UNIVERSITEIT VAN AMSTERDAM

The Diverted Profits Tax

Thesis for the Master Fiscaal recht: Internationaal en Europees belastingrecht Vincent O'Donoghue 10215026 February 2016

Supervisor: prof. dr. O.C.R. Marres

Contents

Contents ...... ii

List of abbreviations ...... vi

1 Introduction ...... 1

1.1 A new tax ...... 1

1.2 Main research question ...... 1

1.3 Supportive questions ...... 1

2 The Diverted Profits Tax ...... 3

2.1 Overview ...... 3

2.1.1 The creation of the diverted profits tax ...... 3

2.1.2 Aim of the diverted profits tax ...... 3

2.2 Entities or transactions which lack economic substance ...... 4

2.2.1 Section 80 ...... 5

2.2.2 Section 81 ...... 6

2.2.3 Calculation of the profits ...... 6

2.2.4 Estimation of the profits ...... 7

2.3 Artificial avoidance of a Permanent Establishment in the United Kingdom ...... 8

2.3.1 Section 86 ...... 8

2.3.2 Calculation of the taxable diverted profits ...... 9

2.3.3 Estimation of the profits ...... 10

2.4 Exceptions ...... 10

2.4.1 Small or medium-sized enterprises ...... 10

2.4.2 Loan relationships ...... 11

2.4.3 Companies with limited sales or expenses in the UK ...... 11

2.4.4 Transfer pricing adjustment ...... 11

2.5 Charging notice ...... 12

ii

2.5.1 Duty to notify ...... 12

2.5.2 The Charge ...... 12

2.6 Comments ...... 13

2.6.1 Scope too limited ...... 13

2.6.2 Uncertainty ...... 14

2.6.3 Existing legislation ...... 15

2.7 Effectiveness ...... 16

3 Double tax treaties ...... 17

3.1 Overview ...... 17

3.2 Interpretation of tax treaties ...... 18

3.2.1 Interpretation of treaties ...... 18

3.2.2 OECD Commentary ...... 19

3.2.3 Case law ...... 20

3.3 OECD model tax convention article 2: Taxes Covered ...... 21

3.3.1 Article 2 ...... 21

3.3.2 Paragraph 1 ...... 21

3.3.3 Paragraph 2 ...... 21

3.3.4 Paragraph 3 ...... 23

3.3.5 Paragraph 4 ...... 24

3.3.6 Conclusion ...... 26

3.4 Further implications for an appeal to double tax treaties...... 26

3.4.1 UK Law ...... 26

3.4.2 OECD commentary ...... 27

3.5 Conclusion ...... 29

4 EU treaty freedoms...... 30

4.1 Overview ...... 30

iii

4.2 Which freedom applies ...... 31

4.2.1 Relevant freedoms ...... 31

4.2.2 Which freedom prevails ...... 32

4.2.3 Conclusion ...... 34

4.3 Is there a restriction? ...... 35

4.3.1 Not restrictive because companies have a choice ...... 35

4.4 Justifications ...... 36

4.4.1 Wholly artificial arrangements ...... 36

4.4.2 Proportionality of the diverted profits tax ...... 37

4.4.3 Necessity ...... 38

4.5 Conclusion ...... 39

5 The diverted profits tax and the BEPS project ...... 40

5.1 Introduction and overview ...... 40

5.2 Comments made on the diverted profits tax in relation to the BEPS project .... 40

5.3 The BEPS action plan and the diverted profits tax ...... 41

5.3.1 The Google Tax ...... 42

5.3.2 Action plan 7 ...... 43

5.4 Differences ...... 45

5.4.1 Difference in the prevention method ...... 45

5.4.2 Differences in scope ...... 45

5.4.3 Difference in time...... 46

5.5 Conclusion ...... 46

6 Conclusion ...... 48

Bibliography ...... 50

Literature ...... 50

Table of Cases ...... 51

iv

Annex 1: Finance Act 2015 Part 3 - Diverterd profits tax

Annex 2: Example B.2 of the final report on BEPS action plan 1

v

List of abbreviations

BEPS Base erosion and profit shifting

CFC Controlled foreign company

CJEU Court of Justice of the European Union

HMRC Her Majesty's Revenue & Customs

OECD Organization for Economic Cooperation and Development

PE Permanent Establishment

SME Small or medium-sized enterprises

TFEU Treaty on the Functioning of the European Union

TIOPA Taxation (International and Other Provisions) Act

UK United Kingdom

UKPE United Kingdom Permanent Establishment

vi

1 Introduction

1.1 A new tax

In 2015 the United Kingdom has introduced the diverted profits tax. This new tax was announced against the background of widespread outrage caused by the revelation of corporate structures and tax arrangements of multinational companies which result in a very low tax burden compared to the large revenues and profits of these companies in the UK. With the diverted profits tax the British government attempts to ensure that companies will pay an appropriate amount of tax on their UK revenue. In short, the diverted profits tax imposes a charge at a rate of 25% on the profits that have been derived from the UK in order to avoid the UK corporation tax.

1.2 Main research question

