The UK Government announced in its 2014 Autumn Statement that it was introducing a new tax, the Diverted Profits Tax (DPT).
DPT is aimed at multinational enterprises (MNEs) that use contrived arrangements to bypass UK rules on Permanent Establishment (PE) and Transfer Pricing (TP) and so divert profits from the UK.
DPT is designed to deter such activities and change corporate behaviour.
It applies to diverted profits arising to both UK and non-UK resident companies on or after 1 April 2015. There are apportionment rules for accounting periods which straddle that date.
In most cases the arrangements put in place by MNEs to divert profits will involve non-UK companies but DPT may also apply where wholly UK structures are used.
Where it applies, the normal rate of DPT is 25% of the diverted profit plus any “true-up interest”. Where the taxable diverted profits are ring fence profits in the oil & gas sector, DPT is charged at a rate of 55% plus true-up interest.
True-up interest is treated as a component of DPT. It is calculated for a notional period starting six months from the end of the accounting period up to the date of the charging notice.
As the current UK Corporation Tax (CT) rate is 20%, DPT is clearly intended as a penal tax. It will encourage businesses to restructure arrangements such that profits are not diverted from the UK and are therefore subject to 20% CT rather than 25% DPT.
DPT is therefore intended to deter and counteract the diversion of profits from the UK by MNEs that:
- seek to avoid creating a UK PE, i.e. a taxable presence in the UK, and either the main purpose of the arrangements is to avoid UK tax, or a tax mismatch is secured such that the total tax derived from UK activities is significantly reduced. This might happen where a foreign company makes sales to UK customers using UK based sales and marketing personnel but where their UK activity is specifically designed to stop short of concluding contacts in the UK; or
- use arrangements or entities which lack economic substance to exploit tax mismatches either through the creation of intra-group expenditure or the diversion of income intra-group where it is reasonable to assume that, in the absence of a tax benefit, the expenditure would not have been incurred or the income would have been within the charge to UK CT. This might occur when a UK company (or branch) transfers IP to a related entity in a low tax country and then pays a UK tax deductible royalty to that entity. The related 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.
Profits which have been diverted from the UK are computed using the same principles which apply for CT, including TP rules, except where the legislation requires arrangements to be re-characterised.
Where it is necessary to re-characterise arrangements, the amount of diverted profit is to be calculated on a just and reasonable basis.
DPT is not self-assessed but companies are required to notify HMRC within 3 months of the end of an accounting period in which they are potentially within the scope of the tax. There is a tax-geared penalty for failure to do so. (For accounting periods ending on or before 31 March 2016, the notification period is extended to 6 months.)
DPT is brought into charge by an HMRC officer issuing a charging notice. The first charging notices could be issued by 30th September 2015.
There are a number of safeguards which allow groups to demonstrate that they are not subject to DPT before a charging notice is issued.
However, once a tax charge is raised it must be paid within 30 days. Payment may not be postponed on any grounds while the final liability is being agreed with HMRC.
The DPT charge will be based on an HMRC estimate. The taxpayer then has 12 months to agree the final liability with HMRC.
If a non-UK resident does not pay the DPT due it may be collected from a related party.
The design of the DPT is intended to ensure that it is not covered by existing double taxation treaties. Therefore liability to DPT cannot be avoided under a double tax treaty.
However, the legislation does contain some specific exemptions. These include small and medium-sized companies, companies with limited UK sales or expenses and where the arrangements give rise only to loan relationships.
As the first charging notices could be issued by 30th September 2015 a group which is potentially within the charge to DPT should be looking to establish its exposure as soon as possible.
If DPT applies to a transaction or arrangement the logical step, in most cases, would be to restructure the arrangement such that the diverted profits become subject to UK CT at the lower 20% rate.
However, the application of DPT is closely linked to the application of TP, which is a key topic of the on-going work on Base Erosion and Profit Shifting (BEPS).
Therefore, any groups taking action to restructure as a result of DPT should also consider the potential implications of BEPS.
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