The Finance Bill amendments include changes to the tax treatment of royalties arising in the UK.
Measures were announced in the 2016 Budget to ensure that all royalties arising in the UK will be subject to withholding tax in the UK, unless the UK has explicitly given up its taxing rights under a Double Taxation Agreement (DTA). The measures announced were:
The legislation for the latter two measures has recently been introduced at the Public Bill Committee Stage and when enacted, will apply to payments made on or after 28 June 2016.
Anti-treaty shopping provision
There are no substantive amendments at this stage to the anti-treaty shopping provisions originally included in Finance Bill 2016. The draft legislation to be introduced at s917 ITA 2007 will deny treaty benefits where royalty payments are routed through a connected company in a treaty jurisdiction where such payment is part of a ‘Tax avoidance arrangement’. The definition of Tax avoidance arrangement is intended to be in line with the recommended Principal Purpose Test (PPT) to be included in tax treaties under Action 6 of the OECD BEPS project and HMRC have stated they will apply the new domestic rule in line with OECD commentary on the PPT.
Expanded definition of intellectual property (IP)
The expanded definition of intellectual property, which applies to payments made on or after 28 June 2016, aligns domestic rules to the taxing rights allocated to the UK under its tax treaties. Consequently, tax will now have to be withheld on royalties or payments for the use of, or the right to use, or payments of sums payable periodically in respect of (a) certain copyrights, (b) patents, trademarks, rights in design, models, plans, secret formulas or processes, (c) information concerning industrial, commercial or scientific experience, or (d) public lending rights in respect of a book. This represents a broadening of the circumstances in which tax must be withheld to include, for example, periodic payments for the right to use trademarks or trade names even where these are not ‘annual payments’. Such withholding tax obligation arises where the usual place of abode of the owner of such IP is outside the UK and the payment is charged to income tax or corporation tax in the UK.
While the obligation to withhold may be reduced or eliminated under a DTA or (for the moment) the EU Interest & Royalties Directive, the change certainly broadens the scope of the regime and creates an increased compliance burden and possible tax costs.
Payments connected with activities of a UK PE of an overseas company and consequential changes to the DPT legislation
Tax currently has to be withheld where a non-resident derives royalties from a source in the UK and such income falls within the charge to income tax or corporation tax. The new legislation explicitly provides that the payment, on or after 28 June 2016, of a royalty or other sum in respect of intellectual property will always have a UK source where the payer is a non-UK resident who carries on a business in the UK through a UK PE and all or part of the payments are in connection with the trade of the non-resident carried on through its UK PE. The new section simultaneously provides anti-forestalling measures in an anti-avoidance rule.
In order to ensure that this change equally applies where a person is brought within the scope of the DPT rules as a result of an avoided UK PE, additional clauses are introduced within the DPT legislation. These amend the calculation of Notional Profits of an avoided PE to include royalty payments on which tax would have had to be withheld if the avoided PE had been a PE in the UK through which the non-resident entity carried on its trade, although there are complex mechanisms included to take into account possible double tax relief under DTAs.
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