Governments, the European Commission, the general public and news media show increased attention for the amount of tax that multination companies pay in the countries where their revenue arises and the way that they are taxed. The diverted profits tax is a new development in the current attention for the tax positions of multinational companies. Besides the effect that the diverted profits tax will have in the UK, its outcome might also be interesting for other countries that are considering legislative measures to tackle tax avoidance. This gives rise to the following main research question of this thesis:

Is the diverted profits tax an effective measure to ensure that multinational companies pay a fair share of tax in the countries where their revenue arises?

1.3 Supportive questions

The answer to the main research question depends on four underlying questions. Since its announcement the diverted profits tax has been a much discussed subject in tax journals. There are four recurring questions that can be derived from the parliamentary debate and the publications on the subject.

First, the diverted profits tax itself will be described in chapter 2. What does it aim to achieve, who will be confronted with the tax and on what base is the tax calculated. Central question in this chapter is whether the diverted profits tax will be effective in achieving its 1 aim from a UK point of view. Second, in chapter three the question will be answered whether a company that is charged with diverted profits tax will be able to claim relieve under existing double tax treaties. If this is the case it could have a negative influence on the effectiveness of the diverted profits tax since a charge will only arise in cross border situations. The third question, central to chapter 4 relates to cross border situations in the European Union. The fundamental freedoms of the TFEU might be restricted in cases where the diverted profits tax charges a company from a Member State with UK related revenue. Finally in chapter 5 the diverted profits tax is discussed in the light of the OECD BEPS action plan. The diverted profits tax and the BEPS action plan share the same underlying base erosion and profits shifting issues. Not only is the unilateral approach the UK has taken in anticipation of the outcome of the BEPS project remarkable in the light of a multilateral approach on tackling tax avoidance. If the diverted profits tax is not in accordance with the recommended measures of the BEPS project it is not an example of effective anti-abuse legislation for other countries. Based on the outcome of chapters 2 to 5 the answer to the main research question will be formulated in chapter 6.

2

2 The Diverted Profits Tax

2.1 Overview

The diverted profits tax is a new tax introduced in the United Kingdom in order to halt two types of tax avoidance. This chapter describes the working of the diverted profits tax and sets out the comments made on the legislative proposal and the diverted profits tax. The central question is whether the diverted profits tax in the way that is it is enacted will be effective legislation in order to put a stop to the tax avoidance it is aimed at. The creation of the tax and its aim will be set out in this paragraph. How the diverted profits tax tries to achieve its aim –its working- will be described in paragraphs 2.2 and 2.3. There are some exceptions to the scope of the diverted profits tax which are set out in paragraph 2.4. The effectuation of the tax via a charging notice is described in paragraph 2.5. As one can expect from a new tax the diverted profits tax has been subject to both parliamentary and academic debate. The comments made are set out in paragraph 2.6. In paragraph 2.7 a conclusion is made as to whether the diverted profits tax will be effective from a UK legal perspective in achieving its aim.

2.1.1 The creation of the diverted profits tax

The diverted profits tax was first announced in the 2014 Autumn Statement by Chancellor of the Exchequer George Osborne. The tax is described as a tax to counter the use of aggressive tax planning to avoid paying tax in the UK, using artificial arrangements to divert UK profits overseas.1 After draft legislation was published in December 2014, it has been debated in parliament in a special debate on 7 January 2015 and on 25 March 2015 as part of the Finance Act 2015.2 Results of a consultation have slightly altered the diverted profits tax as appose to the draft. The diverted profits tax is enacted 31 March 2015 as part of the Finance Act 2015.

