Responses to UK’s “diverted profits tax”

Responses to UK’s “diverted profits tax”

Now that tax professionals have had an opportunity to consider the UK government’s draft legislative language that would impose tax on so-called "diverted profits”—at a rate of 25%—multinational entities are beginning to consider these initial responses.

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Overview

As initially described with respect to the Autumn Statement on December 3, the provision is intended "to counter the use of aggressive tax planning techniques used by multinational enterprises to divert profits from the UK".

The draft legislation (released December 10) provides significantly more detail to that description, including:

  • The 25% tax generally would apply to a company with revenues from sales and/or services to UK customers in excess of £10 million, and that has structured its operations to avoid a permanent establishment in the UK, by having activities conducted by another person if the result of such arrangements is to reduce the overall tax attributable to the UK sales by at least 20%.
  • The 25% tax would also apply to transactions lacking adequate economic substance that occur between commonly controlled entities and similarly reduce tax liabilities by at least 20%. The economic substance test compares the economic contribution attributable to functions and activities of each party's staff to the financial benefit of the tax reduction from the transaction. If a party's economic contribution is less than the tax reduction, then economic substance would be found to be lacking.

Read commentary on the Finance Bill 2015 draft clauses prepared by the KPMG member firm in the UK.

KPMG observation

The concerns that the UK government is addressing with these proposals are a part of what is driving the OECD's ongoing base erosion and profit shifting (BEPS) studies. There has been significant discussion within the OECD regarding potential broadening of the definition of a permanent establishment to take into account more activities undertaken by agents, and much discussion has also focused on the proper allocation of profit to "people functions." However, by proposing to act unilaterally in advance of a firm consensus within the OECD, some observers believe that the UK risks creating an inconsistency with the ultimate OECD proposals—with such inconsistencies in international norms being precisely what tax treaties (and the OECD itself) are designed to minimize.

Without directly criticizing the UK proposal, the OECD has expressed what could be viewed as frustration with it. Pascal Saint-Amans (director of the OECD’s Centre for Tax Policy and Administration) indicated that it would have been “optimal” for the UK to wait for OECD consensus, but recognized the existence of “political imperatives” that might lead to “faster changes than what a purely rational, technical approach would result in.”

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