DIVERTED PROFITS TAX – DTC and EU ASPECTS
Philip Baker QC
Field Court Tax Chambers
3 Field Court
Gray’s Inn
London WC1R 5EP
Tel: 020 3693 3700
FIELD COURT TAX CHAMBERS
OXFORD UNIVERSITY CENTRE FOR
BUSINESS TAXATION
13th January 2015
FIELD COURT TAX CHAMBERS
NOTE
PB’s personal position
Political imperative behind the tax – reflects popular concern at avoidance of UK tax on profits by MNCs
The key now is to get the drafting correct
FIELD COURT TAX CHAMBERS
TAX TREATIES
Question:
How does a State combat tax avoidance which is based on the use of its tax treaties to achieve an unintended result?
Typical examples Use of synthetic commissionnaires to avoid the conclusion of
contracts – Art 5(5) OECD MTC
Fragmentation of activities to fall within Art 5(4)
NOTE: These are within BEPS Action 6 – these are acknowledged as unintended results
FIELD COURT TAX CHAMBERS
TAX TREATIES
Possible answers: Terminate relevant treaties – not very attractive
Renegotiate relevant treaties – possible, but will take time unless a multilateral instrument is developed
Apply a deliberate tax treaty override – e.g. s. 62 F (No 2) A 1987 – post-Padmore
Impose a charge on a sum “computed by reference to…” profits – the Bricom solution for CFC tax: used quite frequently for anti-avoidance measures
Introduce a tax charge which is not covered by the UK’s tax treaties – the alternative issue in Bricom
FIELD COURT TAX CHAMBERS
TAX TREATIES
The DPT is not a “covered tax” – it is not a tax expressly covered (which are usually Income Tax, Capital Gains Tax and Corporation Tax). This is not unusual: nor are NICs, Bank Levy, ATED etc.
Art 2(4) OECD MTC – “any identical or substantially similar taxes” Very little case law or guidance, other than on capital
gains taxes (Kinsella and the Australian Virgin case) – none from the UK
FIELD COURT TAX CHAMBERS
TAX TREATIES
The DPT – is it substantially similar to Corporation Tax? Applies only to diverted profits – is a specific anti-
avoidance measure
Targets specific scenarios – clearly not a tax on general income and arguably not a tax on elements of income (e.g. capital gains)
Applies only to a narrow range of corporate taxpayers only
Has a different method of charge and procedural rules
Has a different rate
FIELD COURT TAX CHAMBERS
TAX TREATIES
Note – under existing principles the UK is not obliged to grant treaty benefits in abusive situations: OECD MTC, Art 1 Comm (since 2003)
“9.3 Other States prefer to view some abuses as being abuses of the convention itself, as opposed to abuses of domestic law. These States, however, then consider that a proper construction of tax conventions allows them to disregard abusive transactions, such as those entered into with the view to obtaining unintended benefits under the provisions of these conventions. This interpretation results from the object and purpose of tax conventions as well as the obligation to interpret them in good faith (see Article 31 of the Vienna Convention on the Law of Treaties).
FIELD COURT TAX CHAMBERS
TAX TREATIES
9.4 Under both approaches, therefore, it is agreed that States do not have to grant the benefits of a double taxation convention where arrangements that constitute an abuse of the provisions of the convention have been entered into.
9.5 It is important to note, however, that it should not be lightly assumed that a taxpayer is entering into the type of abusive transactions referred to above. A guiding principle is that the benefits of a double taxation convention should not be available where a main purpose for entering into certain transactions or arrangements was to secure a more favourable tax position and obtaining that more favourable treatment in these circumstances would be contrary to the object and purpose of the relevant provisions.”