2.1.2 Aim of the diverted profits tax

The diverted profits tax’s aim is to make multinational companies pay tax in the UK on the profits they make which are attributable to UK activity. The tax is thus founded upon the

1 2014 Autumn Statement p.60 (http://www.gov.uk/government/publications). 2 HC Deb 7 January 2015, vol 590, cols 79WH–103WH and HC Deb 25 March 2015, vol. 594, Cols 1434-1535. 3

principle to align taxing rights to economic activity.3 In short this is achieved by imposing a tax (the diverted profits tax) on diverted profits at a rate of 25%. The diverted profits being the profits that are attributable to UK activity but have been diverted in such a way that they cannot be taxed in the UK. The Diverted profits tax is aimed at two distinct types of arrangements used by multinational companies to avoid paying taxes on UK profits. One is the use of artificial arrangements involving entities or transactions which lack economic substance (paragraph 2.2). The other is the artificial avoidance of having a permanent establishment in the UK despite activity being carried on in the UK (paragraph 2.3).

2.2 Entities or transactions which lack economic substance

A UK company or a foreign company with a permanent establishment in the UK that is involved in arrangements using entities or transaction lacking economic substance in order to exploit tax mismatches is targeted by section 80 and 81 respectively. An example derived from the guidance published by HMRC illustrates the targeted arrangements as follows.4 Company A is parent to a group consisting of Company B, which is either a UK resident or qualifies as a permanent establishment of Company A in the UK, and Company C, which is located in a country where it is not subject to tax. Company C receives a capital injection of Company A and uses this to purchase a machine. Company C then leases the machine on a basis of operating lease to Company B. All further activity of Company C only consists of

3 HC Deb 25 March 2015, vol. 594, col 1466. 4 HMRC Diverted Profits tax: Interim Guidance, p.31. 4

owning the machine and the connected administration. The lease payments of Company B will be deducted from its income for UK corporation tax and the payments received by Company C will not be taxed. It is these cases that are targeted by section 80 and 81. The calculation of the taxable diverted profit in this example is described in paragraph 2.2.5.

2.2.1 Section 80

Section 80 is aimed at a company that is a UK resident within the meaning of the Corporation Tax Acts 5 and that is involved in entities or transactions lacking economic substance which erode the companies’ UK tax base. Target of the diverted profits tax is ‘’the material provision’’. The material provision is a provision between the company and another person by means of transaction or series of transaction.6 The term provision is derived from the UK transfer pricing rules 7 and according to HMRC’s International Manual includes ‘’arrangements, understandings and mutual practices whether or not they are, or are intended to be, legally enforceable’’.8 One of the parties – the UK company or the other person has to participate directly or indirectly in the management, control or capital of the other party or the same person has to directly or indirectly participate in the management, control or capital of both of the parties. If so, the participation condition is met.9 The material provision then has to result in an ‘’effective mismatch outcome’’. In short there is an effective mismatch outcome when the material provision results in expenses for the company for which a deduction of taxes has been taken or a reduction in income of the company, as a result of which the relevant payable amount of tax by the company is reduced. If the reduction of the relevant payable amount of tax by the company exceeds the increase in relevant taxes by the other person there is an effective tax mismatch outcome.10 Relevant taxes are UK corporation tax, income tax, a supplementary charge in respect of ring fence trades or any non-UK tax on income.11 The last test of section 80(1) is the insufficient economic substance condition. For this condition the effective tax mismatch outcome must be the result of one or more transactions of which it is reasonable to assume that they were designed to secure the tax reduction.12 This is the case if the financial benefit of the tax reduction exceeds the non-tax

5 Finance Act 2015, s 114(1). 6 Finance Act 2015, s 80(1)(b). 7 HMRC Diverted Profits tax: Interim Guidance, p.12. 8 HMRC INTM412050: Transfer pricing: legislation: rules: meaning of “provision” and “transaction”. 9 Finance Act 2015, s 106 and 80(1)(c). 10 Finance Act 2015, s 80(1)(d), s 107 and s 108. 11 Finance Act 2015, s 107(8). 12 Finance Act 2015, s 110. 5

benefits of the transaction. The involvement of a person in the transaction of whom the non- tax benefits of his involvement do not in terms of functions or activities exceed the financial benefit of the tax reduction also results in the insufficient economic substance condition being met. If the abovementioned conditions are met the company will have to notify HMRC (see paragraph 2.5.1) unless one or more exemptions are applicable (see paragraph 2.4).

