The following is a guest article written by tax barrister Jolyon Maugham, who also writes for his own tax blog Waiting for Godot. These are Jolyon’s views on the new Diverted Profits Tax (“DPT”, or “Google Tax”) that was introduced in the recent Autumn Statement. Jolyon has kindly agreed to share his initial views on Tax Notes.
Before we go into what Jolyon thinks about it all, the following is a brief description of what DPT is about, together with the key conditions.
Diverted Profits Tax
Diverted Profits Tax is aimed at multinational companies that use aggressive tax planning structures to divert their profits away from the “home country” – the country where the business’s goods and services are being produced – to a low tax jurisdiction. As the HMRC Guidance makes clear, there are two scenarios which are being targeted:
- Where the business is structured to avoid a taxable presence in the UK, even though in substance, a lot of the business activities are carried out there. HMRC gives the example of a company that undertakes substantial sales activities, doing everything short of actually signing contracts in the home jurisdiction;
- Creating a tax advantage by using taxable “transactions or entities that lack economic substance.” For example, this could be by creating a tax deduction by paying part of the profits to a company located in a tax haven.
Avoiding a taxable presence – Clause 2
For the rules on avoiding a a permanent establishment – or, PE for short – the following conditions are required:
- There is a foreign company that is not resident in the UK;
- Another person (“the avoided PE”) is carrying on an activity in the UK in connection with the supplies of goods or services by the foreign company to customers in the UK. This person may or may not be UK resident;
- The avoided PE and the foreign company are not SMEs – in other words, this measure is aimed at large companies;
- It is reasonable to assume that the activity of the avoided PE or the foreign company (or both) is designed to ensure that the foreign company is not carrying on a trade in the UK through a permanent establishment by reason of the avoided PE’s activity;
- It is reasonable to assume that either a tax mismatch or a tax avoidance motive is involved.
Economic substance rules (Clause 3):
For the second scenario, where the transactions or entities involved lack economic substance (Clause 3):
- We have a UK resident company C and another person P who may or may not be UK resident;
- A material provision has been made or imposed between C and P by means of a transaction or series of transactions;
- C and P are connected in accordance with the participation condition – broadly one party has a participation in the control or management of the other;
- C and P are not both SMEs – again, the measure is aimed at large companies;
- The material provision must result in “an effective tax mismatch outcome” between C and P;
- The “insufficient economic substance condition” must be met – that is, the transaction(s) or entities involve lack economic substance.
Hopefully the above explanation is sufficient to understand the points that Jolyon is making below. The HMRC Guidance has a series of examples with diagrams from page 30 onwards. The following diagram shows a (simplified) version of the Double Irish structure – this doesn’t work anymore, but it may be helpful in understanding what the draft legislation is trying to do.
Waiting for Godot – Jolyon Maugham
The Government’s new Diverted Profits Tax – the so-called Google Tax – occupies 26 pages of closely drafted legislation. These are my immediate thoughts, a matter of an hour or so later.
The measures tackle two particular types of ‘diversion’ of profits being:
- First, where an economic entity avoids establishing a UK presence (known to tax practitioners as a Permanent Establishment) so that the profits from sales of goods and services to UK consumers fall outside the charge to UK corporation tax (call it the “Amazon diversion”); and
- Second, where an economic entity which has profitable activities in the UK diverts those profits to lower tax jurisdictions abroad (call it the “Starbucks diversion”).
There are a number of important economic concepts embedded in the legislation but the important ones look to me (on an initial reading) to be:
- That the arrangements happen in concert (or as I have put it for shorthand within a single economic entity). This concept is defined in clause 5 “The participation condition”;
- That the arrangements generate a tax saving. This concept is defined in clause 6 “Effective tax mismatch outcome”. Clause 6 contains a key value judgment made by the drafters of the regime. Arrangements offend against the regime if they (broadly) lead to profits being diverted to another country where those profits give rise to a tax charge of less than 80% of that which would arise in the UK; and
- That they lack economic substance. This concept is defined in clause 7 (“Insufficient economic substance condition”) which requires (broadly) that the tax benefits of the arrangements are greater than the non-tax benefits. Putting the matter another way, that the arrangements were effected for tax reasons.
Standing back from the detail, a few observations:
- Diverted profits tax looks to me to be a foothold – only a foothold but a meaningful one – in a new and more fiscally satisfactory world in which tax better reflects the economic substance of transactions;
- The higher rate at which the diverted profits tax is to be charged (compared with corporation tax) may well reflect a policy preference that economic entities bring themselves with the normal domestic corporation tax regime;
- There are signs – quite understandable, given the radical nature of these measures – of caution on the part of the draftsman: the tax liability is fixed following an iterative process of discussion between putative taxpayer and an officer of HMRC. Even after it is fixed, there remains scope for later adjustment;
- The Green Book shows the yield growing from £270m in 2016-17 to £360m in 2017-18. Speculating, I wonder whether built in to these forecasts is an expectation that the measures might adapt as business behaviour adapts. But whether or not that expectation is built into the forecasts, it is my expectation that these measures will have to adapt and change;
- A big question is how other countries will respond to this unilateral measure. For myself, instinctively I doubt that these measures will come to be regarded as contrary to EU law. The bigger question is, what effect might they have on the propensity of our co-signatories to Double Tax Conventions to continue to observe those Conventions. On this point, I would assume that Government had already taken initial soundings.
Draft legislation on the new Diverted Profits Tax is here
Guidance notes here.
Latest posts by Satwaki Chanda (see all)
- Spring Budget 2017 – where are the documents? - Wednesday 8 March 2017
- Spring Budget 2017 announced Wednesday 8 March 2017 - Tuesday 20 December 2016
- Draft Finance Bill 2017 Documents are now available - Monday 5 December 2016
- Google, the Great Tax Avoidance Debate, and why I don’t write about it
- Entrepreneurs’ Relief and Goodwill – what did the Autumn Statement say?
- Consultation Paper – Tackling aggressive tax planning: implementing the agreed G20-OECD approach for addressing hybrid mismatch arrangements
- Vodafone and Tax Avoidance
- Budget 2013 – Buying Corporate Tax Losses – a technical analysis of the new rules on trading losses