Its implementation looks set to be fraught with practical difficulties and the unilateral nature of the measure means that double taxation is likely.
The new royalty withholding tax, announced by the chancellor in the Budget on 22 November, is the latest move by the UK to try to tax the UK-derived profits of the US technology multinationals. However, it is wider than just US tech companies and will potentially apply to any overseas group which is making sales in the UK without a UK permanent establishment (PE) and is paying royalties to a low tax jurisdiction offshore.
The plan is that the new royalty withholding will apply from April 2019 where a non-UK resident entity making sales in the UK pays a royalty to a connected party in a low tax jurisdiction. Such payments will be deemed to have a UK source, so that they will be subject to UK tax under the existing rules and will be within the scope of the withholding rules.
The withholding tax will only 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). It will apply to more than just 'royalties' in the strict legal sense and will catch payments for the right to distribute certain goods or perform specified services in the UK. It will also apply where the non-UK company selling to UK customers pays a royalty indirectly to a low tax jurisdiction, by passing it through another company.
A difficulty with the new withholding tax is that the UK has an extensive network of double tax treaties, which generally give the taxing rights to the country where the intellectual property is held, sometimes subject to a small withholding, and only allow a state to tax profits arising in that state which are attributable to a PE there.
As the government apparently intends to "respect its international obligations", the withholding will only apply if the payment is made to a jurisdiction with which the UK does not have a double tax treaty or where there is a treaty, but it does not contain a non-discrimination article.
Say a US owned group has a subsidiary in Ireland making sales in the UK and then paying a large royalty to an entity in Bermuda. Under these proposals, the UK would be trying to withhold from the royalty paid from Ireland to Bermuda. It would therefore be the tax treaty position as between the UK and Bermuda which would need to be considered. There is no UK/Bermuda tax treaty and so the new withholding could potentially apply.
However, the UK and Bermuda are not the only countries which might think they had a claim to taxing these profits – what about Ireland? It might consider that the UK was trying to tax Irish profits where there was no UK PE, breaching the UK/Irish treaty. What if Ireland wanted to apply a withholding to the royalty? Could you end up with two lots of withholding on the same income?
Disappointingly, the consultation document offers no solutions to these problems, merely stating that the government "welcomes views on circumstances where this approach might lead to inequitable double taxation".
Another complication is that the royalty paid by the non-UK company trading in the UK may relate to a wider geographic area. This would mean that some sort of apportionment of the royalty would have to be carried out to determine how much of it related to UK sales.
The fact that the withholding only applies where there is no UK PE means that, as the consultation document acknowledges, collection of the tax "may be difficult and costly" as it would be a non-UK resident company which would be required to deduct income tax and pay it to HMRC. However, in a clever move on the Treasury's part, related parties within the UK, such as UK group companies, will be made jointly and severally liable. This effectively means the tax can be collected more easily from multinational groups which perhaps have a UK subsidiary performing 'backroom' functions, even though sales to UK customers are made through a company located in, for example, Ireland.
Not only will a related company in the UK potentially have to report the royalties paid by its offshore affiliate which are within the new withholding; under current proposals it will also have to report the royalties which are not subject to withholding because of a double tax treaty. This is apparently so that HMRC can 'risk assess' the application of the rules. So a UK associated company is going to be in a difficult position, having to report upon and potentially apply a 'withholding' to a payment it has not made, in a situation where it will probably not have the necessary information as to the level of royalty paid or as to how much of it relates to UK sales.
And finally, there is going to be an anti abuse rule which will apply to payments made after April 2019, even if they are made under arrangements entered into before that date. This is intended to act partly as an anti-forestalling measure. It will apply to arrangements that have as their main purpose, or one of their main purposes, the avoidance of a liability under this measure.
The Treasury predictions of yield from the new measure are relatively low at £285m for 2019-20 and then reducing over the next three years to £130m for 2022-23. Like DPT it is one of those measures where the Treasury expects the yield from the measure to reduce over the years as companies restructure and pay more corporation tax.
This measure ticks the boxes in relation to appeasing public opinion, but taxing the digital economy is a major challenge, a global problem that needs a multilateral solution – not yet more attempts at a tax grab by the UK.
Eloise Walker is a corporate tax expert at Pinsent Masons, the law firm behind Out-law.com. This article first appeared on accountancylive.com.