2.2.2 Section 81

Section 81 applies to a foreign company which is not UK resident but carries on a trade in the UK trough a permanent establishment (‘’UKPE’’). The diverted profits tax applies to the UKPE if it qualifies as a section 80 company had it been a separate person from the foreign company. For section 81 cases the same tests and conditions apply as for section 80 cases (paragraph 2.2.2).

2.2.3 Calculation of the profits

If section 80 or 81 applies to a company the profits are calculated in accordance with section 84 or 85 depending on whether the actual provision condition is met. The actual provision condition is set out in section 82(7) and is met if the material provision results in deductible expenses for the company or the UKPE and the relevant alternative provision, as a result of the effective tax mismatch outcome would not result in relevant taxable income for a connected company. The relevant alternative provision is the provision that would have been made if tax on income had not been a relevant consideration for any of the parties.13 If the actual provision condition is met the diverted profits are calculated according to section 84. The taxable diverted profits are the amount that results from the material provision adjusted to at arm’s length pricing. Section 85 applies when the actual provision condition is not met. The taxable diverted profits are the income on the basis of section 84 and the amount of income of a connected company which would have resulted from the relevant alternative provision in case the actual provision condition is not met because the relevant alternative provision results in income for a connected company.14 If subsection 4 does not apply, the taxable diverted profits are the notional additional amount arising from the relevant alternative provision and the total amount of income of a connected company which would have resulted from the relevant alternative provision. The notional additional amount being

13 Finance Act 2015, s 82(5). 14 Finance Act 2015, s 85(3),(4). 6

the amount by which the chargeable profits under the corporation tax that would have risen had the relevant alternative provision been made, exceeds the amount that has been taken into account in an assessment to corporation tax as a result of the material provision.15

2.2.4 Estimation of the profits

When an HMRC officer issues a preliminary or charging notice (see paragraph 2.5.2), he determines the taxable diverted profits by estimating the amount in accordance with section 96. When estimating the profits for the preliminary or charging notice, the officer can adjust deducted expenses if he considers the deducted expenses greater than they would have been had the material provision been at arm’s length. When issuing the preliminary or charging notice the deducted expenses are reduced at a fixed rate of 30%. The fixed rate of 30% only applies on the estimation. During the review period it is considered whether the 30% adjustment is a correct transfer pricing adjustment. Instead of a fixed rate the deducted expenses are then adjusted to at arm's length. During the review period the charge based on the estimation of the diverted profits can be adjusted after calculation of the diverted profits in accordance with sections 94 and 95.

2.2.5 Example

The taxable diverted profits in the case of the aforementioned example in paragraph 2.2 could be calculated as follows. UK resident company B leases a machine from connected company C, resident to a low tax jurisdiction. The yearly lease payments are 150 and are deducted from the income of Company B of 155. This results in a profit for B of 5. The lease payments are not taxable income for company C. Instead of the operating lease construction, company B could have bought the machine itself, and for instance - disregarding the correct capital allowances available to B - would have had deductible expenses of only 100. Under the relevant alternative provision company B would have had taxable profits of 55 and company C would not have had any profits relating to the relative alternative provision. In this case the taxable diverted profits are calculated on the basis of section 85(5) and are the profits resulting from the relevant alternative provision less the 'normal' profits of company B. The taxable diverted profits of company B would be 50.

15 Finance Act 2015, s 85(6). 7

2.3 Artificial avoidance of a Permanent Establishment in the United Kingdom

The other types of arrangements that fall within the scope of the diverted profits tax are those that can be qualified as arrangements aimed at artificially avoiding the creation of a permanent establishment in the UK. An example derived from the guidance published by HMRC illustrates the targeted arrangements as follows. 16 Company A is parent to a multinational group and additionally its activity consists of research and development. Company B is located in a European country and manufactures the products. Company C is located in a low tax European company and concludes all sales and contracts with customers in Europe. A UK company, Company D which is not part of the group engages with UK customers in sales support activities for which Company C pays a fee on a cost-plus basis. But as said all contracts are concluded by Company C. The diverted profits tax will tax the profits that would have been attributable to Company D had it been a permanent establishment of the foreign company, if it turns out that the above mentioned structure qualifies as artificial avoidance. The calculation of the taxable diverted profit in this example is described in paragraph 2.3.4.

