INTM630560 - Royalty Withholding: UK Source: Interaction with Diverted Profits Tax: Examples

Please use the diagram in conjuction with the example below

• The group generates the majority of its revenue from online services based around valuable intellectual property (IP). All the companies in the group are within the participation condition.
• Company A, resident outside Europe, owns the IP for its own territory and Company D owns the IP for the rest of the world. Although Company D is registered in “Europe 1” it is tax resident in a zero-tax jurisdiction.
• Company D licenses the IP to Company C, resident in Europe 2, which in turn sub-licenses to Company B in Europe 1. Company B is the European sales and service hub, co-ordinating the group’s activities in Europe and working closely with its parent, Company A.
• Company E, resident in the UK, has a large, well-remunerated staff who have developed the UK market and engage with UK-based business customers buying online services. Over several years Company E’s staff have developed close relationships with these customers, the number of which has been increasing each year. Company E does not own any IP or other assets involved in the generation of revenue and its staff do not complete the sales contracts, which are all finalised online and booked to Company B.
• Company E’s activities are described as marketing and customer support services. It receives payments from Company B based on recovery of its costs with a modest margin added, which is taxable in the UK. It has no other revenue. Companies F and G operate in a similar way in their local markets in European countries 3 and 4.

If the royalties were paid directly from Company B to Company D they would be subject to withholding tax, because there is no double tax treaty between the countries where these companies are resident. However Company C is resident in Europe 2 which does not impose withholding taxes and Europe 2 has a favourable tax convention with Europe 1 so there is no withholding tax on royalty payments from Company B to Company C.

When the detail of the arrangements between Company B and Company E, in the UK, and the activities of the two companies are examined, there is good reason to assume these activities are designed to ensure that Company B is not trading in the UK through a permanent establishment within the terms of the tax treaty between Europe 1 and the UK.

In estimating the taxable diverted profits for the preliminary and charging notices the designated officer would need to consider what the chargeable profits of Company B would have been if it had been carrying on its trade through “the avoided PE”. In addition to this, the calculation of profits chargeable would include an amount equal to the amount of the royalty payment made by Company B in connection with the trade of the avoided PE that have avoided the duty to deduct tax. In this example there is no need to take account of any relevant taxable profits arising in a connected party.

A credit would be allowed against the liability to DPT if the royalty payment would not have given rise to a liability to UK income tax under the terms of a double taxation agreement. The UK may have a DTA with Europe 2 which provides for residence state taxation in which case there would have been no UK liability.

However, if the arrangements were put in place as DTA tax avoidance arrangements that sought to exploit the DTA between Europe 1 and Europe 2, ITA07/S917A applies per FA16/S42(7) – see section INTM630450. Assuming there was no DTA between the UK and the jurisdiction in with Company D is tax resident, there would be no credit against the DPT liability.