INTM489804 - Diverted Profits Tax: application of Diverted Profits Tax: examples and particular situations: specific tangible assets
Example 1
Facts
- A UK company which has traditionally held and managed all its property assets onshore (UK Property Company 1) sets up a company in a very low tax territory with a mixture of debt and equity funding. It then sells a UK property that is in the course of development to that company.
- All costs in relation to the development are incurred by the new company but all the work on the development and all critical decisions are being taken by the management team for the group in the UK.
- When the property is developed, it is leased back to a property subsidiary in the UK (UK Property Co 2) and then on-let to tenants which the UK group finds for the property.
- The rental payments out to the offshore company are set at a level which effectively leaves the UK with only a nominal margin.
- The facts show that the management of the company in the very low tax territory do not have the authority or expertise to do this project on their own or indeed to manage the portfolio – they are effectively acting as conduits.
Analysis
This is a change in the group’s normal pattern of holding properties and the profits allocated to the offshore company are very much out of line with its contribution. It has capital but it is really unable to manage that capital itself. The transactions can, therefore, be considered for DPT purposes as amounting to an arrangement where all the offshore company is doing is holding the asset on behalf of a member of the UK group. This could potentially lead to the conclusion that the transactions would not have occurred absent considerations in relation to tax on the income from the asset. It would follow that DPT would apply by reference to the relevant alternative provision on the basis that no deduction for the rental payments would be due.
However, because the asset is a rented property it would be expected that the arrangements following the transfer of the property would be within the Non-Resident Landlord Scheme (see PIM4800 onwards). Although the arrangement is one in which all the offshore company is doing is holding the property on behalf of the UK member group, there should not actually be any loss of UK tax as the rental income of the company in the low tax territory is subject to UK income tax, either as a result of withholding tax suffered on the rents paid by the tenant or letting agent, or by direct assessment on the filing of an income tax return by the Non-Resident Landlord.
Technically, an effective tax mismatch outcome can arise in the latter circumstance (that is, where this is directly suffered by the landlord, and not by way of withholding tax), perhaps as a result of non-qualifying deductions being taken into account under Section 108(2)(b) FA15, for example interest expense incurred by the overseas company. However, this would not in itself mean that section 80 would apply to potentially give rise to a DPT charge, as the “insufficient economic substance condition” in section 110 must also be considered. As long as there is no real loss of UK tax because of the proper operation of the NRL Scheme, the assumption that the arrangements were designed to secure a tax reduction would not follow and no DPT charge would arise (and therefore no need to provide for a credit to be given for any income tax suffered in computing the liability).
Furthermore, if the computational rules at sections 82 to 85 were to be considered, a relevant alternative provision on the basis that the transactions would not have occurred absent considerations in relation to tax on the income would not follow from the facts (see INTM489740).
Example 2
Facts
- A UK member of a multinational group owns and leases aircraft and other assets to unconnected third-party customers in Western Europe.
- The parent company acquires a company with more expertise in acquiring and managing aircraft than the UK company and whose aircraft leasing activities are more profitable, with large leasing contracts across the world.
- As part of a group restructuring, the UK company transfers ownership of its aircraft to the new foreign affiliate at fair market value on the basis that this is a more appropriate home within the group for those particular assets. This leaves the UK company better able to focus on and develop its more profitable activities. Some of its staff who had worked in the aircraft division transfer to the foreign affiliate.
- A few of the aircraft are leased back to the UK company on arm’s length terms that allows it to make an appropriate profit for leasing them on. Most are used by the foreign affiliate in the ordinary course of its trade.
- The foreign affiliate has very significant substance behind its activities. The UK company does not have a similar level of capability in respect of aircraft and could not perform all the same functions.
Analysis
The substance of the new affiliate company and its functional capability to acquire, manage and exploit aircraft assets more profitably than the UK company should make it unlikely that the transactions or the involvement of the new affiliate company were designed to secure a tax reduction. However even if that was not clear, the presence of those factors would point away from a conclusion that the transactions would not have taken place at all in the absence of a tax reduction.