The UK’s proposed diverted profits tax has been drafted to withstand legal challenges and will complement, rather than conflict with, ongoing OECD work on base erosion and profit shifting (BEPS), a Treasury official said January 7 during a parliamentary debate on the new tax. The official also said that while some MNE profit shifting involving loans is excepted from the diverted profits tax, Treasury is working on the issue in other projects.
The hearing concerned a proposed new 25 percent tax on diverted profits, announced December 10 by the UK government and expected to be included in the 2015 Finance Bill.
The tax has wide reach — set to go into effect on April 1, it targets MNEs that engage in tax avoidance transactions, including companies that supply goods or services to UK customers but avoid permanent establishment rules or use transactions or entities that lack substance.
MPs asked the government to respond to charges that the law will undercut the BEPS process and is contrary to tax treaties and international tax norms.
Treasury economic secretary Andrea Leadsom, in response, said that the new tax is in fact “complementary” to the BEPS process, as it aligns taxing rights with economic activity. The UK remains committed to multilateral action to prevent tax avoidance through the G20 and OECD, Leadsom said.
Leadsom also maintained that the tax does not override treaties. The tax treaties between the UK and other nations are limited to income tax, capital gains tax, and corporate tax, so the diverted profits tax is outside the scope of existing treaties, Leadsom said. Moreover, she noted that commentary to the OECD model tax treaty provides that states can deny tax treaty benefits where arrangements have a main purpose of securing more favorable tax treatment contrary to the object and purpose of the treaty.
Leadsom also said the diverted profits tax is designed to fully comply with EU law. “It is aimed at structures which are clearly designed to erode the UK tax base; as such, it is an appropriate response to those who abuse EU law to divert profits from the UK,” she said. She added that safeguards are built into the legislation to provide taxpayers with opportunities to demonstrate that they should not be subject to the tax. It is “a balanced and proportionate measure that tackles arrangements whose clear design is tax avoidance,” she said.
Ian Swales, Liberal Democrat MP for Redcar, said he welcomed the new proposal, but wondered why loans or other financing arrangements that give rise to an effective tax mismatch are specifically excluded from the proposal. “When one talks to today’s global finance directors, there is no doubt that financing structures and interest payments are the tax avoidance measure of choice — that’s where the largest diversion of profits occurs,” Swales observed.
Leadsom responded that the government will address interest payments, but not as a part of its work on the diverted profit tax. “There is separate work going on to look at that to ensure fairness in those measures so, it’s not being excluded but its being looked at separately,” she said.
She also said that HMRC will have the capacity to enforce the new tax, as the government has significantly increased the resources available to the agency.
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