The UK’s new Diverted Profits Tax
Appeared in the Guernsey Press Accountancy Review - March 2016
The transfer pricing senior manager, and David Waldron, tax director at PwC Channel Islands, ask: how likely is it that the UK’s new diverted profits tax will affect your Channel Islands business?
The short answer is – very likely. Although the media quickly dubbed the new tax the UK’s “Google Tax”, it is now clear that the rules (as currently drafted) will catch a much wider set of businesses, including those in the financial services industry and most others that have operations in a lower tax jurisdiction.
If you have any UK operations, if your business sells goods or services into the UK (even if you have no operations in the UK) and/or if any of your employees ever work remotely from the UK, it is highly likely that your business could be liable for this additional tax.
With a punitive 25% tax rate and an effective date of 1 April 2015, there is little time for companies to prepare for the implementation of this new, and potentially costly, regime. Below is further detail on the new legislation and the implications for Channel Islands- based businesses, along with other practical aspects to consider.
What is the background for this tax?
As outlined in the Finance Bill 2015, the stated aim of the diverted profits tax (DPT) is to “counter the use of aggressive tax planning techniques used by multinational enterprises to divert profits from the UK to low tax jurisdictions”, ultimately trying to ensure that no business with UK operations can achieve an “unfair” tax advantage. Despite HMRC’s original assertions that this is targeted at a few, particularly offensive tax payers, it is becoming clear that the DPT net is much wider than expected and will catch most companies with operations in tax neutral locations, such as Guernsey and Jersey.
The DPT is charged at 25% on profits that are considered to be artificially diverted from the UK. The legislation will be effective in relation to profits arising after 1 April 2015 and taxpayers will have a duty to notify HMRC if they are potentially within the scope of the tax within 3 months of the end of the accounting period to which it relates.
This means that companies with a 30 June year end will have to decide whether to notify HMRC before the end of September 2015. Furthermore, to the extent a business has any quarterly reporting requirements, it may be necessary to consider the impact of the DPT for the period ending 31 March.
Despite this extremely short implementation period and punitive tax rate, the legislation is very complex and so far limited guidance has been provided by HMRC. This has led to a significant level of uncertainty.
So will it affect your business?
The draft legislation outlines a number of tests and thresholds to assess whether DPT will apply to any transaction or business activity. Although the rules are extremely complicated, they could generally apply to:
- a non-UK company that sells goods or services to UK customers, even if only digital products delivered via the internet;
- a non-UK company that has a UK-based entity providing services (e.g. sales, marketing or head office);
- a non-UK company with employees that perform activities in the UK; or
- a UK-based company with operations offshore.
For example, a business with Guernsey-domiciled funds could be caught by the regime where it has functions performed in the UK, such as investor relation, marketing or deal teams. Similarly, Channel Islands service providers, including administrators and other service companies, that have employees travel to the UK to discuss potential contracts could be liable to DPT, even if the contracts are concluded offshore.
As this tax is not considered to be a corporation or income tax, tax relief under existing UK clearances or the double tax treaty with the UK would not be available, and HMRC has stated that there will be no formal clearance process for the DPT.
Overall, any Channel Islands business with operations in the UK could incur the DPT on the profits that HMRC can reasonably assume were diverted from the UK as part of the transaction between the offshore and UK entities. And with limited guidance on what might be “reasonable to assume” by HMRC and a lack of clarity around the various tests included in the legislation, it is not an easy task to determine whether transactions will be taxed.
What can you do to mitigate your risks?
HMRC has promised to revise certain aspects of the legislation, but the DPT has cross-party support and, given the focus on tax avoidance in the current election environment, all indications suggest that the DPT will take effect on 1 April 2015 as scheduled. This gives little time for any significant re-writes, so the final rules are expected to be similar to the current draft.
Although uncertainty remains, Channel Islands businesses can begin a thorough analysis of their transactions and activities involving the UK to assess the level of risk. Where there is a risk of needing to notify HMRC and/or the potential to pay DPT, there is still time, though limited, to review structures and transactions to lower this risk. In any scenario, early engagement with HMRC will also help you achieve some level of certainty in a post-DPT world.
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