The UK Diverted Profits Tax - a unilateral approach to an international problem
April 2015
Given the publicity surrounding the practices of multinationals – in particular a number of the large US technology corporations - in structuring their affairs to minimise their tax liabilities, it is not completely surprising that the UK Government has chosen to act in an election year by introducing a new tax, called the Diverted Profits Tax ("DPT"). The DPT is intended to deter and counteract the diversion of profits from the UK by large multinational groups and will apply at the rate of 25% (rather than the corporation tax rate of 20%).
The legislation enacting the DPT has been rushed through the parliamentary process and the new tax is applicable to diverted profits arising on or after 1 April 2015 (with apportionment rules where the accounting period straddles that date). HMRC has also issued Interim Guidance regarding the application of the rules. There is no grandfathering of existing structures so all existing arrangements can be within the scope of the new tax.
For some commentators, the timing for the introduction of this new tax is questionable, given that it represents unilateral action by the UK Government at a time when the Base Erosion and Profit Shifting ("BEPS") project is well underway and due to complete its recommendations by the end of 2015. One of the key messages of the BEPS project is that countries should work collectively to reform international rules, rather than adopt unilateral measures which could undermine the BEPS project. It is, therefore, disappointing that the UK Government has effectively "jumped the gun" and has introduced a new tax which introduces potentially onerous burdens on large multinational enterprises, and which involves a "pay now argue later" approach giving extensive discretion to HMRC as to the amount of tax applicable to its assessment of an enterprise's diverted profits.
The DPT is intended to apply to two broad situations:
- where a foreign company structures its arrangements to avoid creating a UK permanent establishment ("PE") and, broadly, makes more than £10m annually in UK-related sales revenues from the supply of goods, services or other property and its UK-related expenses exceed £1m. UK-related sales of affiliated companies are also included in determining the application of the £10m threshold where such sales are not subject to UK corporation tax; and
- where entities or transactions (involving affiliated parties) lack economic substance and either involve a UK resident company or a UK PE of a foreign company to exploit tax mismatches where it is reasonable to assume that expenditure in the UK would not have been incurred, or taxable UK income would have arisen, but for the tax benefit of the actual arrangements.
Broadly, profits which are chargeable to UK taxes are generally subject to usual transfer pricing rules (where such adjustments are taken into account in the company’s tax return), with the diverted profits tax intended to apply particularly in those cases where the transfer pricing adjustment is insufficient or there is a recharacterisation of the arrangements and the tax is applicable to diverted profits determined on a just and reasonable basis.
The rules are intended to apply only to large enterprises and not to small or medium sized enterprises ("SME") in any accounting period. SMEs broadly comprise enterprises employing globally fewer than 250 persons and which globally have an annual turnover not exceeding €50m and/or annual balance sheet not exceeding €43m.
The rules are not limited to transactions or arrangements with tax haven or low-tax jurisdictions, but can apply more broadly. Larger multinational enterprises will need to consider the impact of these proposed new rules particularly if they are generating (or are looking to generate) significant revenues from UK activities as these new rules could influence how they structure their activities in the UK. Moreover, these rules should also be considered if multinational enterprises are looking to develop UK property or lease property to UK affiliates.
Whilst there are likely to be valid arguments challenging the validity of this new legislation under existing EU law principles and arguing its impact is limited by existing double tax treaty provisions, the short timeframe for providing notification to HMRC of the application of the DPT and the need to pay the tax well in advance of any challenge to the law’s validity, will expose larger enterprises with significant UK activities to the possibility of having to notify HMRC of the possible application of the diverted profits tax.
Read more about Diverted Profits Tax
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"... the UK Government has effectively 'jumped the gun' and sought to introduce a new tax which introduces onerous burdens on large enterprises."