New UK 'diverted profits tax' on multinationals will raise very little tax, says expert

Heather Self of Pinsent Masons, the law firm behind Out-law.com was commenting as draft legislation for the Finance Bill 2015 was published for consultation. This followed the announcement of the new tax by chancellor George Osborne last week, in his autumn statement.

HM Revenue and Customs (HMRC) states that the main objective of the diverted profits tax (DPT) "is to counteract contrived arrangements used by large groups (typically multinational enterprises) that result in the erosion of the UK tax base".

"This seems to be a political soundbite, which will appeal to the man on the London Underground but will have little real effect in terms of UK tax raised," said Heather Self.

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".

HMRC said that arrangements to exploit the permanent establishment rules are often combined with other arrangements that allow the foreign company to transfer profits associated with those sales to companies resident in territories where little or no tax is paid. This includes the “double Irish" structure that Ireland has announced it will end.

Where a non-UK resident company is carrying on activity in the UK in connection with supplies of goods and services to UK customers it will be subject to the new tax if it is reasonable to assume that any of the activity is designed to ensure that the foreign company is not carrying on a trade in the UK through a permanent establishment and a tax avoidance condition or a 'tax mismatch' condition is satisfied.

Small or medium-sized enterprises will not be subject to the tax and there will be an exemption where total sales revenues from all supplies of goods and services to UK customers do not exceed £10 million for a 12 month accounting period.

The tax will also apply to arrangements which "lack economic substance" involving entities with an existing UK taxable presence. This is aimed at the diversion of profits to low tax jurisdictions  by way of payments, such as royalties.

DPT will apply to diverted profits arising on or after 1 April 2015. Affected companies must notify HMRC within three months of the end of an accounting period in which it is reasonable to assume that diverted profits might arise.

Heather Self said that DPT was probably not needed because the UK's existing general anti abuse rule (GAAR) could be used to counteract artificial tax avoidance by multinationals.

"The worst aspect, in my view, is that by seeking to act unilaterally the UK risks destroying the fragile balance of international consensus which the OECD has held together for so long, and is continuing to try to do within BEPS. We have already seen Australia comment that it might go for a DPT itself – so we are already encouraging others to act. How long before India comes up with its own definition of a permanent establishment and applies it notwithstanding its Treaty obligations?" Self said.

BEPS refers to the shifting of profits of multinational groups to low tax jurisdictions and the exploitation of mismatches between different tax systems so that little or no tax is paid. Following international recognition that the international tax system needs to be reformed to prevent BEPS, the G20 asked the Organisation for Economic Co-operation and Development  (OECD) to recommend possible solutions. It is intended that the BEPS project will conclude its work by the end of 2015.

Last month OECD published a discussion draft considering the need to update the double tax treaty definition of permanent establishment (PE) in order to prevent artificial profit shifting.

Self said that the country which appears to be taking a more measured approach is China, which has announced that it will "comprehensively monitor the profit levels of foreign companies to make sure there is no base erosion and profit shifting"

In June 2013, the Public Accounts Committee said that HMRC needed to be "more effective in challenging the artificial corporate structures created by multinationals with no other purpose than to avoid tax".

It is intended that the legislation will be included in the pre-election Finance Bill in 2015, and will come into force from 1 April 2015.

The draft legislation runs to about 30 pages and a 50 page guidance note has also been published. Heather Self said "Although this new tax sounded like George Osborne pulling a rabbit out of a hat in the autumn statement, it has clearly been thought about for a while. What is less clear is why it has to be rushed in by 1 April 2015 – unless it is because there is a general election coming up in May".