United Kingdom - Response to BEPS

United Kingdom - Response to BEPS

Debate about the tax planning undertaken by multinational companies has been especially vigorous in the United Kingdom. The government has been very publicly studying possible remedies and, in advance of the OECD BEPS Action Plan being completed, has introduced a new ‘Diverted Profits Tax’ to counter arrangements that are perceived to divert profits from the UK. Representatives from HM Treasury, HM Revenue & Customs and other government departments have been active in discussions on the BEPS Action Plan. With the knowledge that change is coming, many UK companies are assessing the impact on their businesses going forward.

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Exchequer Secretary to the Treasury David Gauke has expressed the UK’s support for the OECD BEPS Action Plan: “We’ll continue to work through the G20 and OECD – on the digital economy, on coherence, on substance and on transparency – to make sure that this area is properly reformed.”

With a number of high-profile government officials involved in the OECD BEPS Action Plan, the UK government is sending a clear message that it is taking the OECD’s efforts seriously. Representatives from business, as well as the advisory community, have been actively encouraged by the OECD to get involved in helping to shape the Action Plan in a way that does not disturb ordinary commerce.

Tackling tax avoidance is not a new concept in the UK. In fact, the country has historically been proactive on anti-avoidance. The government has already introduced a new set of CFC provisions, and the regime has been amended to ensure that groups are not able to utilize the rules to generate a UK tax advantage. Most recently, the government introduced a new Diverted Profits Tax, discussed below.

It is understood that the UK tax legislative framework has been studied at the OECD in order to assess what might constitute best practice in designing rules to defeat perceived BEPS activity. An example is the anti-arbitrage rules, which have prevented companies from exploiting asymmetries between different tax regimes by using contrived arrangements. The new CFC provisions are also being reviewed as a potential model for tackling the artificial export of profits from one country to another.

Diverted Profits

TaxThe new Diverted Profits Tax (DPT), which is different from corporation tax, applies to diverted profits arising on or after 1 April 2015. DPT applies at a normal rate of 25 percent, which is higher than the UK’s current 20 percent corporation tax rate.

DPT applies to both UK and non-UK resident companies:

  • For UK resident companies, the DPT applies where profits are considered to have been diverted from the UK through arrangements or entities lacking economic substance.
  • For non-UK resident companies, the DPT applies where profits are considered to have been diverted from the UK by avoiding a UK PE.

Groups that are taking action to restructure as a result of DPT are also considering other changes that are expected to come in as a result of the BEPS Action Plan in due course.

Transfer pricing

A significant component of the OECD BEPS Action Plan relates to transfer pricing, in particular with respect to the extent of documentation needed, hard-to-value intangibles, and risk and capital. Like the tax departments of other multinationals, those of UK companies have historically invested considerable efforts in ensuring that transfer pricing policies are robust. This is a complex area, and companies are keeping a close eye on developments to ensure that business models are disrupted as little as possible.

Hybrid mismatch arrangements

In light of the OECD proposals in relation to hybrid mismatch arrangements under Action 2 of the BEPS Action Plan, the UK is proposing to change its domestic rules. The UK rules are likely to closely follow the OECD’s recommendations, and they are expected to apply to payments made on or after 1 January 2017.

On the horizon

In March 2014, the Chancellor of the Exchequer released a report by way of an update of the government’s thinking on the OECD BEPS Action Plan. Entitled Tackling Aggressive Tax Planning in the Global Economy: UK Priorities for the OECD Project for Countering Base Erosion and Profit Shifting, the report outlines the government’s priorities heading into 2015. The following are some recommendations of particular interest, together with the latest developments in the UK.

  • Examine taxation in the digital economy to update the threshold at which a company becomes taxable in a foreign country, and evaluate transfer pricing to take technological advances into account.
  • Neutralize the effects of hybrid mismatch arrangements with due consideration for intragroup hybrid regulatory capital instruments that are a direct consequence of regulatory requirements. The UK published a consultation document on 3 December 2014 on the UK’s plans for implementing the OECD agreed rules for neutralizing perceived hybrid mismatch arrangements. The consultation closed on 11 February 2015, with legislation currently expected to be effective for payments made on or after 1 January 2017.
  • Prevent treaty abuse by denying benefits to persons whose main purpose is to gain access to tax benefits through those treaties.
  • Develop a CbyC reporting template and transfer pricing documentation to provide tax authorities with the information they need to efficiently identify and assess risks. On 22 September 2014, the UK government formally committed to implementing the new CbyC reporting template.
  • Strengthen CFC rules to make it more difficult for multinational enterprises based outside the UK to divert profits to low-tax countries (to level the playing field between those enterprises and UK domestic businesses).
  • Limit base erosion via interest deductions. The UK already has a number of defenses against excessive interest deductions and awaits the output of the OECD on limiting the use of interest deductibility as a means of shifting profit.
  • Give attention to transparency and substance going forward. The government is mindful of the need for compatibility with existing international law and to support fair competition, as well as to acknowledge legitimate commercial decisions with respect to R&D within the framework of globalized markets and operations.
  • Prevent the artificial avoidance of PE status by re-examining and updating the rules governing the threshold at which a company becomes taxable in a foreign country, and work to prevent businesses from artificially fragmenting their operations to avoid breaching this threshold (i.e. through measures such as the new DPT).
  • Ensure that transfer pricing outcomes are in line with value creation. Authorities will consider whether special measures are required to override the arm’s length principle in certain circumstances.
  • Collect and analyze data on BEPS and counteractions to determine the scale and impact of perceived aggressive tax planning by multinationals.
  • Require disclosure of certain tax-planning arrangements. This builds on a mandatory disclosure scheme introduced in the UK in 2004 and will therefore be familiar to UK businesses.
  • Make dispute resolution mechanisms more effective. This means going to arbitration where tax authorities cannot come to agreement or tax disputes have exceeded a certain length of time.
  • Develop a multilateral instrument to enable participating jurisdictions to implement BEPS measures and enhance bilateral tax treaties. The UK is one of over 80 countries that have so far said they will participate in the ad hoc group to develop a multilateral instrument to implement tax treaty measures to tackle BEPS.
  • Change the Patent Box regime to reflect a ‘modified nexus principle’, which seeks to directly link IP regime benefits to the claimant company’s contribution to the development of the IP in question.

Preparing for change

As the OECD nears the end of its consultations, many UK-headquartered companies are gearing up to respond to the upcoming wave of legislative change. With company directors and upper management taking more interest in the business impact of changing rules in the UK and other countries, many tax executives are modeling various scenarios and potential responses, with particular focus on their legal structures, financing arrangements and operating models. UK companies have also started factoring potential BEPS legislation into their future plans, for example, for proposed mergers and acquisitions.

Planning for the future is particularly difficult in the current context. The OECD Action Items are complex and interdependent, and some of the proposals released to date (e.g. interest deductibility, treaty shopping) offer flexibility in their implementation. Until the OECD proposals are finalized and countries transpose them into their domestic law, UK companies will need to weather uncertainty over exactly how their tax positions will be affected. Companies that are taking steps now to review current and proposed structures in light of the BEPS project will be in a good position to act quickly when needed.

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