New Diverted Profits Tax: how UK and non-UK companies will be affected

This article was produced by Olswang LLP, which joined with CMS on 1 May 2017.

HMRC representatives confirmed in January that the Government intends to press ahead with the controversial new Diverted Profits Tax (DPT), referred to in the media as "Google Tax". Presumably DPT will therefore be included in the pre-election Finance Bill, relying on cross-party support for a measure which appears to be popular with the electorate despite the misgivings of multinationals and their advisers. We await confirmation in the Budget on 18 March.

The draft legislation was published in December and, while HMRC concede that it is not perfect and several aspects of it may require fine-tuning, it is likely to be rushed onto the statute book before all its flaws can be ironed out. The rush to legislate can be explained in part by the fact that it is an election year in the UK, at a time when the UK Parliament's Public Accounts Committee hearings have focused attention on the tax affairs of Starbucks, Google and Amazon and highlighted public outrage at arrangements that were widely seen as an aggressive way for big corporates to avoid paying their fair share of tax. In addition the UK is a key supporter of the current G20/OECD international initiative on Base Erosion and Profit Shifting which is focused on introducing measures to combat aggressive tax avoidance. However, while the low effective rates of tax paid in the UK by such high profile companies may have prompted this new tax, the current draft of the DPT is not limited to just technology companies and coffee shops and it may potentially extend beyond the "aggressive" type of planning referred to in the Autumn Statement.

DPT, which will come into force with effect from 1 April 2015, aims to protect the UK tax base from erosion by preventing multinational enterprises from artificially moving profits outside the UK. It will impose tax at 25% on the amount of the "diverted" profits and will apply to existing as well as new arrangements. Large companies will be obliged to notify HMRC of possible liability to DPT within three months of the end of the relevant accounting period and DPT will initially be paid on the basis of HMRC estimates of the amount of diverted profit, on a "pay now argue later" basis at least as far as quantum is concerned. This has the unfortunate consequence of potentially tying up cash even where a company may not in fact have a DPT liability.

DPT will be chargeable in the following circumstances.

• PE avoidance: this new tax law concept applies where foreign companies make large volumes of sales in the UK but minimise UK tax by ensuring that the sales are not concluded through a UK permanent establishment (PE). Typically such arrangements involve a UK subsidiary or "rep office" which undertakes the majority of UK sales activity and negotiations short of actually concluding the contract which is then done by the foreign company instead to ensure that the sales are not made through a UK PE. The DPT will also apply to other cases of PE avoidance.
• Entities or transactions lacking economic substance: this applies to UK companies (or UK PEs of foreign companies) minimising UK profits through transactions with, or payments to, low-taxed affiliates which lack economic substance. There appears to be significant overlap between this second limb of DPT and normal transfer pricing principles.

For further information, see our summary note here.

Any information contained in this article is intended as a general review of the subjects featured and detailed specialist advice should always be taken before taking or refraining from taking any action. If you would like to discuss any of the issues raised in this article, please get in touch with your usual Olswang contact. This article was included in our Olswang Corporate Quarterly Spring 2015 publication.