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Saturday, 20th April 2024 |
| UK’s ‘Google tax’ may be real cause for concern for Irish companies |
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| The 25% Diverted Profit Tax may be intended in part to ‘divert’ attention ahead of next year’s UK elections but may also have serious implications for freedom of doing business within the EU as a whole, writes Sandra Dawson. |
In what is widely seen as a pre-election move, George Osborne announced in his Autumn statement the introduction of a new tax of 25% on “diverted profits”. The new tax is designed to counteract purported “contrived” arrangements used by large groups (typically multinational enterprises) that might be considered to erode the UK tax base. The rules as drafted, however, may restrict the freedom to provide services within the EU. As a result, the European Commission has indicated that it will examine the rules to ensure that they are compliant with EU single market rules. Dubbed the “Google tax”, the new tax, which is set to come into effect on 1st April 2015, has potentially broad implications for all industry sectors, including financial services.  | | Sandra Dawson |
Diverted profits arise in circumstances in which it is “reasonable to assume” that large multinational enterprises with business activities in the UK have entered into “contrived” arrangements to divert profits from the UK by avoiding the creation of a UK taxable permanent establishment (PE) and/or by other “contrived” arrangements between connected entities. The proposed diverted profits tax (DPT) seeks to impose a 25 per cent tax charge on such “diverted profits” relating to UK activity.
What is an avoided PE?
An avoided PE arises when a foreign company supplies goods, services or other property (eg. land & buildings) with the involvement of another person carrying on activity in the UK and that activity does not amount to a PE (“the avoided PE”) of the foreign company in the UK. It has to be reasonable to assume that any of the activity of the avoided PE and/or the non-UK resident company is designed to ensure that the foreign company avoids carrying on a trade through a PE in the UK. It must also be reasonable to assume that:
• in connection with the supplies of goods, services or property, arrangements are in place, the main purpose or one of the main purposes of which is to avoid a charge to corporation tax; or
• there is an arrangement between the foreign company and another related person which reduces the tax liability of the foreign company by more than 80% of the increase in the tax liability of the other person (the “tax mismatch condition”) or there is insufficient economic substance (see below).
An example of an avoided PE in practice might be an Irish life company selling offshore bond products to UK policyholders on a freedom of services basis. On the face of it, this would appear to be an avoided PE and, assuming that the tax mismatch condition is not met, the Irish company would need to argue that the purpose of the arrangement is not the avoidance of UK corporation tax in order for a charge of 25% of the taxable diverted profits (computed in accordance with OECD profit attribution principles) not to arise. Such considerations as the requirement for the Irish company not to have a PE in the UK in order for the offshore bond product to be effective would be important in demonstrating that the purpose of the arrangement is not the avoidance of UK corporation tax.
Other ‘contrived’ arrangements
‘Contrived’ arrangements exist where there are arrangements between a UK tax resident company and another related entity which meet the “tax mismatch” condition detailed above and also meet the “insufficient economic substance” condition. The insufficient economic substance condition is met if:
• the financial benefit of the tax reduction in the UK is greater than any other financial benefit referable to the transaction; or
• the economic value (in terms of functions and activities of the entity’s staff) contributed by the person that is a party to the transaction is less than the financial benefit of the tax reduction.
For example, a UK financial services entity might make payments for services to its Irish shared services centre. As the tax rate in Ireland is less than 80% of the UK rate, the tax benefit in the UK is greater than 80% of the increase in the tax liability in Ireland.
On the face of it, therefore, taxable diverted profits could arise unless the financial benefit of providing the services from Ireland outweighs the corporate tax saving or the transactions are priced on an arm’s length basis. In this instance taxable diverted profits are calculated as the difference between the arm’s length charge for the services provided and the amount reflected on the UK resident company’s tax return or by substituting an arrangement which it is just and reasonable to assume would have been made in the absence of the tax mismatch and does not itself result in a tax mismatch.
Similarly, reinsurance of risk from the UK to Ireland which is then ceded from Ireland to Bermuda would likely fail the tax mismatch condition and the obligation would be to show that, for example, the capital benefit derived from the reinsurance outweighs the tax saving or that the transaction is priced on an arm’s length basis.
Notification requirements
There is an obligation for the taxpayer to notify HMRC within 3 months (6 months in the case of the first accounting period after the legislation is enacted) of the end of the accounting period in which it is reasonable to assume that a liability to DPT might arise. Once a company has notified for one period, it does not have to notify for subsequent periods, provided there has been no change in circumstances material to whether a DPT charge arises. Notification is not required where:
• HMRC has confirmed that there is no duty to notify;
• it is reasonable to conclude that no DPT liability will arise (unless this conclusion is based on future transfer pricing adjustments); or
• it is reasonable to conclude that sufficient information has been supplied to enable HMRC decide whether a preliminary notice should issue and HMRC has examined that information.
Following notification, HMRC may issue a preliminary notice followed by a DPT charge which must be paid within 30 days. This is followed by a 12 month period in which the charge may be challenged.
It is important to note that the intention is that DPT is not a tax covered by double taxation agreements and therefore normal treaty protections will not be available, potentially leading to increased double taxation.
BEPS
The DPT proposals represent unilateral action by the UK to the BEPS actions 7 and 8-10 on risk and PE. Pascal Saint Amans commented that “It’s a bit bizarre that in the middle of the project, you have a country acting unilaterally because that’s what we’re trying to avoid, but on the other hand, it shows that there is a really big political issue which is not about politicians speaking but politicians taking action.” Australia has already indicated that it will follow suit and it will be interesting to see if other countries do as well with what may be viewed as a more attractive option than the BEPS initiative for more wholesale change to the PE and transfer pricing rules.
Although the intention of these new rules might be to narrowly target cases of “contrived” avoidance of UK tax, the drafting of the provisions is very broad in places and is likely to give rise to considerable uncertainty in its application in the short term. In particular, for many of the tests it only has to be “reasonable to assume” that the test is met as opposed to it actually having been met. This is highly subjective and there is no guidance yet on how HMRC will interpret this in practice. In addition, it is not clear how the non-tax financial benefits of a transaction or the economic value contributed by staff should be measured or assessed.
Given the size of Ireland’s financial services industry and its strong links with the UK, considerable analysis may be required to ensure that the DPT charge might not ultimately bite. This will likely involve greater transparency in relation to transfer pricing policies, the international value chain and substance outside the UK and other countries if they follow suit with similar rules. Every interaction which involves the UK will need to be considered, in this context, to determine whether DTP is an issue. Even if such considerations do not ultimately result in a DPT charge, they may identify in the process other issues in the structure which need to be addressed. |
Sandra Dawson is an associate partner at EY.
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