DIGITAL SERVICES TAX
The government will consult on the detailed design of the Digital Services Tax (DST) and legislate in the Finance Bill 2019-20.
From April 2020, the government will introduce a new 2% tax on the revenues of certain digital businesses which derive value from their UK users. The tax will apply to revenues generated from the provision of the following business activities: search engines, social media platforms and online marketplaces. The new DST will apply to revenues from those activities that are linked to the participation of UK users, subject to a £25m per annum allowance, and will only apply to groups that generate global revenues from in-scope business activities in excess of £500m per annum. There will be a safe harbour provision that exempts loss-makers and reduces the effective rate of tax on businesses with very low profit margins.
This is in line with our expectation given that the UK has been taking a leading position in the debate on the taxation of the digital economy.
In March 2018, the OECD released its interim report Tax Challenges arising from digitalisation. This ‘non-consensus’ document did not reach many firm conclusions, although it provided useful commentary regarding user-generated value, long-term reforms and interim measures. It is worth noting that certain countries (including the US) consider that some issues remain post-BEPS but are of the opinion that these issues are not specific to digital companies and hence any reforms should be of general application. Others consider that digitalisation is putting intense pressure on existing taxation regimes hence targeted solutions are needed (e.g. France, Austria, Bulgaria, Spain, Italy, Germany, Greece and Portugal). The OECD report lists a number of principles for designing interim measures, including being targeted in scope (e.g. not capturing the delivery of goods ordered online), and minimising the impact on business creation and small businesses. The report notes that many countries are of the view that interim measures should focus on only two business models, which are platforms which create revenue from online advertising and platforms which provide intermediation services.
In March 2018, the UK government stressed in the introduction to its updated position paper on Corporate tax and the digital economy that it would continue to actively support work aimed at reaching an international consensus in this area but as the announcement today makes clear, they are not willing to wait too long.
OFFSHORE RECEIPTS IN RECEIPT OF INTANGIBLE PROPERTY (PREVIOUSLY ROYALTIES WITHOLDING TAX)
As announced in the Autumn Budget 2017, legislation will be introduced in the Finance Bill 2018-19 to tax income from intangible property held in low-tax jurisdictions to the extent that it is referable to UK sales. The rules target large multinational groups by taxing a proportion of their income received in low tax jurisdictions where the intangible property is held and where there is UK nexus by virtue of the income being referable to the sale of goods or services in the UK.
Key changes to the original announcement are that the tax will be collected by directly taxing offshore entities rather than applying a withholding tax and a broadening of the income in scope to include embedded royalties and income from the indirect exploitation of intangible property in the UK market through unrelated parties.
A de minimis UK sales threshold of £10 million will apply as well as an exemption for income that is taxed at more than 50% of the UK tax that would apply under these rules, and an exemption for income relating to intangible property that is supported by sufficient local substance.
The measure will take effect from 6 April 2019, with an anti-avoidance rule that applies from 29 October 2018. Guidance from HMRC should be available by April 2019.
The measure will only generally apply to countries where there is no full double tax treaty and so the impact may not be as broad as first thought however with the draft legislation having been drawn widely individual circumstances will need to be analysed.
PERMANENT ESTABLISHMENT: ANTI-FRAGMENTATION RULE
The government will legislate the new anti-fragmentation rule in Finance Bill 2018-19 to give full effect to changes being made to its tax treaties.
The purpose of the new rule is to prevent an enterprise or a group of closely related enterprises from fragmenting complementary functions forming part of a cohesive business operation between locations or among enterprises, in order to claim that the resulting multiple smaller operations benefit from one or more of the specific activity exemptions. In order for the rule to apply:
- at least one of the places where these activities are exercised must constitute a permanent establishment; or
- the combination of activities goes beyond what is merely preparatory or auxiliary.
In summary, the anti-fragmentation rule targets non-resident companies which artificially fragment their business operations to avoid coming within the charge to corporation tax in the UK.
