INTM489645 - Diverted Profits Tax: application of Diverted Profits Tax: legislation – Finance Act 2015 – core provisions: consequences of section 80 or 81 applying - section 85 - calculation by reference to the relevant alternative provision

Section 85 applies where the actual provision condition is not met. That is, either the relevant alternative provision would not have resulted in expenses of the same type and for the same purpose or would have resulted in relevant taxable income (or both).

Where section 85 applies, the taxable diverted profits are to be determined as if the relevant alternative provision had been made or imposed instead of the material provision.

However, if the only reason the actual provision condition is not met is that the relevant alternative provision would have resulted in relevant taxable income, then the taxable diverted profits that arise to the relevant company, in relation to a particular material provision, will be an amount equal to the sum of relevant taxable income and any additional amounts, over and above those in the company’s corporation tax return, from transfer pricing adjustments, that is, transfer pricing adjustments based on the material provision.

Otherwise, the taxable diverted profits will be the sum of the relevant taxable income (if any) plus the “notional additional amount.” The notional additional amount is, in relation to the particular material provision being considered, the amount that would have been chargeable to corporation tax had the relevant alternative provision been made or imposed less the amount included by the company in its corporation tax return in respect of the material provision and which is chargeable to corporation tax by virtue of Part 4 of TIOPA 2010 or which, in a case where section 81 applies, are attributable to the UKPE under sections 20 to 32 of CTA 2009. The tax treatment of the taxable diverted profits is considered on the basis that the additional amount required to bring those taxable diverted profits into charge to corporation tax is additional to the company’s overall tax position under the material provision.

So, for example it may be the case that as a result of the material provision a UK company pays a royalty or other expense to an affiliate in a territory where no tax is paid in respect of an asset held there, but that the relevant alternative provision would have resulted in the UK company holding that asset itself, that is, that there would have been no provision (on the basis that the main reason for the affiliate holding the asset is to secure the tax reduction). If so then the taxable diverted profits of the UK company would be: the profits to which it would have been chargeable to corporation tax on the basis of the relevant alternative provision (that is, that the UK company held the asset itself and no royalty was payable); LESS the profits to which it is chargeable to corporation tax taking account of any transfer pricing adjustment in the company’s corporation tax return made before the end of the review period. The DPT legislation provides an additional opportunity for a company charged to DPT to amend its company tax return during the first 12 months of the review period (s101A Finance Act 2015). This is in addition to the period in which the company can amend its return under Para 15, Schedule 18, Finance Act 1998.

However, the notional additional amount would be at least the full amount of the royalty less any excess element adjusted for under transfer pricing rules. The DPT charge could only be eliminated in full in the event that the transfer pricing adjustment reduced the royalty to nil.

Taxable diverted profits would also arise where the relevant alternative provision would have resulted a company being in receipt of relevant taxable income. For example, a UK company may use an asset that is located in a territory where no tax is paid which absent the contrived arrangement would have been held by another UK connected company. If, under the relevant alternative provision, the UK company would have paid a royalty to the other UK company for the use of that asset then that royalty income is to be added to the taxable diverted profits of the first UK company for the purposes of calculating the DPT.

This will be the case for as long as the relevant alternative provision would have continued to operate. In circumstances where the relevant alternative provision would have ceased to apply, the position is examined on the basis of the then applicable facts. The relevant alternative provision has no impact on the application of taxes other than DPT.

Example 1

UK Company A pays a royalty to a subsidiary in a low tax regime for the use of an asset held there. A’s pre royalty profits are £50m and the deduction claimed in its accounts for the royalty is £20m, giving it taxable profits, as originally returned, of £30m. On consideration of the facts and circumstances HMRC concludes that the relevant alternative provision would have resulted in Company A holding the asset itself and that no royalty would have been paid.

During the review period the group agrees that the arm’s length price for the royalty is £12m and adjusts A’s corporation tax return accordingly, increasing its taxable profits to £38m.

Based on the relevant alternative provision A would not have made a royalty payment for the use of the asset so the actual provision condition does not apply. The taxable diverted profits are therefore the amount by which the amount in respect of which A would have been chargeable to corporation tax for the period had the relevant alternative provision been made or imposed instead of the material provision, that is, £20m exceeds the amount in respect of which the company Is chargeable to corporation tax following transfer pricing adjustments made, that is, £8m, resulting in taxable diverted profits of £12m less an amount in respect of expenses it would be just and reasonable to assume would have been incurred by A in holding the asset. It should be noted that the profits chargeable to corporation tax also increase by £8m. In this case there is no relevant taxable income.

Example 2

The facts are the same as example 1 except that consideration of the facts and circumstances leads HMRC to conclude that the relevant alternative provision would have resulted in a separate UK Company B holding the asset and charging royalties for its use to other group companies.

During the review period the group agrees that the arm’s length price for the royalty is £12m and adjusts A’s corporation tax return accordingly, increasing its taxable profits to £38m.

Based on the relevant alternative provision A would have had expenses for which a deduction would be allowed for corporation tax purposes and the relevant alternative provision would also have resulted in expenses for Company A of the same type and for the same purpose as the material provision. However, the relevant alternative provision would result in the royalty being paid to B and which would be relevant taxable income within the meaning of section 82(8). Therefore, the taxable diverted profits will be calculated by reference to the relevant alternative provision but in accordance with section 85(3) and (4).

A’s taxable diverted profits are the sum of the profits in respect of which A is chargeable to corporation tax following the application of the TP rules to the material provision, but which are not taken account of in an assessment to corporation tax before the end of the review period plus the relevant taxable income of a connected company. In this case Company A has made an adjustment to its self-assessment to properly give effect to the TP rules. As the company has adjusted its return within the review period this element of diverted taxable profits is nil. In addition, Company B has relevant taxable income of £12m less expenses which would have been incurred by Company B in earning that income.

On this basis A’s total taxable diverted profits are £12m less an amount in respect of expenses it would be just and reasonable to assume would have been incurred by B.