by Anne Fairpo
The UK government in its 2016 Finance Bill, released Thursday, and in its Budget, published on March 24, has proposed changes designed to broaden the categories of royalty payments made to nonresidents that are subject to withholding tax. The proposals would also limit tax treaty relief for royalty payments in some cases.
The UK’s approach to withholding tax on royalties in domestic law has been rather haphazard. Until these changes are brought into effect, withholding tax is applied to limited types of intellectual property, and to certain types of intellectual property payments. The rules are inconsistent and not particularly intelligible.
Under UK law, withholding tax is applied to royalty payments which are:
- payments for copyright (but not film or video recording copyright),
- payments for design rights,
- payments for public lending rights in respect of books (and I would love to know just how much tax this category brings in …),
- payments for UK patents, and
- payments that are considered “annual payments.”
“Annual payments” are defined in case law as being “pure income profit” in the hands of the recipient. As a result, payments made to businesses with a trade of protecting and exploiting intellectual property generally are not annual payments as there will be expenses incurred by the recipient in generating that, and so it will not be pure income profit.
The net effect of these rules is that there has been quite a wide range of intellectual property to which no UK withholding tax applies when royalties were paid to non-residents (regardless of any provisions in double tax treaties, as any treaty benefit requires a withholding under domestic law in the first place).
Broadening the scope
The Budget and Finance Bill would substantially widen the scope of withholding tax on royalties so that tax will be withheld on any royalties paid in respect of “intellectual property,” as defined in UK tax legislation, without any need for the payment to be an annual payment.
This is a broad definition and, in particular, includes trademarks and know-how, neither of which are now subject to withholding tax unless the royalty is shown to be pure income profit, which, as noted above, is unlikely.
As a result, from the date of Royal Asset for the Finance Bill (likely to be late July/early August), more payments will be subject to UK domestic withholding tax at 20 percent – although, as usual, relief may be available to reduce that through provisions in the UK’s tax treaty network and the EU Interest and Royalties Directive.
Note that the legislation changes for this extension of withholding tax are to be introduced to the Finance Bill at a later stage; the draft legislation was included in a technical note on March 16, but did not make it into the Finance Bill draft, published on March 24.
Anti-treaty shopping
In addition to extending the scope of UK withholding tax on royalties, the Budget and Finance Bill also add limitations on the benefit of tax treaties in respect of royalties.
The changes provide that relief will not be available under a tax treaty in respect of UK withholding tax on royalties where “it is reasonable to conclude that the main purpose or one of the main purposes of the arrangements was to obtain a tax advantage by virtue of any provisions of a double taxation arrangement and obtaining that tax advantage is contrary to the object and purpose of those provisions” and the payment is between connected persons.
This goes well beyond the “conduit” measures often discussed, and there is no direct provision for a “substance” or similar defense.
The changes largely follow the OECD/G20 base erosion profit shifting (BEPS) framework proposal for an anti-abuse test in treaty limitation of benefits provisions, although the BEPS framework has it applying more generally and not only to withholding tax on royalties.
These anti-treaty shopping provisions would apply from March 17, and are included in clause 40 of the Finance Bill.
UK PE use of intellectual property
The changes also bring into the scope of withholding tax payments made in respect of intellectual property used by a UK permanent establishment, where the payment is made between non-residents.
For example, company A makes a payment to company B in respect of a piece of intellectual property. Neither A nor B is located in the UK, but the intellectual property is used by A’s UK PE.
These changes mean that UK withholding tax would be required to be deducted and accounted for in the UK (presumably by the UK PE, as that’s the only entity with a UK presence and is, accordingly, likely to be the easiest entity to recover tax from in the case of non-compliance).
The same widening of scope will apply where a non-resident company has an ‘avoided’ UK PE under the diverted profits tax rules to ensure that such deemed PEs are treated in the same way as actual UK PEs.
The draft legislation for this change is not yet available; it is to be included in the Finance Bill at a later stage, and the changes will apply from the date of Royal Assent for the Finance Bill.
It’s been clear for a long time, as highlighted by the BEPS project and EU investigations, that cross-border payments for intellectual property are continuing to increase.
Withholding taxes are the easiest way to capture local taxation for exploitation of intellectual property in a jurisdiction, and the UK is hardly likely to be the only country looking at its withholding tax provisions at the moment.
— Anne Fairpo is a barrister at Temple Tax Chambers and a lecturer at Queen Mary University of London. She specializes in taxation of technology business.
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