by Sandy Bhogal and Kitty Swanson, Mayer Brown, London
HM Revenue & Customs confirmed on 27 June that a new UK law that extends the scope of the withholding tax on royalties paid to non-residents will apply from 28 June, the day the rules were introduced to the Public Bill Committee as an amendment to Finance Bill 2016. The law has not yet received Royal Assent, but this is expected later this year.
The new rules, which were announced at the March 2016 Budget, form part of a suite of measures targeting the erosion of the UK tax base by means of royalty payments and, as stated in an HM Revenue & Customs tax information and impact note, are intended to “align the UK deduction of tax at source regime in respect of royalties with the UK taxing rights over such income and counteract contrived arrangements that are used by groups.”
The new provisions:
(i) amend the definition of intellectual property rights in respect of which withholding tax applies on royalty payments to ensure it is consistent with the definition of rights in respect of which income is chargeable to tax; and
(ii) provide that royalties paid by a non-UK resident carrying on a business in the UK through a permanent establishment and making the payments in connection with the trade carried on through that permanent establishment will be considered to come from a source in the UK.
The new measures are subject to an anti-forestalling rule, which disregards arrangements with a main purpose of avoiding the effects of the new rules.
Expanded royalty definition
Prior to the introduction of these new rules, tax was required to be withheld on royalty payments to non-UK resident persons in respect of the following intellectual property: copyright, a right in design, a public lending right in respect of a book, the use of patents and annual payments.
This meant that royalties paid for the use of intangible assets such as trademarks and trade names were only subject to withholding tax if the payments constituted annual payments for UK tax purposes. Broadly speaking, this concept excludes amounts which are not treated as “pure income profits” in the hands of a recipient. Since the recipient will often treat such payments as receipts of a trade of protecting and exploiting intellectual property, they would typically not be “pure income profit” and therefore not annual payments which are subject to withholding tax.
The new rules therefore seek to extend the definition of intellectual property to which royalty withholding tax applies (unless taxing rights have been explicitly conceded under a double tax treaty or the EU Interest & Royalties Directive) to include all payments defined as royalties by the OECD model tax treaty. This includes trademarks, models, plans, processes, and information concerning industrial, commercial or scientific experience.
The intended effect of this change is to simplify the withholding tax rules, as they will now apply more broadly and it will no longer be necessary to determine whether a particular type of royalty is an annual payment or not. Furthermore, it should be noted that this new rule will not in itself create a withholding requirement where treaty relief applies.
In order to determine whether royalty payments are within scope of this rule, HM Revenue & Customs guidance confirms that it is necessary to (i) look at the nature of the trade carried on through the permanent establishment, (ii) determine whether the royalty payment is connected to that trade, and (iii) apportion the royalty on a just and reasonable basis in cases where the royalty payment is made in connection with a trade that is also carried on outside the UK. If apportionment is needed, only the proportion payable in respect of UK connected sales will be considered to be UK source for these purposes.
It is also worth noting that consequential amendments were made to ensure equivalent treatment between situations where a non-resident has an actual permanent establishment in the UK or has avoided a taxable presence in the UK in circumstances that bring it within the “avoided permanent establishment” test under the UK diverted profits tax.
It will be interesting to see whether HM Revenue & Customs considers extending the UK source rule for payments from a UK permanent establishment to other payments that may be subject to withholding tax, e.g. interest, or otherwise codifying the concept of UK source (which has historically been the preserve of case law).
New anti-avoidance rule for royalties
In addition to these rules, a new anti-avoidance rule that targets conduit and other “treaty shopping” arrangements applies from 17 March, the day after it was announced at the Budget.
The measure, which also forms part of Finance Bill 2016 but was published on Budget day, imposes a withholding requirement in respect of payments of royalties to connected persons as part of arrangements the purpose of which is to obtain a tax advantage by virtue of a provision of a double tax treaty other than where obtaining that benefit in those circumstances is in accordance with the object and purpose of that double tax treaty.
This rule has been modelled on the principal purpose test designed under action 6 of the OECD/G20 base erosion and profit shifting (BEPS) project, and HM Revenue & Customs has indicated that it expects to follow the OECD commentary when applying this rule.
This measure will apply even in circumstances where the applicable double tax treaty would otherwise restrict the UK’s taxing rights in respect of such payments. However, it is not clear how this will be monitored, as withholding in respect of royalty payments is currently subject to self-assessment and there will be uncertainty regarding whether taxpayers are subject to the provisions of the anti-avoidance rule.
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Kitty Swanson
Kitty Swanson is an associate in the tax practice at Mayer Brown. She advises on the tax aspects of a wide range of domestic and cross-border matters and transactions.
Email: [email protected] .
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