2.3.1 Section 86

Section 86 is aimed at the artificial avoidance of a Permanent Establishment in the United Kingdom. A person, whether or not UK resident that carries on activity in the UK in connection with the supplies of services, goods or other property made by a foreign company

16 HMRC Diverted Profits tax: Interim Guidance, p.34. 8

in the course of its trade, falls within the scope of section 86 and is called the avoided PE.17 It has to be reasonable to assume that the activity of the avoided PE or the foreign company is designed to avoid the foreign company from carrying on a trade in the UK for the purposes of corporation tax.18 Section 86(1)(f) introduces the mismatch condition and the tax avoidance condition of which at least one has to be met. The mismatch condition differs from the mismatch condition in section 80. The material provision must be between the foreign company and another person and must be connected to the activities of the avoided PE.19 The tax avoidance condition requires arrangements to be in place of which the main purpose is to avoid or reduce a charge to corporation tax. 20 Arrangements can be agreements, understandings, schemes, or transactions.21

2.3.2 Calculation of the taxable diverted profits

The taxable diverted profits are calculated according to either section 89, 90 or 91. The criteria to determine the applicable section are set out in section 88. It mainly depends on whether or not the mismatch condition of section 86(2) and the actual provision condition of section 88(9) are met. The actual provision condition is met if the material provision results in expenses of the foreign company which would have been notional PE profits and the relevant alternative provision would also have resulted in expenses of the foreign company but would not be relevant income for the connected company. The notional PE profits are defined in subsection 5 and are the profits which would have been PE profits had the avoided PE been a UKPE. The notional PE profits depend on the attribution of profits to the PE based on the existing rules for attribution of section 20 to 32 of CTA 2009. 22 The relevant alternative provision is the provision that would have been made between the foreign company and another company had tax not been relevant. Depending on the outcome, the taxable diverted profits are (what would have been) the notional PE profits or if calculated based on section 91, the relevant taxable income of a company as a result of the relevant alternative provision.

17 Finance Act 2015, s 81(1)(a),(b),(c). 18 Finance Act 2015, s 81(1)(e). 19 Finance Act 2015, s 86(2). 20 Finance Act 2015, s 86(3). 21 Finance Act 2015, s 86(7) . 22 Finance Act 2015, s 88(5). 9

2.3.3 Estimation of the profits

For the purpose of issuing a preliminary or charging notice the HMRC officer estimates the taxable diverted profits in accordance with section 89, 90 or 91. In estimating the taxable diverted profits the HMRC officer can deduce the expenses that would be allowable expenses in computing the notional PE profits by 30% if he considers the deducted expenses not at arm's length. During the review period the adjustment based on the fixed rate will be adjusted to the correct transfer pricing adjustment.

2.3.4 Example

The taxable diverted profits in the case of the aforementioned example in paragraph 2.3 would be calculated as follows.23 The UK sales supports D engages with UK customers on a cost plus basis resulting in a very limited UK tax base of 1. The European Sales company C concludes all contracts with UK Customers. The UK related profit of C is 200 of which a 100 in fees is paid to D. The diverted profits are the notional PE profits, the profits which would have been attributable to a UK PE hadn't one been avoided. The activity of C in relation to the UK sales is very limited and based on the existing rules for attribution most of the profits of C should be attributable to the avoided PE. Instead of 50% of the UK profits of 200 only 2% should be attributed to company C, resulting in 48% being attributable to the avoided PE.24 The taxable diverted profits are therefore 96.

2.4 Exceptions

The diverted profits tax contains several exceptions of which the exception for small or medium-sized enterprises (‘’SME’s’’), certain loan relationships and the exception for companies with limited sales and expenses in the UK are the most important. The exceptions for SME’s and foreign companies with limited UK-related sales and expenses are in line with the tax’s aim at large multinational companies.