FIELD COURT TAX CHAMBERS
TAX TREATIES
NOTE DPT – targeted anti-avoidance measure Cl 2(1)(c) – “so designed as to ensure…[avoided PE]”
Cl 2(4) – main purpose to avoid corporation tax
Cl 7(4), (5), (6)(c) – “designed to secure the tax reduction”
NOTE BEPS Action 6 – 2014 Deliverable, para 14 – agreement on the inclusion of at least a minimum of anti-avoidance measures in DTCs or domestic law, including the Principal Purpose Rule
FIELD COURT TAX CHAMBERS
TAX TREATIES
Tax treaties are given effect in UK law only so far as domestic law expressly so provides – see s. 6 TIOPA; s. 158 IHTA 1984 – the UK’s position is well known here
No domestic law gives effect to DTCs with respect to the DPT
FIELD COURT TAX CHAMBERS
TAX TREATIES
Anyone seeking to challenge the cl 2 charge (on an avoided PE), for example, as contrary to a UK DTC would need to show: The DPT is a covered tax or a substantially similar tax
That they were entitled to the benefits of the treaty, as properly interpreted in line with the OECD Commentary
That they did not have a PE in the UK, when the DTC is correctly applied to their facts and circumstances
AND then would fall a cropper that either: The DTC is not given effect with regard to the DPT; or
Parliament has enacted an implicit tax treaty override
FIELD COURT TAX CHAMBERS
EU LAW
More complex as EU tax law is still evolving – especially with regard to justifications (not acte claire)
Question: Must it be consistent with EU law that a state permits companies to earn significant profits in its territory without paying the Corporation Tax normally due on those profits?
NOTE: If it is a problem of EU law for the UK to combat base erosion and profit shifting unilaterally, it must equally be a problem for any BEPS outcome that offers a similar or identical solution on a multilateral basis
FIELD COURT TAX CHAMBERS
EU LAW
Relevant freedom: Art 49 TFEU – freedom of establishment (DPT only applies
to control situations – in effect, the argument could only be based on a restriction on market access)
Art 56 TFEU – services
So no argument with respect to Third States
Note some MNC group members might not be able to satisfy requirements of a genuine establishment – note cl 3 charge targets “entities or transactions lacking economic substance”
Note Cl 2 only applies cross-border; Cl 3 is not so limited
FIELD COURT TAX CHAMBERS
EU LAW
Assuming (without conceding) that the DPT restricts the freedom of establishment / freedom to provide services (which is not necessarily the case as the company can pay the Corporation tax normally due on its profits)
Then the issues of justification and proportionality arise
FIELD COURT TAX CHAMBERS
EU LAW - JUSTIFICATIONS
The DPT is consistent with the international principle of fiscal territoriality – that a state may tax profits arising in its territory See Futura C-250/95 – paras 21 and 22 and subsequent
cases
FIELD COURT TAX CHAMBERS
EU LAW - JUSTIFICATIONS
Justifications: combatting tax avoidance
Cadbury Schweppes formulation: see Itelcar Case C-282/12, para. 34 targets wholly artificial arrangements which do not
reflect economic reality and whose sole purpose is to avoid the tax normally payable on the profits generated by activities carried out on national territory
les montages purement artificiels, dépourvus de réalité économique, dont la seule fin est d’éluder l’impôt normalement dû sur les bénéfices générés par les activités réalisées sur le territoire national
FIELD COURT TAX CHAMBERS
EU LAW - JUSTIFICATIONS
Justifications: combatting tax avoidance wholly artificial arrangements – does the Court really mean
wholly artificial?
Cadbury Schweppes uses the “wholly artificial” formulation, but then accepts that CFC legislation can satisfy the test , so long as tp has opportunity to prove objective facts showing genuine establishment
DPT can be seen as a sideways CFC charge DPT: cl 2(4) – tax avoidance condition: main purpose test OR
mismatch condition (which includes insufficient economic substance condition)
DPT: cl 3 – entities or transactions lacking economic substance
DPT: cl 7 – insufficient economic substance conditions
FIELD COURT TAX CHAMBERS
EU LAW - JUSTIFICATIONS
Justifications: combatting tax avoidance which do not reflect economic reality – NB not always
included in Court’s formulation NOTE: it is the combatted arrangements which must not reflect
economic reality
E.g artificial avoidance of PE status
E.g. How does it reflect economic reality that representatives are restricted from concluding contracts?
