INTM489690 - Diverted Profits Tax: application of Diverted Profits Tax: legislation – Finance Act 2015 – core provisions: section 87 - exception for limited UK-related sales or expenses

In order to focus the operation of section 86 (“avoidance of a UK taxable presence”) on situations where there is a substantial level of economic activity in the UK there is an exception based on the level of a foreign company’s sales that are related to activity in the UK. Where those sales revenues of the foreign company taken together with certain sales revenues of connected companies are no more than £10 million in a 12-month accounting period, section 86 cannot apply.

This threshold is reduced proportionally if the accounting period is less than 12 months. In considering “connected” companies’ sales, the connection definition follows section 1122 CTA 2010.

Section 87 provides definitions in relation to this exception, starting with “UK activity”, meaning activity carried on in the UK in connection with supplies of services, goods or other property made by the foreign company (the supplies that are relevant to section 86). “UK-related sales revenue” means, for the foreign company, its revenues from “UK-related supplies” (see below), together with the trading revenue of connected companies so far as they arise from UK activity and are not taken into account in calculating the profits of those companies for corporation tax purposes.

So, if a company connected with the foreign company makes sales that are included in its corporation tax computation, either because it is UK-resident or is carrying on a trade through a UK PE, these will not be included. This helps the condition focus on the relevant UK activity in cases where a group may already have a substantial taxable presence in the UK in relation to a separate activity.

“UK related supplies” are supplies of services, goods or other property made by the foreign company or a connected company that relate to UK activity.

There may be some doubt as to the extent to which sales revenues of a company connected with the foreign company relate in some way to the activity carried on in the UK in connection with the supplies made by the foreign company in the course of its trade. The wording of the definition of UK activity at section 87(5) mirrors that of section 86(1)(c) and is broad in its scope. However, where there is clearly no connection at all between the UK activity taken into account for the trade of the foreign company that is tested for section 86 and the activity that would be taken into account in relation to the revenues of the connected company, the latter would not be brought in by the definition.

Example 1

Company X in country X heads a group engaged in a diverse range of activities. Its subsidiaries include Company Y in country Y and Company Z in country Z. Company Y sells household goods, under the Y brand name, to UK retailers. It has a subsidiary in the UK that carries on activity in connection with those supplies. Company Z sells specialist building materials, under the Z brand name, to UK construction companies and builders’ merchants. It has a subsidiary in the UK that carries on activity in connection with those supplies. The operations of Companies Y and Z are completely independent of each other, as are those of their two UK subsidiaries. In testing the UK-related sales revenues of Company Y there is no need to take account of those of Company Z (and vice-versa).

However, even in diverse groups, there may in practice often be considerations such as shared facilities, use of the same brand names or the similarity of the activities and markets that would not support the same conclusion.

The requirement to include the UK-related sales revenues of companies connected with the foreign company is not just aimed at deliberate fragmentation to achieve an amount below the threshold, so there is no motive test. The requirement should also reduce the scope for the exception applying in different ways depending on the detail of particular group structures.

Example 2

Company A in country A heads a group engaged in the manufacture and sale of perfumes and cosmetics. It has a subsidiary in the UK that carries on activity in connection with supplies totalling £17m in the accounting period in question, well above the threshold for the limited UK-related sales exception.

A group headed by Company B in country B manufactures and sells a similar range of products. However, for the last ten years Company B has had two subsidiaries in country C – Company C, which distributes cosmetics and Company P, which distributes perfumes. There is another subsidiary in the UK that carries on activity in connection with supplies totalling £9m of cosmetics for Company C and £8m of perfumes for Company P. In testing the UK-related sales revenues of Company C it is necessary to take account of those of Company P (and vice-versa). So the total UK-related sales revenues for the purposes of testing the application of the section 87 exception to either company, will be £17m.

There is also an exception from section 86 based on the level of “UK-related expenses”. This means expenses that relate to UK activity. The exception applies if such expenses of the foreign company, together with those of companies it is connected with, do not exceed £1m. Again this threshold applies for a 12-month accounting period and is reduced proportionally if the accounting period is shorter. The principles in relation to the requirement to take account of the UK-related expenses of connected companies are the same as for UK-related sales revenues.

For the purposes of the exceptions, both revenues and expenses are amounts that are recognised as such in the company’s profit and loss account or income statement in accordance with generally accepted accounting practice (GAAP). GAAP takes its section 1127 CTA 2010 meaning, which is either UK GAAP or GAAP under International Accounting Standards.

If there are no accounts following GAAP, as defined, then the amounts are what would have been recognised as revenues and expenses if such accounts had been drawn up.