2.4.1 Small or medium-sized enterprises

Small or medium-sized enterprises are exempted from application of the diverted profits tax in sections 80(1)(g) and 86(1)(h). Whether a company qualifies as an SME is determined

23 HMRC Diverted Profits Tax: Interim Guidance, p.34. 24 HMRC Diverted Profits Tax: Interim Guidance, p.34. 10

in accordance with section 172 of TIOPA 2010. 25 The definition is based on the recommended definition by the European Commission.26 In contrast to the EU definition a company does not qualify as an SME if it is a large-sized enterprise for a single accounting period instead of the recommended two consecutive accounting periods.27 In the case of a possible section 80 charge both the UK company and the other person have to be an SME. The same goes for the avoided PE and the foreign company in section 86 cases.

2.4.2 Loan relationships

The diverted profits tax is not aimed at loan relationships and both the section 80 and 86 charges consist of an exception for loan relationships by referring to section 109. The deductible expenses or the reduction of income deriving from the material provision resulting in an effective tax mismatch outcome as described in section 107(3) may arise from a loan relationship. These results are exempted if the arrangements in place would qualify as a loan relationship or derivative contract within the meaning of part 5 or part 7 of the Corporation Tax Act 2009 respectively.

2.4.3 Companies with limited sales or expenses in the UK

Foreign companies with limited sales or expenses in the UK are exempted from the section 86 charge. To fall within the scope of the exception in section 87 the UK-related sales revenues of the foreign company and its connected companies must not exceed £10.000.000, or UK-related expenses of the company and its connected companies must not exceed £1.000.000.

2.4.4 Transfer pricing adjustment

The transfer pricing adjustment is not an actual exemption but does have as a result that diverted profits will not be subject to diverted profits tax. For the section 80 and 81 charge no diverted profits arise if the full transfer pricing adjustment of section 83 is made and the actual provision condition is met.28 By taking the calculated diverted profit into account in an assessment to corporation tax the full transfer pricing adjustment condition is met. A

25 Finance Act 2015, s 114(1). 26 Commission Recommendation 2003/361/EC. 27 Commission Recommendation 2003/361/EC, annex article 4(2) and HMRC Diverted Profits tax: Interim Guidance. 28 Finance Act 2015, s 82(1) and s 83. 11

company can thus escape the higher tax rate of the diverted profits tax and instead of paying 25% diverted profits tax pay 20% corporation tax.

2.5 Charging notice

2.5.1 Duty to notify

A company has the duty to notify an HMRC officer within three months after an accounting period if section 80 or 81 applies in connection with a material provision and the financial benefit of the tax reduction is significant relative to the non-tax benefits.29 Similarly a notification must be made if section 86 applies.30 No notification has to be made if it is reasonable for the company to conclude that no charge will arise, or that HMRC has been provided with significant information to decide on giving a preliminary notice. The notification must contain a statement as to which sections apply as well as a description of the material provision and its parties. 31 HMRC requests companies to disclose additional information such as a worldwide group structure and detailed information about intellectual property and related payments connected to activity in the UK is.32

2.5.2 The Charge

An HMRC officer must give a company a preliminary notice within 24 months after the accounting period in which he believes diverted profits arise. The preliminary notice must state on which sections the charge is based and contain a clarification of the determination of the profits. After receiving the preliminary notice the company has 30 days to make representation on limited grounds set out in section 94(3). After this 30 day period the HMRC officer has another 30 days to give a charging notice or notify the company that no charging notice will be issued.33 The tax then must be paid within another 30 days period despite any review or appeal. This means that the tax is to be paid before an appeal can be made. Within the twelve-month review period the HMRC officer must review the charge to see if the charged diverted profits tax is excessive or insufficient.34 If the charge was excessive the amount of taxable diverted profits is to be reduced. If the amount of taxable diverted profits

29 Finance Act 2015, s 92(3). 30 Finance Act 2015, s 92(4). 31 Finance Act 2015, s 92(9). 32 HMRC Diverted Profits tax: Interim Guidance, 68-69. 33 Finance Act 2015, s 95(2). 34 Finance Act 2015, s 101. 12

was insufficient the officer issues a supplementary charging notice. The company can appeal against the charging notice within 30 days after the 12 month review period has ended.

