The UK is consulting on the provisions of a new provision to tax diverted profits with effect from 1 April 2015. It is worth quoting the description in full:
“The diverted profits tax is a new charge on diverted profits. The main objective is
to counteract contrived arrangements used by large groups (typically multinational
enterprises) that result in the erosion of the UK tax base.”
The provision sits within the anti-avoidance ambit of UK taxation and the charge is outside corporation tax so it is not subject to the restrictions of double taxation treaties. The charging section is:
“This section applies in relation to a company (.the foreign company.) if.
(a) the company is non-UK resident,
(b) a person (.the avoided PE.), whether or not UK resident, is carrying on
activity in the United Kingdom in connection with supplies of goods or
services made by the foreign company to customers in the United
(c) it is reasonable to assume that any of the activity of the avoided PE or
the foreign company (or both) is designed so as to ensure that the
foreign company is not carrying on a trade in the United Kingdom
through a permanent establishment in the United Kingdom by reason
of the avoided PE.s activity (whether or not it is also designed to secure
any commercial or other objective),
(d) it is also reasonable to assume that the mismatch condition (see
subsection (3)) or the tax avoidance condition (see subsection (4)) is met
or both those conditions are met, and
(e) the avoided PE and the foreign company are not both small or medium sized
“The mismatch condition. is that.
(a) in connection with the supplies of goods or services mentioned in
subsection (1)(b) (or in connection with those supplies and other
supplies), arrangements are in place as a result of which provision is
made or imposed as between the foreign company and another person
(.A.) by means of a transaction or series of transactions (.the material
(b) the participation condition is met in relation to the foreign company
and A (see section 5),
(c) the material provision results in an effective tax mismatch outcome as
between the foreign company and A (see section 6),
(d) the insufficient economic substance condition is met (see section 7),
(e) the foreign company and A are not both small or medium-sized
(f) the material provision is not an excluded loan relationship (see
“The tax avoidance condition. is that, in connection with the supplies of goods
or services mentioned in subsection (1)(b) (or in connection with those supplies
and other supplies), arrangements are in place the main purpose or one of the
main purposes of which is to avoid a charge to corporation tax.”
So the target is contrived arrangements where the main or one of the main purposes is corporate tax avoidance. The company has a duty to notify in writing that it may be liable to the charge :
“Where a company meets the requirements of subsection (2) or (3), it must
notify an officer of Revenue and Customs of any accounting period of the
company which is a period for which it is reasonable to assume taxable
diverted profits might arise to the company.”
And then has to persuade HMRC that its arrangements are not in breach of the provision.
So why has the UK government introduced the measure and should we be worried about it?
Well I suspect that this is a holding measure introduced for political reasons for the period until various BEPS measures start to come into operation. Given the need to raise tax revenues to reduce the deficit and to be seen to be hard on the public perception of tax avoidance in the run up to the General Election, this provision is hardly surprising. Perhaps it has also been brought on by the continuing protestations of some multinationals that their tax planning is perfectly acceptable under the current international tax standards.
It is worth noting that the Finance ministers of Germany, France and Italy have written to the EC with proposals to harmonise European tax to deal with this issue, which they recommend should be a firm proposal by the end of 2014. To quote:
“In the context of the OECD/G20’s final adoption of the BEPS conclusions by the end of 2015, the appropriate response by the EU is the adoption of a set of common, binding rules on corporate taxation to curb tax competition and fight aggressive tax planning.
We, Finance Ministers of France, Germany and Italy, are convinced that this can only be reached through a comprehensive anti-BEPS Directive, to be adopted by the 28 Member States before end-2015. The diagnosis is made and the solutions are already known, so we should act without any delay.
First, the lack of transparency between tax administrations fosters aggressive tax planning, as their decisions may have an impact on the location of the tax base within the internal market. The Commission’s proposal to make information exchanges on cross-border tax rulings mandatory and automatic, which should also cover decisions relating to transfer pricing, is necessary. Moreover, one should think about stricter conditions and rules for the issuance of such unilateral rulings.
In addition, we have a real opportunity to go further in this area. For instance, the EU law could do more on trusts, shell companies and other non transparent entities, by establishing registers or other mechanisms requiring that beneficial owners are identified and available for tax administrations. The directive should also include disclosure requirements for companies’ intra-European cross-border restructuring and other operations.
Second, transparency is not enough. We can surely not concede that situations where Treaty freedoms are misused in order to avoid tax remain unaddressed. For this reason, the anti-BEPS Directive should set a general principle of effective taxation.
As a consequence, the exemptions provided for by the Interest-Royalties and the Parent-Subsidiary Directives should be denied if they lead to no effective taxation. On the issue of the hybrid arrangements, it is particularly crucial to prevent double non-taxation in any sort of cross border situation.
Consistently, the anti-BEPS Directive should ensure at the EU level that tax benefits are not obtained through inappropriate arrangements. Thus, our work on a common general anti-abuse provision has to be achieved and it must be incorporated into the EU law.”
It seems to me that this demonstrates a frustration with the pace in addressing the perceived problem of multinational tax avoidance, the difference is between the approach proposed (the UK government would be unlikely to support a harmonised EU tax approach given its position on tax subsidiarity).
So the UK is targeting avoidance and interestingly is providing a notification procedure similar to other domestic tax avoidance products. This puts multinationals in a difficult position, they will have to notify where there is any doubt about the structure they use, notify their auditors and disclose to their audit committee. There will be a discussion about whether a tax provision is required in the accounts. They will then have to negotiate the treatment under this provision with HMRC.
HMRC gains a great deal. It will have a list of corporate inbound planning structures into the UK on an almost real time basis, in terms of numbers and tax impact. Politicians will be able to use this information – will they disclose it publically in aggregated form? This will aid it in developing strategies on the BEPS project. HMRC will be able to negotiate how this provision works with taxpayers, which in itself will act as a deterrent for some corporates.
From a corporate perspective, this is a difficult provision. The disclosure provision means that a tax structure is being disclosed as a tax avoidance structure. If this becomes public then how will staff and customers react? Under the OECD Multinational Guidelines might this be the basis of a challenge by an individual that a corporate was not following the “letter and the spirit of the law”?
I’m not surprised that European governments have reacted to their perception of the lack of progress in tackling corporate tax structures. The fact that the UK, Germany, France and Italy are all either implementing or calling for swift action could have been foreseen. The UK proposals are clever in that they throw a challenge back to corporates as to which tax structures they want to use and the justification for them. The spirit of the law in this proposal is pretty clear, it will be interesting to see the reaction.