The Government’s new Diverted Profits Tax – the so-called Google Tax – occupies 26 pages of closely drafted legislation. These are my immediate thoughts, a matter of an hour or so later.
The measures tackles two particular types of ‘diversion’ of profits being:
- first, where an economic entity avoids establishing a UK presence (known to tax practitioners as a Permanent Establishment) so that the profits from sales of goods and services to UK consumers fall outside the charge to UK corporation tax (call it the “Amazon diversion”) and
- second, where an economic entity which has profitable activities in the UK diverts those profits to lower tax jurisdictions abroad (call it the “Starbucks diversion”).
There are a number of important economic concepts embedded in the legislation but the important ones look to me (on an initial reading) to be
- that the arrangements happen in concert (or as I have put it for shorthand within a single economic entity). This concept is defined in clause 5 “The participation condition”
- that the arrangements generate a tax saving. This concept is defined in clause 6 “Effective tax mismatch outcome”. Clause 6 contains a key value judgment made by the drafters of the regime. Arrangements offend against the regime if they (broadly) lead to profits being diverted to another country where those profits give rise to a tax charge of less than 80% of that which would arise in the UK and
- that they lack economic substance. This concept is defined in clause 7 (“Insufficient economic substance condition”) which requires (broadly) that the tax benefits of the arrangements are greater than the non-tax benefits. Putting the matter another way, that the arrangements were effected for tax reasons.
Standing back from the detail, a few observations
- diverted profits tax looks to me to be a foothold – only a foothold but a meaningful one – in a new and more fiscally satisfactory world in which tax better reflects the economic substance of transactions
- the higher rate at which the diverted profits tax is to be charged (compared with corporation tax) may well reflect a policy preference that economic entities bring themselves with the normal domestic corporation tax regime
- there are signs – quite understandable, given the radical nature of these measures – of caution on the part of the draftsman: the tax liability is fixed following an iterative process of discussion between putative taxpayer and an officer of HMRC. Even after it is fixed, there remains scope for later adjustment
- the Green Book shows the yield growing from £270m in 2016-17 to £360m in 2017-18. Speculating, I wonder whether built in to these forecasts is an expectation that the measures might adapt as business behaviour adapts. But whether or not that expectation is built into the forecasts, it is my expectation that these measures will have to adapt and change.
- a big question is how other countries will respond to this unilateral measure. For myself, instinctively I doubt that these measures will come to be regarded as contrary to EU law. The bigger question is, what effect might they have on the propensity of our co-signatories to Double Tax Conventions to continue to observe those Conventions. On this point, I would assume that Government had already taken initial soundings.
Waiting for Godot 
I do wonder why reliance is placed from the outset on a test of whether X is designed to ensure Y, rather than simply where Y is the case, especially if it is stated to be irrelevant whether X is designed for any other purpose.
A few initial comments too.
The 25% rate is clearly (and as you suggest deliberately) discriminatory. Non-UK taxpayers might pay the new tax at 25%; corporation tax is 21% and shortly 20%.
The de minimis of £10m UK sales will help a lot of people (not Google, Starbucks or Amazon, but it might explain the limited expected revenue). There will be a compliance burden on those who need to notify liability and claim a credit for tax paid on the same profits elsewhere.
Do these measures override the allocation of taxing rights under existing double tax treaties? Before those treaties are amended as a result of BEPS Action 7?
There is only so much tax base to go around. Businesses operating across borders are going to need revenue authorities to sign up to much quicker and more effective mutual agreement / dispute resolution procedures.
I think it’s because the notion of diverting profits involves a comparison between a factual (low tax because you have diverted profits) and a counterfactual (the tax which might otherwise be payable). If you are seeking to catch the counter-factual you need to start by asking why the factual has been created. Looking at it in another way, if you’re just taxing Y then you’re taxing what we already have.
The discriminatory 25% rate is deliberate to try to change behaviour. The desired result would be best if the “Amazon style” company decides to establish a UK tax presence and the “Starbucks type” company stopped diverting profits through contrived arrangements and both instead decided to pay normal Corporation tax at 21% on genuine commercial UK profits.
If the companies in question can see that they will pay less tax this way (and have more certainty over the amount and timing of the tax cash flow) then they will quickly revert to these normal business structures and the contrived tax avoidance will stop.
Then there would be no issues with Double Tax Conventions and no extended negotiations on how to calculate how much diverted profit gets taxed at 25%.
The most effective may to close tax loopholes is normally achieved by making it commercially more attractive to not do the contrived tax planning in the first place.
Thanks Steve. I rather agree – and it was this that I was alluding to in my second ‘Observation’ bullet point.
Ah yes, so you did. And now I read your post properly I can see that you put it so much more concisely than my attempt 🙂
Easily done 🙂
Not in this case because Y is already a negative. That is, “not carrying on a trade in the United Kingdom through a permanent establishment in the United Kingdom by reason of the avoided PE’s activity”. Obviously that “not” means ‘what we already have’ cannot be taxed.
So my wondering is why there is not more of an objective test around this rather than a subjective test of reasonableness of assumption about whether the activity was designed to ensure that this was the case.
Not sure how much further we can take our alegbraic formulation. But the “insufficient economic substance condition,” I think, encapsulates an objective test: was it “reasonable to assume” the transaction was designed to secure a tax reduction (see clause 7).
One might think objective tests are to be preferred (because otherwise different taxpayers in identical circumstances can face different liabilities to tax). The law typically tends to adopt subjective tests, however, because one only looks to counteract transactions that reduce tax bills if they actually reduce tax bills and to focus purely on the effect of that transaction might be to ignore that a taxpayer might have (for him) commercial reasons for entering into it (the leading case on this is still Brebner v IRC).
You might well conclude, however, that the end is nigh for subjective tests.
It’s not just ‘Amazon style’. It is also ‘Google style’ (and probably hence why the tax was dubbed such by the spinners at the Treasury). It seems quite clearly aimed at both of them – one with its Ireland structure and one with its Luxembourg structure.
Given that the UK’s corporate tax rate is low in comparison with many other countries, there will I am sure be UK companies that export and ensure they do not have a p/e abroad. If all other countries start implimenting similar taxes to this, what then?
It seems to me that every tax change advocated assumes there will only be one outcome, more tax for the UK exchequer.
It ain’t necessarily so.
Not sure why it isn’t contrary to EU law. The diversion of profits may well be to EU countries such as Ireland or Luxembourg (to pick two at random…); penalising an entity for setting up in Ireland and trading with the UK without a PE compared to operating with a UK PE seems to me to be prima facie contrary to Article 56, free movement of services?
Nicely put.
It’s for that reason, amongst others, that I considered the 80% test to be the “key value judgement” being made by the drafters of the google tax. It’s basically just our domestic draftsman’s assessment of how much tax is ‘enough’. And, as you point out, others (for example the US with a 35% corporate tax rate) may think that our 20% rate (representing 57% of its rate) is ‘not enough’.
Not sure I follow your argument. But there will (undoubtedly) be arguments to be formulated that these measures impinge upon the free movement of capital. What those arguments will, ultimately, boil down to is whether there is a fundamental EU freedom to move capital to avoid tax. We’ve had what seems to me to be an analogous argument in the ECJ in a different context: it led to the abuse of rights principle for VAT. My instinct is that that is where we will end up here.
I think so too. That will be interesting. Though remembering that from legislation to resolution of the ‘abuse’ cases took about ten years!
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