2.6 Comments

The diverted profits tax has been subject of parliamentary debate on two occasions. In a debate held on 7 January 2015 the Economic Secretary of the Treasury responded to some of the concerns raised by Members of Parliament. Though the proposed diverted profits tax legislation was in general positively received, some comments have been made. From the first announcement of the tax, tax-advisory companies and commentators in legal journals have also commented on the tax. The concerns raised and questions asked will be set out below. Questions about a possible challenge of the DPT to EU law and tax treaties and the BEPS project will be handled in the respective chapters dedicated to these subjects.

2.6.1 Scope too limited

The diverted profits tax has been accused of having a too limited scope to be an adequate measure against tax avoidance. One of the remarks is that the exemption for SME’s makes it possible for smaller groups to maintain arrangements aimed at avoiding corporation tax without facing the 25% diverted profits tax rate. The minister justifies the limitation of the scope to large multinational companies because particularly those companies are guilty of aggressive tax planning.35 Limiting the scope with a reference to the existing SME criterion increases certainty for companies as it provides a clear line if the diverted profits tax might apply on the arrangements a company is involved in.

The exclusion of loan relationships has been called a flaw in the design of the diverted profits tax.36 In the parliamentary debate it was also stated that financing arrangements with excessive interest payments on intercompany loans are one of the most used ways of diverting profits.37 The minister was then asked why these arrangements have been exempted from the diverted profits tax. 38 According to the minister loan relationships have been

35 HC Deb 7 January 2015, vol 590, col 97WH. 36 HC Deb 25 March 2015, vol 594, col 1435. 37 HC Deb 7 January 2015, vol 590, col 90 WH. 38 HC Deb 7 January 2015, vol 590, col 91 WH. 13

excluded because these problems will be looked at separately.39 Perhaps existing transfer pricing principles and anti-abuse legislation are sufficient to tackle these arrangements.

The limitation of the scope of the diverted profits tax inevitably means a limitation of the possible yield of the tax. The estimated yield of the diverted profits tax is about 350 million GBP per annum.40 In the parliamentary debate it has been stated that this number could be much higher.41 It needs to be understood though that the diverted profits tax itself does not necessarily has a budgetary incentive. The tax might also result in companies abandoning their artificial arrangements and include their UK earnings in an assessment to UK corporation tax. This will also contribute to the diverted profits tax achieving its aim of making multinational companies pay their fair share of tax in the UK. The fact that the diverted profits tax is not a legislative answer to all types of tax avoidance does not mean it will not succeed in tackling some of the arrangements that multinational companies have in place.

2.6.2 Uncertainty

The diverted profits tax is technically difficult legislation. The tax has a layered structure and consists of various conditions some of which are designed especially for the diverted profits tax. A wide range of arrangements potentially fall within the scope of the diverted profits tax and will have to be tested against the conditions of sections 80 or 86. The wide scope of the tax and the unfamiliar conditions might cause uncertainty for multinational companies with UK-related revenue whether a charge will arise. As Baker argues, the uncertainty for companies is relatively limited given the tax advisors they employ or consult.42 Moreover, tax laws are not known for their simplicity and especially anti-abuse legislation often contains both detailed as well as broadly formulated provisions. I doubt whether simplicity should be preferred over fairness, by which I mean that those who aggressively avoid the ‘’normal’’ tax rules should not complain when they meet difficult anti- avoidance rules introduced by the legislator as a reaction to this practice. Along with the new legislation extensive guidance has been published by HMRC which expresses the view of how HMRC will apply the new rules. The minister has emphasized on the fact ‘’that

39 HC Deb 7 January 2015, vol 590, col 102WH. 40 2014 Autumn Statement p. 64. 41 HC Deb 25 March 2015, vol 594, col 1435. 42 Baker, Diverted profits tax: a partial response, British Tax Review 2015, 2, 167-171. 14

calculation of the charge follows well-established transfer pricing principles’’ and that ‘’those principles are widely understood and routinely applied by businesses.’’43

Another concern regarding the draft legislation relates to the duty to notify when a company is potentially in scope of the diverted profits tax.44 The notification duty would not only be an excessive burden for companies to comply with, it was also feared that HMRC would receive too many notifications. The final legislation has been changed and the interim guidance published by HMRC contains several exemptions on the basis of which companies are not required to send a notification.45 However, the exemption from the duty to notify does not discharge a company from its potential liability to diverted profits tax. HMRC can still decide to give a company a preliminary notice.

