scope of the
definition of "permanent establishment"
("Case 1"); or
using entities or transactions which lack economic substance
("Case 2").
What is the charge
on?
The precise determination of the amount subject to charge
depends on a detailed analysis of the relevant arrangements by
reference to a number of factors, many of which are similar to
factors applied in the UK's transfer pricing rules.
Broadly, however, the tax is applied to the proportion of the
UK-related profits which it is "reasonable to assume"
have been subject to artificial diversion away from the UK (within
the terms of the legislation).
Is DPT subject to the
UK's self-assessment rules?
Technically, no, but taxpayers nonetheless are required (on
pain of tax-geared penalty) to notify HMRC within 3 months of the
end of the relevant accounting period if the new rules
might apply to their arrangements (analysis likely
to command significant compliance budget), following which an
assessment and appeal process (which may last as long as two to
three years) will commence.
When will the tax be
due?
HMRC have 2 years following the end of the relevant accounting
period (4 years where there has been no voluntary notification of
potential liability by the taxpayer) to issue a preliminary notice
of chargeability.
Following 30 days for taxpayer representations, the preliminary
notice is withdrawn or a charging notice is issued.
The tax potentially due (plus estimated interest) must be paid
up within 30 days of the issue of a charging notice. Failure to pay
can result in secondary liabilities for connected companies.
There will follow a further period of 12 months in which the
taxpayer and HMRC can engage further (and during which the amount
of charge may be varied up or down) and the taxpayer has 30 days
from the end of this period in which to make a formal appeal (if
any) against the final charge to the tax tribunal.
What are the key risk factors
which might bring arrangements within Case 1?
(listed risk factors are not exhaustive and
are not necessarily applied
cumulatively)
A foreign enterprise ("FE") benefits
from profits arising on supplies of goods or services within the
UK/made to UK customers.
An entity ("UKE") within the UK is
involved in connection with those supplies. UKE may be any person
or legal entity.
UKE is not a permanent establishment of FE under existing law
and it is reasonable to assume that arrangements are in place to
ensure that UKE is not treated as such.
The tax advantages of the arrangements outweigh other
commercial benefits and/or are not justified by the location and
levels of actual economic activity of the relevant entities.
The arrangements are such that FE receives a tax deduction in
respect of a payment and the recipient of the payment pays a
relatively lower rate of tax on those receipts than FE would have
paid.
What are the key risk factors
which might bring arrangements within Case 2?
(listed risk factors are not exhaustive and
are not necessarily applied
cumulatively)
A UK resident company ("UKC") is
subject to arrangements which include a provision between UKC and
any other person ("P") who is connected
with UKC.
A non-UK resident company ("NUKC")
has a taxable UK permanent establishment
("UKPE") which is subject to
arrangements which include a provision between UKPE and any other
person ("P") who is connected with
NUKC.
The relevant provision (which may include the operation of any
number of transactions) results in UKC/UKPE receiving a tax
deduction in respect of a payment (or payments) and the recipient
of the relevant payment pays a relatively lower rate of tax on
those receipts than UKC/UKPE would have paid.
The tax advantages of the arrangements outweigh other
commercial benefits and/or are not justified by the location and
levels of actual economic activity of the relevant entities.
What exclusions might apply?
(listed exclusions may apply for the purposes
of Case 1 or Case 2 or both)
DPT should not apply if all relevant companies
are Small or Medium Enterprises ("SME"s). Very broadly
speaking, an entity is an SME if it meets condition A and one of
Conditions B or C:
Condition A – fewer than 250 employees.
Condition B – Annual turnover of €50m or less.
Condition C – Annual balance sheet total of €43m or
less.
Each entity must be assessed by reference to other companies
with which it is connected, and totals relevant to Conditions A-C
aggregated for the test.
The DPT may not apply if the relevant entities
are not connected and the affected UK entity is an agent of
independent status.
The DPT may not apply where the total UK sales
revenues of the relevant entities (including connected entities) is
less than £10m in any accounting period.
The DPT may not apply where the relevant
provision between the relevant parties gives rise
only to one or more "loan relationships"
(which are subject to a specific tax regime in the UK) for the
entities which would otherwise be subject to the DPT.
What if the relevant
arrangements are already the subject of one or more advanced
pricing agreement(s) ("APA"s) under the applicable
transfer pricing rules?
Although in many cases there will be a great deal of overlap
between the practical application of the DPT and the application of
existing transfer pricing rules, the DPT extends the scope of
HMRC's powers and arrangements which have the benefit of APAs
may still be at risk of a DPT charge (albeit with a credit for UK
tax already accounted for under a transfer pricing
adjustment).
HMRC have said that they expect that APAs agreed after 1 April
2015 will take into account the DPT and so APAs agreed after that
date should, although not a complete defence against the DPT,
provide greater comfort to taxpayers than APAs agreed before that
date.
What about UK fund managers
of non-UK resident investment funds?
The DPT is potentially of application to UK fund managers of
non-UK resident investment funds.
Most such arrangements would be expected to fall within Case 1
rather than Case 2 under the DPT legislation.
There is a specific exemption from Case 1 where UKE qualifies
for the UK's existing Investment Management Exemption
("IME").
We would normally expect non-UK resident funds which have a UK
resident investment manager to fall within – or take steps to
comply with – the terms of the IME and on this basis, we
would expect such funds to be outside the scope of the DPT.
Each fund's facts should be considered and monitored on an
ongoing basis to confirm the application of the exemption.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.