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New profit fragmentation rules impact UK individuals and partnerships

New profit fragmentation rules impact UK..

Draft Finance Bill 2018/19 introduces new anti-avoidance legislation targeting business diverting profits to overseas territories.

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This legislation in Draft Finance Bill 2018/19 aims to prevent UK businesses from avoiding UK tax by arranging for their UK-taxable business profits to accrue to entities resident in territories where significantly lower tax is paid than in the UK. The rules will commence with effect from April 2019 for any value transferred after that date and can apply to any UK resident person carrying on a business including in partnership. If it is reasonable to conclude profit fragmentation arrangements were entered into to obtain a tax advantage, and the various conditions are met, the arrangements are counteracted by making any such adjustments that are just and reasonable. Business will need to self-assess any such adjustments. There are also onerous obligations for the UK resident person to notify HMRC of the profit fragmentation arrangements.

Profit Fragmentation Arrangements

The legislation contains a number of detailed provisions that will require careful consideration against individual fact patterns. However, arrangements are profit fragmentation arrangements if:

  1. There is an arrangement (referred to as a ‘material provision’) between an overseas party and a UK resident person carrying on a business;
  2. As a result of the material provision, value is transferred to the overseas party which derives directly or indirectly from anything done in connection with a business which is subject to UK tax;
  3. The value transferred is greater than an arm’s length price for services provided by the overseas party;
  4. The material provision results in a tax mismatch; and
  5. A relevant individual, who is the UK resident person, or is a member of the partnership including the UK resident person or a participator in the company who is the UK resident person, meets the enjoyment conditions.

For the purposes of condition 4, the material provision will result in a ‘tax mismatch’ where:

  1. It results in either a tax deductible expense or a reduction in income for the UK resident party;
  2. The resultant reduction in tax payable in the UK exceeds the relevant increase in taxes payable by the overseas entity; 
  3. It is not an exempted payment (broadly, charitable donations, pension contributions, payments to sovereign states or payments to offshore funds and authorised investment funds); and
  4. The ‘80 percent payment test’ is not met.

The 80 percent payment test is met if the resulting increase in taxes paid abroad is at least 80 percent of the amount of the resulting reduction of tax in the UK resident party.

Notification Requirements
There is a requirement to notify HMRC where conditions a), b), d) and e) of the profit fragmentation arrangements test are met, and the tax mismatch is not adjusted under transfer pricing, controlled foreign company (CFC) or Diverted Profits Tax (DPT) rules. This notification must be made in the tax return of the UK resident person.

Analysis
These rules are wide-ranging and can potentially cover a wide range of arrangements that UK businesses have in place with non-UK entities which are not at arm’s length. It is worth noting that the ‘80 percent payment test’ requires a specific calculation of the increase in the relevant taxes in the overseas entity, adjusted for deductions or reliefs available in the overseas territory. It is not just a comparison of the in force tax rates of the UK and the overseas jurisdictions.

Furthermore, the notification requirement excludes the condition that the provisions are not at arm’s length, so potentially covers a wide range of commercial transactions. Where similar reporting requirements were included in DPT legislation this led to a large number of notifications being made to HMRC.

For further information please contact:

Paul Harden

Rhys Owen
 

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