INTM610160 - Exception Conditions: Tax Mismatch: Quantifying the Resident Party’s Tax Reduction

Paragraph 6 Schedule 4 Finance Act 2019 sets out that the reduction in the resident party’s liability to a relevant tax is measured using the following formula:

A x TR

“A” is the sum of –

• absolute value of any increase in expenses (see below for details regarding what is meant by expenses in this context) of the resident party

and

• the absolute value of any reduction in income of the resident party.

“TR” is the rate at which those profits would be chargeable to the relevant tax for the accounting period.

For the purposes of the above calculation, the expenses of the resident party should be the lower of the expenses and the amount of the tax deduction secured for them (so any “super deduction” given under, for example, a tax incentive regime is ignored).

For the purposes of the above calculation, the rate, TR, at which those profits would be chargeable to that tax for that period is the highest rate at which that tax would be chargeable for that period if those profits were added to the resident party’s total income. This will apply in circumstances where the resident party is a UK resident individual paying tax at various rates.

The increase in the relevant taxes to be paid by the overseas party for the period corresponding to the tax period is any increase in the total amount of relevant taxes that would fall to be paid by that party (and not refunded) on the assumptions that:

• the overseas party had income for that period equal to “A” as a result of the material provision;
• account were taken of any deduction or relief (apart from “qualifying loss relief” or a “qualifying deduction” – see below) taken into account by the overseas party in determining that party’s actual liability to any relevant taxes in consequence of the material provision; and
• all further reasonable steps have been taken to minimise the amount of tax for which the overseas party is liable in the country or territory in question (apart from in relation to qualifying loss relief or a qualifying deduction) under the law of any part of the UK or any country or territory outside the UK and under double taxation arrangements made in relation to any county or territory.

The ‘reasonable steps’ from the third assumption include claiming or otherwise securing the benefit of, reliefs, deductions, reductions or allowances and making elections for tax purposes.

Tax to be paid by the overseas party is taken to include withholding tax on payments made to it (to the extent that such tax is not refunded).

Tax is treated as refunded to the extent that a repayment or payment in respect of credit for tax is made to any person, directly or indirectly in respect of tax payable by the overseas party. However, a refunded amount is ignored to the extent that it results from qualifying loss relief obtained by the overseas party.

Example 14 – Determining the Relevant Taxes Payable

This example should be read alongside Example 15 below.

A is self-employed and liable to income tax at the 45% rate. A has expenses of £30,000 resulting from Profit Fragmentation Arrangements that have resulted in a deduction, and income of £50,000 which as a result of the arrangements has been omitted.

The reduction in A’s liability to UK income tax would be computed as:

(£30,000 + £50,000) x 45% = £80,000 x 45% = £36,000

O is the overseas party to whom the value is transferred under Profit Fragmentation Arrangements. O pays tax at a rate of 10% on the value transferred and has no expenses.

The increase in the relevant taxes to be paid by the overseas party is:

(£30,000 + £50,000) x 10% = £80,000 x 10% = £8,000

Example 15 – The 80% Payment Test

This example illustrates the application of the 80% payment test which is described at INTM610150, and should be read alongside Example 14 above.

If we assume the facts are as above such that the reduction in A’s liability to UK income tax was £36,000 (“X”) and the increase in relevant taxes to be paid by the overseas party is £8,000 (“Y”).

A comparison now needs to be made between these two figures to determine if the 80% payment test is met. This is done by dividing Y by X – to determine the percentage. In this case:

£8,000 / £36,000 = 22.2%

This means that the increase in the overseas party’s tax liability is (22.2%) of the reduction in the resident party’s liability to UK tax which is less than the required 80% meaning the 80% payment test is not met.