FIELD COURT TAX CHAMBERS
EU LAW - JUSTIFICATIONS
Justifications: combatting tax avoidance whose sole purpose is to avoid the tax normally payable
on the profits generated by activities carried out on national territory Cl 2(1)(c) – designed to ensure no PE
Cl 7(4), (5), (6) (c) – designed to secure the tax reduction
FIELD COURT TAX CHAMBERS
EU LAW - JUSTIFICATIONS
Justifications: combatting tax avoidance Alternative formulation: Marks & Spencer
Combatting tax avoidance combined with preservation of the fiscal principle of territoriality
Justifications – the category is not closed E.g. Felixstowe – combatting tax havens!
Combatting base erosion and profit shifting?
Application of balanced application where the UK is not obliged to give treaty benefits (see above)
FIELD COURT TAX CHAMBERS
EU LAW - PROPORTIONALITY
Itelcar “37 In that connection, it is apparent from the case-law of the Court
that, where rules are predicated on an assessment of objective and verifiable elements for the purposes of determining whether a transaction represents a wholly artificial arrangement entered into for tax reasons alone, they may be regarded as not going beyond what is necessary to prevent tax evasion and avoidance, if, on each occasion on which the existence of such an arrangement cannot be ruled out, those rules give the taxpayer an opportunity, without subjecting him to undue administrative constraints, to provide evidence of any commercial justification that there may have been for that transaction (see, to that effect, Case C-524/04 Test Claimants in the Thin Cap Group Litigation, paragraph 82, and Case C-318/10 SIAT [2012] ECR, paragraph 50).”
FIELD COURT TAX CHAMBERS
EU LAW - PROPORTIONALITY
DPT Initial onus on HMRC in issuing preliminary notice to
point to facts to show it is reasonable to assume that the activity was, for example, designed to avoid a PE – Cl. 14(3)(a)
Cl. 15 – Representations
Similar obligation on HMRC in a charging notice – Cl. 15 (5)(b)
Cl. 20 – HMRC Review
FIELD COURT TAX CHAMBERS
EU LAW - PROPORTIONALITY
Effect of application of DPT is to apply normal attribution of profits rules (Cl. 8(3) – applying ss. 20 – 32 CTA 2009) or transfer pricing rules (Cl. 10(3) applying Part 4 TIOPA – subject to Cls. 10(5) – (7))
Consistent with Itelcar and SGI
FIELD COURT TAX CHAMBERS
EU LAW – ADDITIONAL POINTS
25% tax vs 20% corporation tax – clear incentive element built in: encourages submission of profits to corporation tax at 20%
Payment within 30 days of charging notice Contrast quarterly payments of Corporation Tax on profits as estimated
Note – target companies are MNCs
Legitimate expectation Commissionnaire arrangements – always expected to have a limited life
expectancy
BEPS highlights changes expected
Note: specific provisions to eliminate double taxation
FIELD COURT TAX CHAMBERS
EU LAW To bring a successful challenge under EU law a company would need
to show:
That it was within the DPT – it had designed its arrangements to avoid a PE / obtain an effective tax mismatch outcome and was unable to present objective evidence why it was not within the tax
That it was entitled to rely upon the relevant freedom – probably freedom of establishment
That the tax had a restrictive effect (i.e. it should not be liable to pay the Corporation Tax normally due)
That the charge was not justifiable under combatting tax avoidance or preserving territoriality or combatting BEPS / balanced allocation
Or the charge was disproportionate
AND would have to be willing to proceed to the CJEU (in about five years) as matter is not acte claire
DIVERTED PROFITS TAX – DTC and EU ASPECTS
Philip Baker QC
Field Court Tax Chambers
3 Field Court
Gray’s Inn
London WC1R 5EP
Tel: 020 3693 3700
FIELD COURT TAX CHAMBERS
OXFORD UNIVERSITY CENTRE FOR
BUSINESS TAXATION
13th January 2015
