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Finance Bill: Updated profit fragmentation rules impacting UK Businesses

Finance Bill: Updated profit fragmentation rules

The rules on profit fragmentation have been updated to remove the additional notification requirements and introduce a new reasonableness test.

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On 7 November 2018, Finance Bill 2018-19 was published and we have highlighted some of the key measures in the last two editions of Tax Matters Digest. This week we look at targeted provisions in the bill to tackle tax avoidance arrangements implemented by UK residents involving the fragmentation of business profits with an overseas person. The new rules work by applying a number of tests which consider whether non-arm’s length arrangements have resulted in profits arising outside of the UK at a nil or very low tax rate, and may thereafter accrue to persons that have economic links to a UK individual. The rules largely follow the draft legislation that was published on 6 July 2018 alongside a consultation response document on the subject. However, the Finance Bill removes the onerous additional reporting requirements for businesses. The new rules apply for value transfers from 1 April 2019 for corporation tax, and 6 April 2019 for income tax.

When do the rules apply?

The rules apply where the following cumulative conditions are met:

  • There is a provision between a UK resident entity (for example, an individual or corporate body) and an overseas entity as a result of the relevant arrangements;
  • As a result of the provision, value is transferred from the UK resident entity to the overseas entity which derives directly or indirectly from the profits of a business chargeable to income tax or corporation tax;
  • The value transferred is greater than an arm’s length price from a provision made between independent persons;
  • The enjoyment conditions are met in relation to a related individual; and
  • There is a tax mismatch.

The purpose of the rules is to effectively extend the scope of the UK transfer pricing rules to all UK businesses. For instance, the new legislation will apply to businesses which previously did not apply transfer pricing because they operated within scope of the SME exemption, or to certain situations where the participation condition is not met but where there is an individual which provides a link between the UK entity and the overseas entity.

Other considerations

An overseas entity includes an individual, company, partnership, trust or other entity or arrangement established outside the UK, and the related individual can be the UK resident entity, a member of a partnership of which the UK resident entity is a partner or a participator in a company which is the UK resident entity.

The enjoyment conditions are extremely broad and are based on the enjoyment conditions in the Transfer of Assets Abroad legislation. However the enjoyment conditions found in the profit fragmentation rules are potentially wider in scope.

There is a tax mismatch if there is:

  • An increase in tax deductible expenses or a reduction in taxable income by the UK resident entity;
  • The reduction in tax payable by the UK resident entity exceeds the increase in taxes paid by the overseas entity; and
  • the increase in taxes paid by the overseas entity is less than 80 percent of the reduction in tax payable by the UK resident entity.

Noteworthy changes from the draft legislation published on 6 July 2018 include:

  • A ‘reasonableness test’ has been introduced. The rules do not apply if it is not reasonable to conclude that the main, or one of the main, purposes of the arrangements was to obtain a tax advantage; and
  • There is no longer an obligation to notify HMRC of ‘potentially profit fragmentation arrangements’.

Double tax relief is available to prevent double payment of tax by reference to the same income or profits.

What is the result of meeting the conditions?

If the conditions apply then adjustments are to be made to the tax computations of the UK business which:

  • Relate to the relevant expense, income, profits or losses of the UK resident entity;
  • Are based on an arm’s length provision; and
  • Must be just and reasonable.

Commencement

The new rules apply for value transfers from 1 April 2019 for corporation tax, and 6 April 2019 for income tax. This would include profits accruing after those dates on existing structures.

With the rules commencing directly following Q1 2019, UK businesses should self-assess their structures in order to determine whether these new rules apply. If you have structures in place that require review in light of the rules described above, please speak to your usual contact.

 

For further information, please contact Paul Harden

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