The surprises in the new proposed UK diverted profits tax (DPT) for overseas companies - A personal view
Well, as I predicted in my first blog, something has happened: but it is not what anyone expected! The idea of a new improved anti-avoidance rule hinted at by the UK Chancellor of the Exchequer, has morphed into a new proposed tax at 25% on profits diverted away from the UK.
DPT is aimed at so called multinational companies which have diverted their profits away from the UK with a view to encouraging them to change or even dismantle their tax structures, on the basis that the UK's corporation tax rates are more beneficial. It is a national tax. The anticipation of the introduction of a so called "google tax", was only part of it. Companies within the tax charge will be in every industry.The size of the threshold for the potential charge is much lower than the size of global multinationals. Companies will also need to be within various tests which will be applied to their activities, to be within the charge to tax.
I attended the recent Open Day on DPT. The presentations and slides at the Open Day made it clear that the DPT is to encourage from a UK point of view, good behaviour and to counter arrangements which in the words of HM Treasury (and I wrote them down) are abusive and contrived schemes designed to erode the UK tax base. Despite several requests on the day, we were told that this wording would not appear in the statute.
Will DPT really be enshrined in statute before the deadline of the closure of parliament?
Yes if all goes as planned. We were told, March 18 is when the statute is expected to be finally passed under a guillotine procedure without debate in Parliament. That will be 12 days before the required dissolution of Parliament on 30 March before the UK General Election. It was made clear that now is the time for representations on the Act. My firm will join in the requested written consultation on DPT which closes on the 4 of February. The overall consultation process may well create a number of changes. Also I have read some comments that the Finance Bill including DPT will be debated.
What is expected to be covered by the proposed DPT?
It is proposed that the new tax will cover profits which would have been made in the UK but for (in my words);
- Under Section 2 , the avoidance of a UK permanent establishment by an overseas company because it hasn’t established a full UK trading subsidiary in the UK for sales to UK customers. The avoidance typically occurs where the overseas company, or its trading subsidiary outside the UK, signs up directly with UK customers. In the wording of the UK non-full trading entity, it is defined as the "avoided PE", and
- Under Section 3, as extended to overseas companies in Section 4, by the creation of excessive intra-group expenditure by a UK trading company by making payments from the UK entity either directly or indirectly to entities in low tax jurisdictions.
Thus in both cases, reducing the UK tax net.
If all companies involved are SMEs i.e. with a balance sheet of under 43 million Euros, with less than 250 employees, and a turnover/sales of less than 50 million Euros, then all are protected in that accounting period under this exemption, and therefore exempt until one of the companies grows outside these statistics.
Most so called emerging overseas companies will grow to hit the 43 million Euros balance sheet test very quickly, particularly on a B or C round of VC funding. Also outside the TMT sector, any successful overseas company would like to hit near to 50million Euros in sales in its home country before going overseas. Therefore DPT has a much lower threshold than expected, but companies may not then fall within various additional tests and rules about their structure.
A second exemption is under Section 2 only, where sales in the UK to UK customers are under £10 million in the relevant accounting period. There is no exemption for sales in Section 3, so if the overseas company has set up a double (now single) Irish and/or a Dutch triple sandwich structure with European IP rights in the BVI , Cayman or wherever, they will be caught under Section 3 as extended anyway, unless all are SMEs (as there is no £10million sterling exemption).
We have current queries from overseas companies asking whether they should set up a European holding companies in Cayman, BVI, Cyprus, Ireland, the Netherlands or elsewhere. Most appear larger than the SME test. Will their UK sales to UK customers be potentially within the charge and subjected to the various tests? I think so yes, as there will be no substance or not enough substance in these set ups. Of course, being exempt doesn’t mean that a charging notice won't be issued anyway unless the company has been in discussions with the HMRC. As mentioned, the legislation will contain various additional tests before the charge can be made. Those tests and the charging procedure will be looked at again and may change after the consultation.
