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The Proposed United Kingdom "Diverted Profits Tax"

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The United Kingdom proposes to introduce, on profits arising as of April 1, 2015, a “Diverted Profits Tax.” This is intended to override the normal international tax arrangements when H.M.R.C. (the U.K. tax authority) does not like the outcome. Domestic laws, O.E.C.D. practice, and a network of Double Tax Agreements provide a definition of “Permanent Establishment” defining what income is or is not taxable within the country of operation. Similarly, “Transfer Pricing” rules should enable the tax authorities to ensure that the price used for transactions between related entities is appropriate for calculating proper division of taxable revenue between the countries concerned. While many believe that these are not working as well as they should, the problems need a more subtle and sophisticated solution rather than a blunderbuss approach.

The “Diverted Profits Tax,” at a rate of 25% (mildly penal, compared with the Corporation Tax rate of 21%), is to be imposed if H.M.R.C. does not like the answer produced by these well-established procedures and succeeds in claiming, under this new law, that profits have, nevertheless, been “diverted.” The draft legislation sets out very detailed rules. These are available on the H.M.R.C. website, but those who follow matters very closely would be well-advised to continue to examine the extensive comments that are being made. The draft legislation gets very close to giving H.M.R.C. the power to determine unilaterally the level of taxable income. “Tax by administrative discretion” is a policy normally associated with authoritarian or left-wing governments. The United Kingdom may well, post-election, have a leftwing government who will be delighted to be presented with what, to them, is a very attractive measure.


What do those affected by the draft legislation and their advisers need to do or know? The provisions will not apply to S.M.E.’s, i.e., groups with less than £10 million of annual sales within the U.K. Others will need to consider their position very carefully and make contingency plans on the assumption that the provisions will be enacted, although perhaps in a substantially amended form. H.M.R.C. forecasts that the measure will eventually bring in £350 million per annum, but goes on to say that it “is not expected to have a significant economic impact.” American readers in particular will be well aware that there is a huge gap between the initially-forecast yield of a tax avoidance measure and the outcome. Hastily proposed and badly designed tax legislation is often more successful at creating economic damage than producing revenue or desirable changes in activities.