Last week I looked at (yet) another brick in the formidable wall of tax avoidance measures being built by the Government in the shape of the diverted profits tax to be applied to corporations satisfying certain conditions laid down in the legislation. Given its potential impact a “breezeblock” in the wall might be a more apt analogy.
Anti-avoidance legislation and litigation against individuals (for example, naming and shaming rich and famous tax-avoiders) has had huge publicity. It seems it has had a serious impact on what is now accepted as permissible and non-permissible tax planning by UK taxpayers. However, lost tax from corporations successfully implementing aggressive/officially unacceptable tax planning is huge.
According to an estimation of the UK’s tax gap, around £12bn is lost to the public purse each year via corporate tax avoidance. After all of the naming and shaming (in particular through the Margaret Hodge led Public Accounts Committee) it is perhaps unsurprising to see the emergence of the proposed diverted profits tax legislation applying a “substance over form” approach to the said “diverted profits”. Diverted profits, broadly speaking, are profits earned through UK trading by corporations with a “real” UK presence but which are not taxed in the UK.
In general terms, the diverted profits tax would be applicable if one of two rules applied. The first rule is designed to address arrangements that avoid a UK permanent establishment and comes into effect if a person is carrying on activity in the UK in connection with supplies of goods and services by a non-UK resident company to UK customers, provided the detailed conditions are met.
The second rule will apply to certain arrangements that lack economic substance involving entities with an existing UK taxable presence. The primary function is to counteract arrangements that exploit tax differentials and will apply where the detailed conditions, including those on an “effective tax mismatch outcome”, are met.
The first rule only applies where the UK person and the foreign company are not small or medium-sized enterprises and the second rule where the two parties to the arrangements are not SMEs (the SME test will apply to the group). The first rule will be subject to an exemption based on the level of the foreign company’s (or a connected company’s) total sales revenues from all supplies of goods and services to UK customers not exceeding £10m for a 12-month accounting period. The diverted profits tax will not reflect any profits relating to transactions involving only loan relationships.
The legislation will provide that where a designated HMRC officer determines the diverted profits tax should apply a preliminary notice would be issued explaining, among other things, the reasons the amount of the charge and the basis on which it has been calculated (including the details of the amount of the taxable diverted profits).
The recipient would have 30 days to make representations. The designated HMRC officer may consider certain specified matters within a further 30-day period before either issuing a charging notice based on the original or a revised amount or confirming that no charge arises.
Where specific conditions are met and the designated HMRC officer considers certain expenses otherwise deductible may be greater than they would have been at arm’s length, the diverted profit charge will initially reflect a 30 per cent disallowance of those expenses.
The charging notice will require the payment of the diverted profits tax within 30 days. Penalties will apply for late payment.
Following the due date for payment, there is a 12-month review period during which the charge may be adjusted based upon evidence. At the end of the review period the business has the opportunity to appeal against any resulting charge. The review period can be brought to a conclusion earlier with the agreement of both parties. There will be no postponement of the disputed tax during the review period or due to any subsequent appeal.
So, action at last. This may appease the protesters but the proof of the anti-avoidance pudding will be in the shape of how many companies swallow it.
In closing it is worth mentioning that, to accompany the “stick” of the diverted profits tax, there is the “carrot” of the Fair Tax Mark. SSE has recently become the first company to win the right to display this badge of proof it is officially a good corporate (fair tax-paying) citizen. It is hoped that just as “naming and shaming” has the potential to cause a negative commercial impact based on public opinion, “naming and faming” might have the potential to deliver some positive commercial benefit to the companies who win the right to display the mark. More on this next week.
Tony Wickenden is joint managing director at Technical Connection