The UK government has introduced a Diverted Profits Tax (DPT) effective 1 April 2015, referred to as the “Google” tax, to catch mainly large MNCs with business activities in the UK who enter into contrived arrangements to divert profits from the UK by avoiding a taxable presence and / or by other contrived arrangements between connected entities. The DPT will operate two basic rules:
1. Rule one (Avoidance of taxable presence): is designed to address arrangements which avoid a UK permanent establishment (PE) and comes into effect if a person is carrying on activity in the UK in connection with supplies of goods and services by a non-UK company to customers in the UK, provided that the detailed conditions are met. Example: a US MNC arranges contractual billing arrangements from a low-tax country into the UK but largely the profits accumulating in the low-tax jurisdiction are derived from sales to UK resident customers and UK-centered activities.
2. Rule two (Insufficient economic substance): will apply to certain arrangements which lack economic substance involving entities with an existing UK taxable presence. The primary function is to counteract arrangements that exploit tax differentials and will apply where the detailed conditions, including those on an “effective mismatch outcome” are met. Example: a UK group transfers its IP to a group company with little commercial substance in a tax haven which licences it back.
a. The first rule will be subject to an exemption where the total sales to UK customers does not exceed £10 million for a 12-month accounting period. The diverted profits tax will not reflect any profits relating to transactions involving only loan relationships.
b. The DPT will be levied at a rate of 25% on a”pay now, argue later” approach. The taxpayer has to inform HMRC within 3 months of the end of an accounting period if it is reasonable to assume that a DPT might arise.
c. HMRC will then raise a preliminary notice stating why the DPT arises, how it is calculated, who is liable and when it is payable.
d. The taxpayer has 30 days to make representations to HMRC providing further information to challenge it or to argue that exemptions apply.
e. HMRC then have 30 days to either issue a charging notice or to confirm that no charge arises. If there is a DPT, then it must be paid within 30 days of the issue of the charging notice.
The introduction of the Diverted Profits Tax means that MNCs must review their activities and structuring arrangements in the UK so as not to fall foul of these new tax rules.