The measure will apply where the non-UK entity making the sales in the UK does not have a taxable presence in the UK, either through a permanent establishment (PE) or through an avoided PE within the scope of diverted profits tax (DPT). Related parties within the UK, such as UK group companies, will be made jointly and severally liable for paying the tax.
"This new royalty withholding looks to be aimed at the mostly US-owned tech companies which have not been caught by the avoided PE limb of DPT. However, it will potentially apply to any overseas group which is making sales in the UK without a UK PE and is paying royalties offshore," said Eloise Walker, a corporate tax expert at Pinsent Masons, the law firm behind Out-law.com.
DPT was introduced in 2015, as an anti-avoidance measure aimed at multinationals operating in the UK. One of the situations in which it applies is where a non-UK resident trading company carries on activity in the UK in connection with supplies of goods, services, or other property and that activity is designed to ensure that the non-UK company does not create a PE in the UK, and either the main purpose of the arrangements put in place is to avoid UK tax, or a tax mismatch is secured such that the total derived from UK activities is significantly reduced.
“Taxing the digital economy is a major challenge, but it is a global problem that needs multilateral solutions – not yet more attempts at a tax grab by the UK. The OECD is continuing its focus on this area, and is clearly concerned that short-term solutions imposed unilaterally by impatient Governments could lead to double or even multiple taxation, which would be harmful to economic growth,” Walker said.
Although the UK is party to international agreements which enable it to collect UK tax liabilities from non-UK residents, the consultation document acknowledges that this "may be difficult and costly". The government is therefore proposing joint and several liability for the charge within the group. This would enable it to recover the charge from any group company with a UK presence.
As the government says it intends to "respect its international obligations in the application of this measure", the withholding will only apply if the payment is made to a jurisdiction with whom the UK does not have a double tax treaty or with whom the UK does have a double tax treaty, but that treaty does not contain a non-discrimination article.
A non discrimination article provides that nationals of one country will not be subjected in the other country to any taxation which is more burdensome than the taxation requirements to which nationals of that other country in the same circumstances are or may be subjected.
"The UK is trying to tax a payment made by a non-UK resident company to another non-UK resident, it is therefore very likely that another country will also want to tax the payment. Although, the government acknowledges this, the consultation document offers no solutions at all, merely stating that the government 'welcomes views on circumstances where this approach might lead to inequitable double taxation'," said Walker.
Under the current rules, income arising to a non-UK resident is chargeable to UK income tax only if it is "from a source in the United Kingdom". UK source is not defined in the legislation, although changes introduced in Finance Act 2016 provide that the payment of a royalty by a non-UK resident will always have a UK source when the payer is a non-UK resident carrying on a business in the UK through a PE in the UK and the payments are made in connection with the trade of the UK PE.
Income tax should be deducted at source from royalties paid to a non-resident, subject to the terms of any double tax treaty.
The government proposes to introduce legislation providing that payments made between connected persons for the exploitation of IP or certain other rights in the UK have a source in the UK for the purposes of withholding tax.
As well as royalty payments, the new rules will also apply to payments for the use or exploitation of rights over intellectual property and other intangible assets in the UK. The consultation document says this will include the right to distribute specified goods or provide specified services in the UK, but will not include payments for services.