INTM630440 - Royalty Withholding: UK Source: Amount of the royalty with a UK source

Where the non-UK resident carries on only part of their trade through the UK PE, the amount of any royalty with a source the UK is calculated on a just and reasonable basis, having regard to all the circumstances (ITTOIA05/S577A(3)). The will depend on the facts of the arrangement.

Most third party licencing arrangements will determine the royalty payable under the licence by reference to sales made using the intellectual property. Therefore, sales will usually represent an appropriate apportionment in calculating the amount of the royalty with a UK source.

Metric other than sales

Where the royalty is determined by a metric other than sales, it may be appropriate to use an alternate basis of calculation. There is no direct link between the rules for attributing profit to a PE (CTA09/S19) and whether a royalty has a source in the UK/ the amount of that UK source.

There may be a connection in some cases. For example, where the full extent of the PE’s activities represent the conclusion of sales made by the non-UK resident, the amount of the royalty paid by the non-UK resident that is attributable to the UK PE under S19 for the purposes of computing its chargeable profits may be the same as that determined to have a UK source.

Any metrics other than sales will require scrutiny. Any alternate will need to reflect the full context and circumstances of the arrangement.

Example

A non-UK resident has total sales of £120m. It pays royalties of £40m in respect of what its UK PE sells and £40m in respect of sales in its country of residence. If sales in the UK and the non-UK resident’s own country of residence were £60m (and setting aside any complications of the permanent establishments selling in other markets), the apportionment to a UK source would be calculated as follows:

Total royalty payable x UK sales/ Total sales

Which in the above example would be:

£40m x 60/120 = £20m

No regard is to be had to that income of the non-UK resident person which has no effect on the payment of the royalty which that person makes.

Example 2

Non-UK resident has total sales of £120m. It pays royalties of £40m in respect of what its UK and French PEs sell, but nothing in respect of what it does in its own country of residence or in respect of what its German PE does. If sales in each of the four countries were £30m (and setting aside any complications of the permanent establishments selling in other markets), the apportionment to a UK source would be calculated as follows:

Total royalty payable x UK sales/ Total sales contributing to value of royalty payable

Which in the above example would be:

£40m x 30/60 = £20m

Payments made throughout the year

Where the non-UK resident makes royalty payments throughout the year, a calculation of the element of the royalty payment made in connection with the UK permanent establishment will be required.

For example, the royalty contract may require a non-UK resident to make payments of £10m on 1 April, 1 July and 1 October, with a balancing payment reflecting the end of year sales position on 1 January.

A reasonable apportionment of each £10m payment will be required to reflect the element of that payment that is connected to UK sales. Prior year payments (i.e. the UK proportion of total sales in the previous period) might represent a reasonable apportionment. An actual apportionment will be appropriate if sufficient reliable information is available regarding UK sales to date in proportion to total sales contributing to the quantum of the royalty.

Royalty payment not for exploitation in the UK

A royalty may be connected to the trade of a UK PE, but may in fact not be for exploitation of IP in the UK. For example, a licencing agreement may provide the non-UK resident with the right to exploit a patent in the UK and manufacturing know-how that allows production the relevant product. Manufacturing of the product takes place outside the UK. Assuming a dependent agent PE in the UK, through which the products are sold, payment of the royalty for manufacturing know-how is connected to the UK PE because without payment of that royalty, there would be no product for the UK PE to sell. However, it would be just and reasonable to remove that element of the royalty from the calculation of the amount of the royalty with a UK source because the payment is not for exploitation of IP in the UK (it is for use of that know-how in the jurisdiction in which the product is manufactured).

Nature of UK activities

The nature of the activities undertaken by the UK PE may also influence the amount of the royalty that has a UK source. For example, the amount of the royalty payment that has a source in the UK may be higher where there is a dependent agent PE in the UK where significantly all of the activity that leads to the sale is undertaken in the UK, as opposed to a fixed place of business permanent establishment through which sales support is provided.

The amount that it is just and reasonable to attribute to the UK will depend on the particular facts of each arrangement.

A further example is included at INTM630460.