With effect from 1 April 2015, the UK Government introduced a new tax: the Diverted Profits Tax (“DPT”). The DPT is aimed at countering the use of aggressive tax planning techniques used by multinational enterprises to divert profits from the UK and has been set at a deliberately punitive rate of 25% (compared to the prevailing 20% rate of UK corporation tax).
There are two types of charge. The first is on non-UK companies (“foreign companies”) which are considered to have diverted profits from the UK by avoiding a UK taxable presence. The second is on UK companies (or existing permanent establishments (“PEs”) of non-UK companies) which are considered to have diverted profits from the UK by involving entities or transactions lacking economic substance.
Companies are required to notify HM Revenue & Customs (“HMRC”) that they may have a potential liability to DPT. HMRC will then issue a charging notice and the taxpayer must pay the tax charged before it can appeal. If no notification is made and DPT is chargeable, the company is subject to penalties. A brief introduction to DPT is provided below, whilst full HMRC guidance can be found on the GOV.UK website.
Avoidance of a UK taxable presence
DPT applies where foreign companies make substantial sales through activity in the UK whilst avoiding the creation of a UK PE.
The legislation tests whether there is a person, “the avoided PE”, carrying on activity in the UK in connection with supplies made by the foreign company. It applies where “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 does not, as a result of the avoided PE’s activity, carry on that trade in the UK for the purposes of corporation tax . . .”
Where the conditions are met, the legislation will apply to attribute profits to the UK on branch attribution principles. The broad effect is that the foreign company will pay DPT on the part of its profits which are attributable to UK activity and not already subject to UK corporation tax (e.g. as a result of payments to associated UK service companies).
There are several exemptions available, for example where the foreign company’s total UK-related sales revenues are no greater than £10m per annum.
Lack of economic substance
The legislation essentially considers provisions made between a UK company and a foreign group company. Where both the “effective tax mismatch outcome” and “insufficient economic substance” conditions are met, the DPT applies.
The broad effect is that where UK companies make tax deductible payments to foreign group companies based in low-tax jurisdictions and the foreign company does not have sufficient economic substance to warrant the receipt of such an amount (by reference, for example, to the staff employed, the economic risks borne or the non-tax related savings generated by such an arrangement), DPT applies to the amount “overpaid”.
Several exemptions apply with one of the main ones being that applicable to small and medium-sized enterprises (“SMEs”). An SME is a company which employs fewer than 250 employees and has an annual balance sheet total of €43m or less and/or annual turnover of €50m or less.
These thresholds are calculated on a worldwide group basis.
A company which considers that it is potentially within the scope of DPT must notify HMRC within 3 months after the end of the accounting period (extended to 6 months for the first period, i.e. that ending between 1 April 2015 and 31 March 2016).
If it is reasonable for the company to conclude that no charge to DPT will arise, then no notification to HMRC is required (albeit it should be noted that there is a penalty for failure to notify).
The DPT legislation is complex and has the potential to apply to a wide variety of arrangements. Added to this, the legislation has been brought in rapidly and puts the onus on the taxpayer to notify HMRC if it is considered likely to apply. As such, all large companies with links to the UK should consider whether the rules may apply.