Commonly referred to as the “Google Tax,” Diverted Profits Tax is targeted at large multinationals, but the breadth of the rules means it can apply to medium-sized groups and can catch commercially driven structures. It was introduced in the U.K. 2015 to address concerns that multinationals could be artificially diverting profits outside of the U.K. tax net.
Following concerns internationally around large multinational groups paying “their fair share” of taxes and the perceived ability of multinationals to arrange their affairs to reduce their tax bills by pushing profits into low tax jurisdictions, the G-20 appointed the Organization for Economic Co-operation and Development (“OECD”) to review matters.
This resulted in the OECD publishing a number of recommendations, leaving the member countries to implement these into their own legislation. The recommendations included proposals on how transactions between group companies should be priced for tax purposes, when a group has a taxable presence in a particular country, and requirements to send the tax authorities detailed information on their turnover and assets and profits in each jurisdiction in which they operate.
Together these measures form the Base Erosion and Profit Shifting (“BEPS”) initiative.
The U.K., together with most major jurisdictions, has embraced the BEPS proposals, and in most instances has introduced the OECD’s proposals into U.K. tax law. That said, U.K. authorities have also gone beyond the BEPS requirements, by introducing the Diverted Profits Tax (“DPT”) in April 2015.
The DPT was designed to target what was perceived as unacceptable tax planning. Very broadly, it is a set of measures designed to catch profits which are artificially diverted away from the U.K., either by using entities or transactions which lack economic substance, and/or arrangements designed to avoid a U.K. taxable presence.
A typical structure which could be caught, for example, would be where a multinational moves its high value intellectual property (“IP”) and intangible assets to a low tax regime, with group companies in higher tax locations then making payments to the lower taxed overseas company for use of the IP. Depending on the substance of the arrangements, whether they are commercial, for example, DPT could apply in these circumstances.
Where DPT applies, tax is charged at a rate of 25 percent on the profits that are artificially diverted from the U.K. This compares with a corporation tax rate of 19 percent, which is due to drop to 17 percent in 2020.
Furthermore, businesses are required to notify Her Majesty’s Revenue & Customs (“HMRC”) of arrangements that could fall within the DPT regime. Clearly, DPT is designed to discourage businesses from using arrangements that would be caught, and effectively to bring those diverted profits onshore.
Issues for Taxpayers
The DPT rules are very complex, and many of the sections are open to interpretation. While HMRC has published guidance notes, this has left many taxpayers facing uncertainty over whether they fall within the scope of the rules and whether they need to notify HMRC, which could lead to them possibly incurring very significant professional costs in taking detailed advice on the application and interpretation of the rules in their specific circumstances.
In particular, it can be necessary for taxpayers to demonstrate why a structure which was implemented many years ago was done in a specific way. For some groups, it has been possible to discuss these problems with their customer relationship manager at HMRC, but anecdotal evidence suggests differing levels of knowledge on the rules within HMRC, leading to a sometimes inconsistent approach from the authorities.
Response from Multinationals
Multinationals tend to be very concerned at the prospect of adverse publicity, and particularly at the prospect of being accused of not paying the proper amount of tax. When DPT was introduced, HMRC did not anticipate collecting vast amounts of DPT; they envisaged that multinationals would amend their structures to bring profits within the scope of corporation tax to avoid DPT, both because of the lower tax rate and to avoid potential reputational damage.
HMRC has recently published statistics on the operation of the DPT which show it yielded additional tax of 31 million pounds ($40,413 million) in 2015–16, 281 million pounds in 2016–17 and 388 million pounds in 2017–18. These amounts include both DPT charged, and additional corporation tax where taxpayers changed structures to avoid paying DPT itself; that is, where they effectively restructure to choose to pay corporation tax at 19 percent rather than DPT at 25 percent.
The number of groups notifying HMRC that they may be within the scope of DPT was 48 in 2015–16, 145 in 2016–17 and 220 in 2017–18. It should be noted that DPT will not necessarily apply in all these case.
In perhaps the highest profile example to date, Diageo were reported to have paid corporation tax of 190 million pounds in order for HMRC to return DPT previously paid of 107 million pounds. HMRC will doubtless be pleased to see press reports that a number of other major groups are also agreeing to increased corporation tax payments to avoid DPT.
Anecdotal evidence of taxpayers changing their behavior to avoid falling within DPT, together with the HMRC statistics on yield, suggest that DPT is working, from the government’s perspective. Furthermore, when setting up new structures, arrangements which were common in multinationals a few years ago would not now be considered.
While it is commonly called “Google Tax” in the press, the DPT rules catch a much wider range of businesses. DPT may be targeted at the very large multinationals, but it also affects many medium-sized groups. HMRC’s focus to date appears to have been on the very large multinationals but we may now see them starting to turn their attention towards medium-sized groups.
DPT is clearly an important measure for HMRC in countering what it perceives as unacceptable tax planning arrangements and encourages taxpayers to break up certain structures while discouraging them from entering those type of arrangements in the future.
It is anticipated that HMRC will be increasing the number of DPT challenges they make, so taxpayers will need to ensure that they have properly considered their position and consider specialist advice where appropriate to make sure they comply with the regulations.
Paul Fay is a Partner, Corporate Tax, at national audit, tax, advisory and risk firm, Crowe UK.
He may be contacted at: firstname.lastname@example.org