INTM489745 - Diverted Profits Tax: application of Diverted Profits Tax: legislation – Finance Act 2015 – core provisions: the effective tax mismatch outcome – reduction in the income of the first party

In most cases it should be clear whether the material provision results in “expenses of the first party”, but it may be more difficult to know whether it results in “a reduction in the income of the first party that would otherwise have been taken into account …”. Such a reduction in income may relate to an arrangement to net an expense against income, but also where income itself is diverted and the first party’s income is reduced to less than it would receive under arm’s length conditions.

A situation that could be in scope would be where a UK company transfers an asset with an established income stream to an affiliate in a low tax jurisdiction and that affiliate, because of its own lack of substance, relies on the UK company to manage the asset. The material provision is not just made by the transfer of the asset but also by the transaction under which the UK provides the functions needed to develop, enhance, maintain, protect and exploit the asset. This of course results in income to the UK company, but less than either; what would have been the case if the asset had not been transferred, or if the transaction had been calculated in accordance with the arm’s length principle.