INTM489655 - Diverted Profits Tax: application of Diverted Profits Tax: legislation – Finance Act 2015 – core provisions: section 86 - avoidance of a UK taxable presence – situation 3

Section 86 of the legislation can apply where foreign companies make substantial sales through activity in the UK while avoiding the creation of a UK permanent establishment (PE). Such arrangements are often combined with other arrangements that allow the foreign company to transfer profits associated with those sales to companies resident in territories where little or no tax is paid. (These arrangements are sometimes given names such as “double Irish” in the press and tax publications, but there are many variations.)

The legislation seeks to identify these cases by identifying whether economic activity takes place in the UK in connection with the supply of services, goods or other property by a foreign company, but structured so as to ensure that the foreign company is not carrying on a trade in the UK for corporation tax purposes. This includes, for example, arrangements involving significant sales activity in the UK, but designed to stop short of the conclusion of contracts.

Section 5(2) CTA 2009 (Territorial scope of charge), states that a non-UK resident company is within the charge to corporation tax only if it carries on a trade in the UK through a PE in the UK. The meaning of PE is defined at paragraph 24 Chapter 2 CTA 2010 but the domestic law definition is restricted by any narrower definition given in a tax treaty in force between the UK and the country of residence of the foreign company.

Section 86 applies where the following conditions are met:

  • there is a company, that carries on a trade, that is not resident in the UK (the “foreign company”);
  • a person (“the avoided PE”) is carrying on an activity in the UK in connection with the supplies of services, goods or other property by the foreign company in the course of its trade. It does not matter if that person is a UK resident;
  • it is reasonable to assume that the activity of the avoided PE or the foreign company (or both) is designed so as to ensure that the foreign company does not, for the purposes of corporation tax, carry on the trade referred to in the first bullet in the UK (whether or not it is also designed to secure any commercial or other object). In practice, because of the effect of section 5(2) CTA 2009 mentioned above, this means that the activity is designed so as to ensure that the foreign company is not treated as carrying on a trade through a UK PE;

and

  • the avoided PE and the foreign company are not small or medium sized enterprises, as defined by Section 172 TIOPA 2010 (INTM412080).

For it to be reasonable to assume that activity is designed to ensure that the foreign company is not carrying on a trade through a UK PE there will be some degree of contrivance in the arrangements present in the accounting period, irrespective of the accounting period in which that contrivance was designed. They will differ in some material way to the arrangements that we would expect to have been made if there had been no considerations around the PE threshold.

For it to be reasonable to assume that the arrangements I are designed to avoid the existence of a UK PE, it must be the case that, in the absence of the arrangements, a UK PE would have existed under UK domestic law and/or treaty provisions.

In addition either or both of the following conditions must be met:

  • the mismatch condition (which is based on the section 80 rules described at INTM489595), or
  • the tax avoidance condition.

These two conditions are described at INTM489675 and INTM489680.