The current domestic law definition of Permanent Establishment (PE) is similar to and has the same broad effect as the Organisation for Economic Co-operation and Development (OECD) Model Treaty Article 5 definition of PE.
The Base Erosion and Profit Shifting (BEPS) Action Plan 7 initiated in 2013 called for a review of the PE definition in Double Taxation Conventions to prevent the use of certain common tax avoidance strategies that were being used to circumvent the existing PE definition. Changes to the PE definition were also thought to be necessary to prevent the exploitation of the specific exceptions to the PE definition currently provided for by Art. 5(4) of the OECD Model Tax Convention.
However, the UK elected not to implement the revised PE standards through the multilateral instrument with the exception of the anti-fragmentation rules.
Multinationals should review their existing operations in the UK to ensure that any fragmentated business operations in the UK would not constitute a PE which would be subject to UK corporation tax under this new rule. It is also important for businesses to revisit their global operations to understand how the new PE definition proposed by the OECD BEPS Action Plan 7 will impact their taxable presence in those countries.
DIVERTED PROFITS TAX RULES AMENDMENTS AND PROFIT FRAGMENTATION
The government will legislate in Finance Bill 2018-19 to amend the Diverted Profits Tax (DPT) rules.
The current DPT rules target two types of arrangements used by large groups to artificially shift profits from the UK to a lower tax jurisdiction. The two arrangements are:
- artificially avoiding creating a UK PE where a person carries on activities in the UK for a foreign company, and
- where a company with a UK taxable presence uses arrangements lacking economic substance to shift profits from the UK to a lower tax jurisdiction.
The amendments will be made to Part 3 of the Finance Act 2015, including:
- closing tax planning opportunities, whereby Corporation Tax amendments can be made to a company’s return after the review period has ended and the DPT time limits have expired;
- making clear that diverted profits that are subject to DPT will not also be subject to corporation tax and introducing modifications for potential double taxation to the mechanics of the DPT legislation; and
- extending the DPT review period to 15 months and to permit taxpayers to amend their CT return during the first 12 months of the review period.
These amendments will generally apply from Budget or Royal Assent of Finance Bill 2018-19 but will be deemed to have always had effect where they are wholly relieving.
In addition, as announced in the Autumn Budget 2017, the government will legislate in the Finance Bill 2018-19 to introduce targeted legislation that 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 taxable UK profits will be increased to the actual, commercial level.
Following consultation, changes have been made to the draft legislation to remove the duty to notify HMRC of relevant arrangements meeting certain criteria, to clarify the adjustments required to be made under this legislation, and to make a number of small technical changes.
The measure will have effect from 1 April 2019 onwards for Corporation Tax and 6 April 2019 for income tax and class 4 National Insurance contributions and will apply to all profits diverted on or after those dates.
Given that DPT has been an area which has attracted increasing attention from HMRC, businesses should review their current operations to confirm that their structure is not caught by the DPT legislation and ensure that their transfer pricing policies in place for any intercompany transactions are in accordance with the arm’s length principle.
HYBRID MISMATCH RULES
Legislation will be introduced in the Finance Bill 2018-19 to make two changes to the hybrid mismatch rules in order to ensure that they are fully aligned to the EU’s Anti-Tax Avoidance Directive. These changes relate to the treatment of certain permanent establishments and the treatment of regulatory capital. These changes will take effect from 1 January 2020.
INTERNATIONAL TAX ENFORCEMENT: DISCLOSABLE ARRANGEMENTS
Draft legislation has been released to allow the introduction of international disclosure rules about offshore structures that could avoid tax, or could be misused to evade tax. The legislation allows the government to implement Directive 2018/822 amending Directive 2011/16/EU regarding mandatory automatic exchange of tax information as it relates to reportable cross-border arrangements. It will also permit the implementation of new OECD model mandatory disclosure rules, should the decision be taken to implement those.