Taxes can be complicated to understand. Here, Price Bailey Partner, Jay Sanghrajka looks at what the Diverted Profits Tax really is and how it might affect you.
Why has it been introduced?
The DPT has been introduced to deter and counteract activities that divert profit from the UK. The legislation is a response to the perception that large companies are generating significant profits from the UK, but paying very little UK tax. The DPT is intended to target those large multinationals that undertake contrived planning to avoid or reduce UK tax on profits generated in or connected to the UK.
What is the rate of DPT?
Where it applies, the DPT taxes diverted profits at a rate of 25%. The current UK Corporation Tax rate is 20% and the DPT is intended as a penal tax to encourage businesses to restructure relevant arrangements such that profits are not diverted from the UK and instead the arrangements are subject to the lower 20% rate of Corporation Tax (which will reduce even further in the next few years).
In what circumstances might the DPT apply?
Broadly, and subject to any applicable exemptions, the DPT applies in either of two different circumstances:
Where a UK company has arrangements in place with a related non-UK entity that reduce UK tax liabilities and those arrangements lack economic substance. For example: a UK company (or branch) transfers IP to a related entity and then pays a UK tax deductible royalty to such related entity. The tax haven entity does not have the technical and management capacity to develop, maintain and exploit such IP and the transfer is only being undertaken for tax purposes.
A foreign company carries on trading activities in the UK but those activities are specifically designed to avoid creating a permanent establishment (a taxable presence) for that foreign company in the UK. For example: a foreign company makes sales to UK customers that are generated by the activities of UK based sales and marketing personnel, where the sales/marketing activity is specifically designed to stop short of concluding contracts in the UK (which would create a taxable permanent establishment in the UK for the foreign company). A good example is Amazon with its head office in Luxembourg and sales personnel in the UK.
Are there any exemptions from liability?
Arrangements may be exempt from the DPT in the following circumstances:
- Small and medium enterprises ( EU definition) are not subject to the DPT
- Certain loan relationships are not subject to the DPT
- Where a mismatch arises solely due to persons being exempt from tax by reason of being a charity, pension scheme or having sovereign immunity, the DPT will not apply.
Avoided PE exemption
- Activities of agents of independent status are excluded
- Certain alternative finance arrangements are excluded
- Foreign companies are not subject to the avoided PE DPT charge where either
- Their total UK-related sales revenue in a 12-month period does not exceed £10m
- Their total UK-related expenses in a 12-month period does not exceed £1m.
Can a double taxation treaty help to avoid liability to the DPT?
HMRC consider that the design of the DPT means that it is not covered by existing double taxation treaties and therefore liability to DPT cannot be avoided pursuant to a double tax treaty. This position could potentially be challenged.
How might the DPT impact on typical property structures?
There was initially some uncertainty regarding the application of the DPT to real estate structures, but it has been made clear in the revised legislation that the DPT does apply to real estate structures.
In fact, the HMRC guidance on the DPT contains two specific real estate examples which appear to indicate that the DPT could potentially apply to a wide range of common real estate structures. The examples given are as follows:
- A UK company is currently renting property from a related UK company, but then transfers that property to a related non-UK company and at the same time increases the rent payable to maximise tax deductions
- A UK company transfers a property under development to a non-UK company, with a subsequent lease of the developed property back to the UK company
Other common real estate arrangements that could potentially be caught by the DPT include:
- Property development, whereby UK property is developed by non-UK residents, again to the extent that such development is supported by associated activity in the UK (e.g. development/sales/marketing activity)
- Asset management structures in respect of UK property that are supported by associated activity in the UK
There remains significant uncertainty regarding the application of the DPT to property structures. Such structures were not the stated target of the DPT at its inception, but it is very clear now that property as an asset class has no exemption from the DPT. Property businesses will need to consider their structures on a case by case basis to determine both whether any DPT notification is required and whether any DPT charge might be payable. If there is any risk of DPT becoming payable, such arrangements may need to be restructured.
This post was written by Jay Sanghrajka. You can find out more about how we can help through our tax services or if you would like to find out more about Diverted Profits Tax then contact Jay at [email protected].