The introduction of the new Diverted Profits Tax (DPT) comes at a time of unprecedented change in the world of international tax, with G20 countries working together with the OECD to tackle perceived tax avoidance under the Base Erosion Profit Shifting (BEPS) plan. Furthermore, it is being introduced with little warning and is proposed to take effect from 1 April 2015.
The DPT means that taxpayers will have to notify HMRC if they believe that ‘diverted profits’ might arise in their company. Cynics point out that there is an election only a few months away and that a policy that targets large corporates plays well with an electorate and media who believe that certain businesses are not paying enough tax. There is also likely to be a less than enthusiastic response from other countries, many who consider that multinationals actually have an incentive to divert taxable profits into the UK at their expense, given that the UK Government has lowered the corporate tax rate to just 20%. There are also concerns that the new tax might reduce the attractiveness of the UK as an investment location and could also lead to problems in relieving double taxation under international tax treaties.
The DPT, which has been clarified as being a whole new tax, separate from income tax and corporation tax, will apply at a rate of 25% on diverted profits which arise on or after 1 April 2015.
The two diversion tests
The rules will counteract diversion of profits from the UK in two situations:
1. Where a foreign company exploits the permanent establishment (PE) rules to avoid UK tax
2. Where a UK company or a foreign company with a UK PE reduces UK tax through arrangements that lack economic substance SMEs (based on the EU definition) and large companies whose UK sales are less than £10 million will be exempt from the first rule. For the second rule, if both parties to the transaction meet the SME definition, they will also be exempt, as will transactions carried out by large companies, which involve loan relationships only.
HMRC’s guidance, which has been published alongside the draft rules, sets out a number of examples where the new DPT is expected to apply.
How will it operate?
Perhaps the most controversial area of the draft legislation is the enforcement of the tax and process of appeal.
Companies are required to self-assess within three months of the end of the accounting period in which the diversion occurs. Taxgeared penalties apply for failure to do so.
HMRC will then issue a “preliminary notice” to the company, which will include the basis for application of the rules, quantify the profits subject to DPT and the date by which the tax must be paid. Where the company fails to notify, HMRC has up to four years from the end of the affected accounting period to raise such a notice.
Following receipt of the preliminary notice, the company has 30 days to make written representation. After the end of the 30 day period, HMRC must decide on whether to pursue with a “charging notice” and, if so, has 30 days to do so.
The charging notice creates a formal liability for DPT, which must be paid within 30 days of issue. The tax cannot be postponed on any grounds, nor can the notice be appealed at this stage. A 12 month review period then follows during which the charge can be increased or decreased based on evidence. After the end of the review period, the company has 30 days to appeal the charging notice (and any subsequent notices).
In a further indication that the UK is leading the global charge against tax avoidance, it was also announced that measures will be introduced requiring businesses to supply a country-by-country report to assist tax authority risk assessing. This will allow HMRC greater transparency to spot the potential diverted profits that the new charge is seeking to tax.
Given the existing armoury of weapons that HMRC has to tackle diversion of profits, combined with the current BEPS project aimed at strengthening international tax rules, one wonders what this new tax is actually going to achieve and why the Government has acted unilaterally at this stage. The types of arrangements being targeted are readily identifiable by those that have been following the great debate on tax avoidance by multinationals. So, is this really a measure to crackdown on naughty multinationals, or largely a response to public opinion?
In view of the very short timeframe before the introduction of the tax, businesses should be considering if they are caught by the rules. There is a consultation process but the time limit for responses is 4 February. Given the onerous obligations of disclosure, payment of tax and appeal process, companies need to act fast and seek expert advice.
For further information on this issue please contact Baker Tilly’s specialist International Taxation team.
Baker Tilly – Head of Transfer Pricing
Source: RSM Global