Charging notices and the like
There is a duty on the company to notify the HMRC if "it is reasonable to assume" that it is within DPT for an accounting period. That notification must be made within 3 months from the end of the accounting period. The HMRC may issue a "preliminary notice" within 2 years after the end of the accounting period. But extends that period to 4 years if there has not been a notification and it is reasonable for the the HMRC inspector to believe that there may be a DPT charge. The preliminary notice sets out, inter alia, an explanation of the determination of the DPT by the HMRC.
The company then has (only) 30 days to send written representations in respect of the preliminary notice and the officer "may" consider representations that are made on certain specified grounds. Having considered the representations (which must include his having determined that he cannot (or perhaps will not) consider the representations), the officer must, within 30 days, either issue a "charging notice" or confirm that no charging notice will be issued.
DPT charged by charging notice must be paid within 30 days; payment may not be postponed "on any grounds". After the DPT has been paid, an HMRC officer must carry out at least one review within 12 months. He can issue notices that reduce or increase the DPT stated in the charging notice. He can issue as many notices that reduce DPT as he likes, but he may issue only 1 notice that increases the DPT amount during this period.
Only after the review period has ended may the company seek to appeal to the Tribunal (NB, it is out of pocket for the DPT tax during the 12 months of the HMRC's review.
There can be no postponement of the DPT whilst the appeal is pending.
We were also told that companies should expect to disclose all of their group structures and supply chain. We were told that all prior HMRC approved pricing arrangements (APAs) up to 1 April 2015 will not be safe as they will not have included full group structure information within the ambit of the re-characterisation rules. (Re-characterisation is an adoption of the BEPS recommendations.)
Will DPT change worldwide taxation with other countries following the UK lead?
Some other countries are expected to follow suit. France already has an abuse law. The Australian and the UK governments discussed DPT because Australia was considering the introduction of a similar tax. Germany is in a dialogue with the UK on a number of issues. Other countries are certain to follow the UK lead. Will another member state or company be brave enough to persuade the EU commission to bring in fraction proceedings under EU law? The Treasury made it clear that it does not consider DPT and BEPS to be contradictory.There is also a question of how DPT will operate in connection with the double tax treaty network. The Treasury states it is a UK tax and treaties aren’t relevant.
What I propose overseas companies should do if they think they may be affected?
On the current draft version of DPT my suggestions are as follows, even though the final detail of the DPT legislation is not yet known;
- For smaller overseas companies with no other overseas subsidiaries the same traditional cost plus structures for tax planning will continue until any company looks as though they are about to become an SME and to exceed £10M in sales (as explained above) triggering Section 2. The companies should therefore regularly review the total value of their UK sales.
- For larger companies and multinationals with little or no substance in their tax structures, some modelling will be necessary. Will it be better to pay the DPT and keep everything the same, or change to a UK buy/ sell with third party style payments of royalties and bought in products? (In this regard let's remember that UK corporation tax rates were at 26% in 2012 and have come down to 20% since then.)
- All overseas companies which are concerned, should discuss their tax position with their HMRC officer now (although there is no advance clearance process). We were told that his will need to include full disclosure of all group structures and supply chains (which looks like being inevitable under BEPS anyway).
- New overseas companies should not set up complex tax structures at present unless they can easily reverse out of them .
I predicted in my first blog that the BEPS changes would echo for generations. The UK looks like it is already adopting some key BEPS recommendations early. In the future, we will be advising on third party style trading arrangements, and we will be drafting agreements concentrating on co-location of IP rights, exploitation, risk allocation and nexus.
Will we have some quick fixes for existing structures in 2015? Yes we will have some, once we see how the final version of the statute has changed. Of course each companies issues may prove different.
The introduction of BEPS action plans has seemed gradual, allowing companies to prepare. DPT will be immediate for existing overseas companies in the UK. Due to the speed at which the DPT is to be introduced, it is going to be a busy time especially as the proposed legislation evolves further.
The author is an International Corporate and Foreign Direct Investment partner at Fieldfisher an international law firm. He has helped around 2000 US companies set up HQs in Switzerland, Ireland, the Netherlands, Luxembourg, and of course the UK.