A new U.K. tax charge on multinationals using intangibles held in low tax jurisdictions to generate revenue in the U.K. could have a greater impact than the U.K.'s proposed new digital services tax.
Digital Services Tax
Digital Services Tax (“DST”) caught the headlines after the U.K.'s Budget in October 2018 because it is likely to affect high profile companies like Facebook, Google and Amazon. It is a 2 percent charge on the revenues of search engines, social media platforms and online marketplaces which are linked to U.K. “user participation.”
It is intended to be an interim tax, which will fall away if and when the international tax rules are amended to address the problem that digital companies pose for countries like the U.K. These countries see large profits being made as a result of digital activities in their jurisdiction, but very little tax making its way into their coffers as a result.
The U.K. government is consulting upon the DST proposals at the moment: they are due to come into force in April 2020.
Tax on Overseas Intangibles
A new income tax charge on offshore receipts in respect of intangible property was also announced in the Budget, but has received less attention than DST. As well as coming into force sooner—on April 6, 2019—it will apply to a wider range of businesses than are caught by DST and could therefore have a greater impact on multinationals operating in the U.K.
Any non-U.K. owned business with intellectual property held in a low tax jurisdiction could be caught by the intangibles charge if it is making sales in the U.K. through an offshore company or other structure. The measure is likely to affect a wide range of multinationals, particularly U.S. owned groups which have adopted structures incorporating low tax jurisdictions, such as “double Irish” arrangements.
A 20 percent income tax charge will apply to gross income realized by a non-U.K. resident entity with intangible property that is used to generate U.K. sales revenues. It will not apply to non-U.K. entities which operate through a U,K, permanent establishment and are therefore already within the U.K. tax net.
The measure was first proposed and consulted upon in late 2017, although then it was proposed as a royalty withholding tax. Respondents to the consultation highlighted difficulties in structuring the tax as a withholding tax and particularly concerns about the likelihood of double taxation. The U.K. government has therefore decided to structure the tax as an income tax charge on the entity which holds the intangibles.
The U.K. government estimates that the offshore intangibles measure will raise more in its early years than DST. This is presumably because multinationals are expected to restructure so that they will not be caught by the tax, or will need to restructure anyway if they are using “double Irish” structures, which are due to be phased out by 2020.
The U.K. government forecasts that tax on offshore intangibles will raise 475 million pounds ($599.6 million) in 2020–21, falling to 275 million pounds in 2021–22 and 165 million pounds by 2023–24. In contrast it estimates that DST will raise 275 million pounds in 2021–22 but that the receipts will increase to 440 million pounds by 2023–24.
The tax charge will apply to sales made to U.K. persons directly by the non-U.K. resident entity or through related parties. It will also potentially apply to the indirect exploitation of the intangible property in the U.K. market through unrelated parties.
“Intangible property” is widely defined and will include patents, know-how, trademarks, distribution rights and even customer lists. The tax charge will apply only to the proportion of the non-U.K. resident entity’s intangible property income that is “derived” from U.K. sales. Like DST it will be charged on income, rather than profits.
The U.K. tax authority, HM Revenue & Customs (“HMRC”), gives an example of a company located in a low tax country ("IP Co") owning trademarks, know-how, distribution rights and customer lists. IP Co licenses this intangible property to Sales Co, a connected party, located in another country outside the U.K. In turn, Sales Co uses this intangible property to manufacture and make direct sales of goods, such as laptop computers, to U.K. customers.
HMRC says that the fee paid by Sales Co to IP Co for the use of the intangibles would be potentially within the scope of the tax as it would be referable to the sale of goods to a U.K. customer.
Exceptions and Exemptions
One of HMRC’s examples suggests that the tax charge will not apply if the intangible does not represent a “substantial” part of the value attributable to the U.K. sale, but that is not reflected in the current draft legislation. This adds to the uncertainty for non-U.K. companies trying to work out whether or not they are caught by the new charge. There will be particular challenges where the intangible relates to a component of a larger product.
The tax charge will only apply to entities located in jurisdictions with which the U.K. does not have a double tax treaty, or where there is a treaty but it does not contain a non-discrimination provision. This will usually be low tax jurisdictions and will include Bermuda, the British Virgin Islands and the Cayman Islands.
In order to ensure the measure only applies where intangibles are held in low tax jurisdictions, there is also an exemption from the charge where the local tax paid by the foreign entity in respect of U.K.-derived amounts is at least 50 percent of the U.K. income tax charge. Note however that this exemption may be difficult to obtain as the local tax is likely to be on profits, whereas the U.K. tax will be on revenue.
There are some further exceptions to the charge but these are likely to be difficult to apply in practice. There is a de minimis limit so that the tax charge will only apply to non-U.K. entities if the total value of their U.K. sales and those of entities connected with them exceeds 10 million pounds.
There is also an exemption for non-U.K. entities which have not acquired their intangible property from related parties and where all, or substantially all, the trading activities have always been undertaken in the low-tax jurisdiction.
U.K. Acting Unilaterally
This new charge is another example of the U.K. acting unilaterally. It is worrying that the measure comes into force so soon. There has only been one broad consultation on the proposal—which was then structured as a royalty withholding tax—and the draft legislation was only published last month. There are considerable uncertainties surrounding the measure as the legislation is very broadly drawn. HMRC guidance (not yet available) as to how the rules will apply will be crucial.
Probably in acknowledgment that the legislation is not adequate, it contains a wide power for the government to make any changes it chooses by regulations at any time until December 31, 2019. This is controversial because regulations receive very little parliamentary scrutiny.
The legislation contains anti-forestalling provisions from October 29, 2018 and a targeted anti-avoidance rule (TAAR), which will protect against arrangements designed to avoid the charge, for instance by transferring ownership of intangible property to another group entity resident in a full treaty jurisdiction. This is also controversial as the current draft appears to be a disincentive to transferring the intangibles into the U.K., which one would have thought the U.K. would want to encourage.
Challenges for Taxpayers
Many groups will experience difficulty in calculating their possible exposure to the new rules. This will be particularly difficult where sales are made in the U.K. through unrelated parties who may be selling in a variety of jurisdictions and there may be instances where a group is not even aware that its goods or services are being sold to U.K. customers.
Aside from the challenges of quantifying a non-U.K. company’s exposure to the rules, collecting tax from non-U.K. resident companies poses a number of challenges for taxpayers and for HMRC. Nonresidents will be required to notify HMRC that they have a U.K. tax liability and complete a self assessment of the tax due.
HMRC will have long time limits to assess nonresidents—20 years in the case of non-notification of liability and 12 years for an incorrect return. It will also have wide powers to collect the tax from any person within the same “control group” as the offshore company. U.K. resident group companies will therefore be targeted should their offshore affiliates not comply.
Any non-U.K. company selling goods or services directly or indirectly to U.K. customers which holds intellectual property or other intangibles in a low tax jurisdiction needs to check whether it will be caught by the proposals and what its potential exposure will be.
Even though the new tax does not apply until April 2019, the “anti-forestalling” provisions apply from October 29, 2018. These provisions need to be considered if any restructuring of activities or structures is taking place, even if for non-U.K. tax reasons.
Eloise Walker is a Partner with Pinsent Masons LLP, specializing in corporate tax.
She may be contacted at: firstname.lastname@example.org
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