Diverted profits tax: Businesses still have concerns over final legislation says expert

Diverted profits tax (DPT) is a new UK tax "aimed at large multinationals who artificially shift their profits offshore". The new 25% tax will apply where a foreign company "exploits the permanent establishment rules" or where a UK company or a foreign company with a UK-taxable presence creates a tax advantage by using transactions or entities that "lack economic substance". It will apply to any profits arising from 1 April 2015.

Although the DPT legislation in the Finance Act is "much improved" from the draft that was published in December 2014, Heather Self said that businesses continue to be concerned about the "wide ambit" of the legislation and the fact that it could still catch unintended targets. She said that there are concerns that captive insurance companies, intra group treasury operations, shared service centres, real estate structures and Europe wide sales and marketing structures could all potentially be caught.

Heather Self said that one situation that was not within the intended target of the rules but on the face of the legislation looked to be caught, was where a group company paying tax at the normal rate of corporation tax provided group functions to an oil and gas company within the 'ring fence regime' paying at 50%. The oil and gas ring fence regime operates at a basic rate of 30%, with a supplementary charge of a further 20%. Companies within the ring fence regime will pay DPT at 55%, rather than 25%.

"In some cases groups will ultimately be able to get themselves comfortable that because there is sufficient economic substance where services are being performed, DPT will not apply. However, for many groups the wide ambit of the legislation will lead to uncertainty and increased compliance burdens." she said.

Some changes to the legislation have been welcomed. In particular the legislation has been changed so that companies will not need to notify if it is “reasonable to assume” that there will be no charge to DPT. Under the original draft legislation affected companies were obliged to notify HMRC within three months of the end of an accounting period in which it was "reasonable to assume" that diverted profits "might arise". There had been concerns that this could lead to unnecessary notifications.

Another change to the legislation makes it clear that a charge to DPT does not generally arise if a full transfer pricing adjustment has been made. Heather Self said "It is now clear that, in many circumstances, a company can ensure that it is not liable to DPT by ensuring that it has an agreed transfer pricing policy".

She explained that one important point to note about DPT is that it "goes beyond transfer pricing in that it looks not just at whether a royalty paid to a company in a tax haven is reasonable given the value of the intellectual property (IP) rights, but whether it is reasonable given the economic substance (or lack thereof) of the group's activities in the tax haven."

The 25% rate of DPT is higher than the rate of corporation tax which will be 20% from 1 April. Heather Self said that any company which is seriously concerned it may be subject to DPT would be likely to change its transfer pricing, and suffer corporation tax at 20% rather than DPT at 25%. She said that DPT itself may not raise much revenue, but there may be a rise in corporation tax receipts. DPT is therefore being used to 'persuade' companies to change their behaviour.

The 349 page long 2015 Finance Bill was published on 24 March and debated in Parliament for a single day on 25 March. It received Royal Assent a day later.

In the House of Commons debate on the Finance Bill, Labour MP Shabana Mahmood, the Shadow Exchequer Secretary acknowledged that the rushed consideration of the Finance Bill was "not a satisfactory way in which to make very complex taxation legislation". She said that Labour supported "the thrust of what the Government intend to do" and said "In our first Finance Bill when we are in government, we will seek to remedy any defects that prevent that measure from being both effective and strong".

HMRC has announced that it is working with five other tax authorities to share information about how digital multinationals might be shifting their profits to tax havens. It said that information from the ‘E6 project' will feed into how HMRC applies DPT. It is not clear which other jurisdictions are involved.

It is expected that HMRC will publish guidance on the operation on DPT over the weekend.