INTM610150 - Exception Conditions: Tax Mismatch

Paragraph 2(2)(a) Schedule 4 Finance Act 2019 provides that arrangements will be excepted from being Profit Fragmentation arrangements if the material provision does not result in a Tax Mismatch for the tax period of the resident party. Paragraph 5 and paragraph 6 Schedule 4 Finance Act 2019 define Tax Mismatch and the 80% Payment test (these are both discussed below).

Paragraph 5 Schedule 4 Finance Act 2019 says that the material provision will result in a tax mismatch for a tax period of the resident party if:

  • in that period, in relation to a relevant tax, it results in one or both of

  • an increase in the expenses of the resident party for which a deduction is taken into account in calculating the amount of the relevant tax payable by the resident party, or

  • a reduction in the income of the resident party which would otherwise have been taken into account in calculating the amount of the relevant tax payable by the resident party,

  • it is reasonable to conclude that

  • the resulting reduction in the amount of the relevant tax which is payable by the resident party exceeds the resulting increase in relevant taxes payable by the overseas party for the period corresponding to the tax period, and

  • the overseas party does not meet the 80% payment test, and

  • the results are not exempted by paragraph 5(5) Schedule 4 Finance Act 2019 (see section 4.1.4 below).

References to the tax reduction in the Profit Fragmentation rules are to the amount by which the resident party’s tax reduction is greater than the overseas party’s increased liability. It does not matter whether the resident party’s tax reduction results from the application of different rates of tax, the operation of a relief, the exclusion of any amount from a charge to tax, or otherwise.

In some instances, the tax periods of the UK and overseas parties will not coincide. Where this occurs, the rules concerning corresponding accounting periods at paragraph 5(6) Schedule 4 Finance Act 2019 apply. A notional tax period, which coincides with that of the resident party, is imposed on the overseas party and taxable amounts are apportioned to that notional tax period on a just and reasonable basis.

Tax period in relation to the resident party means a tax year or if the resident party is a company, an accounting period of that party.

Relevant tax for the purpose of the tax mismatch condition is defined in paragraph 5(7) Schedule 4 Finance Act 2019 to mean one of the following:

  • income tax,
  • corporation tax on income,
  • a sum chargeable under section 269DA of CTA 2010 (surcharge on banking companies) as if it were an amount of corporation tax,
  • a sum chargeable under section 330(1) of CTA 2010 (supplementary charge in respect of ring fence trades as if it were an amount of corporation tax), or
  • any non-UK tax on income.

Non-UK tax has the meaning at section 187 CTA 2010, which means a tax chargeable under the law of a territory outside the UK which is charged on income and corresponds to UK income tax, or is charged on income or chargeable gains or both and corresponds to UK corporation tax. The non-UK tax need not be a national tax: it may be a tax imposed by a province or state of a foreign country.

Increase in Expenses and Reduction in Income

In most cases it should be easier to identify whether the arrangements result in “an increase in expenses of the resident party” as the expenses will be included in the resident party’s tax computation.

It may be more difficult to know whether the arrangements result in “a reduction in the income of the resident party that would otherwise have been taken into account …”. This is because such a reduction in income may relate to an arrangement to net an expense against income, but also where income itself is diverted.

The reduction of income should be considered in line with the guidance regarding the transfer of value given at INTM610080.

The 80% Payment Test

This test ensures that the legislation applies only if the tax reduction resulting from the material provision is substantial. If the test is met then there is not a tax mismatch and the arrangements will not be Profit Fragmentation Arrangements.

It is met if the increase in the relevant taxes paid by the overseas party is at least 80% of the reduction in the amount of relevant tax payable by the resident party.

See Examples 14 and 15 at INTM610160 for an example showing how the 80% payment test will work in practice.

Exemptions

A transaction will be exempt from being a tax mismatch if it arises solely from payments to certain bodies as detailed at paragraph 5(5) Schedule 4 Finance Act 2019. This includes payments to charities, pension schemes, persons exempt from tax by reason of sovereign immunity, and funds the investors in which are charities, pension schemes or sovereign-immune persons, where they meet the criteria detailed in the legislation.

This exemption is meant to ensure that genuine commercial arrangements involving such parties in the circumstances outlined are not impacted. In any cases where these exemptions are exploited in order to facilitate profit diversion HMRC will seek to deny the benefit of the exemption, including where appropriate through use of the General Anti-Abuse Rule (GAAR).