2.6.3 Existing legislation

HMRC might have tried to tackle the arrangements targeted by the diverted profits tax by using existing anti-abuse legislation. Piccioto mentions other countries that have interpreted the substance requirements of the PE status in such a way that they could constitute a PE.46 Neidle addresses the same option and discusses that the artificial avoidance of a UKPE with an appeal to double tax treaties could have been argued by HMRC. 47 Both writers acknowledge that this approach would inevitably result in legal cases. Neidle and Self both see a purpose for the General Anti Avoidance Rule in tackling the problem. 48 The new diverted profits tax legislation will give HMRC a stronger stance against the artificial avoidance of a PE status, even if a charge or the diverted profits tax itself will be tested in the court. It is beyond the scope of this thesis to elaborate on the possibility of tackling tax avoidance by other UK tax legislation. Additionally the diverted profits tax has a more extensive use as it is also aimed at arrangements and entities lacking economic substance. Another reason for the choice to propose new legislation can be found in the statement of the minister that the diverted profits tax does not result in a treaty override because the diverted

43 HC Deb 7 January 2015, vol 590, col 101 WH. 44 HC Deb 7 January 2015, vol 590, col 83 WH, 45 HMRC Diverted Profits tax: Interim Guidance, p.66-67. 46 Piccioto, The UK’s Diverted Profits Tax: An admission of Defeat or a Pre-Emptive Strike?, Tax Notes International, January 19 2015, 239 (online). 47 Neidle, The diverted profits tax: flawed by design?, British Tax review, 2015, 2, 147-166. 48 Neidle, The diverted profits tax: flawed by design?, British Tax review, 2015, 2, 147-166, And Self, give beps a chance, Tax Journal, 15-12-2014 (Online). 15

profits tax is not covered by double tax treaties.49 This argument will be further dealt with in chapter 2.

2.7 Effectiveness

The diverted profits tax is a new step in the battle against tax avoidance by multinational companies. The effectiveness of the tax mainly depends on the willingness of multinational companies to contribute to paying a fairer amount of tax in the countries where their profits arise. Companies can either pay the diverted profits tax or dissolve artificial arrangements and pay UK corporation tax. It is not unthinkable however that some companies and tax advisers will explore possible ways around the diverted profits tax. The criteria set out in the diverted profits tax will be put to the test to see if they are fit to battle the tax avoidance strategies used by multinational companies. If the charges survive in court, from a UK view the diverted profits tax will be a success.

49 HC Deb 7 January 2015, vol 590, col 100WH. 16

3 Double tax treaties

3.1 Overview

The diverted profits tax imposes a charge on profits diverted from the United Kingdom to another jurisdiction. The diverted profits might be subject to tax in that other jurisdiction as well. Bilateral double tax treaties attempt to avoid double taxation by allocating the taxing rights on certain income to the states that are party to the treaty. For companies and other tax payers it is important to know forehand if they face any tax charges and where they face these charges. Double taxation treaties contribute to the certainty of the taxpayer and the predictability of the charges that will rise. It is therefore important to know if the diverted profits tax, which is a new tax, is (or should be) covered by existing tax treaties. This is the central question in this chapter.

The UK government takes the position that the diverted profits tax is not a tax covered by its existing double tax treaties.50 Under UK law a tax payer cannot claim relieve directly on the basis of a double tax treaty. One might argue that the question whether the diverted profits tax is covered by existing tax treaties or not is not relevant because tax treaties under UK law do not apply to the diverted profits tax (see par. 3.4.1). For the scope of this thesis this question is indeed relevant.

The UK has concluded double tax treaties with over 120 countries. 51 Most of these treaties are based on the OECD Model Tax Convention.52 Even though the treaties tend to share a similar structure based on the model convention, the UK tax treaties are not identical.53 This is an inevitable effect of the fact that not all treaties have been concluded at the same time and are thus based on different versions of the model convention, the fact that the OECD Model Tax Conventions leaves open some options and that the treaties are the result of extensive negotiations between the parties to that particular treaty. To be able to answer the question if the diverted profits tax is covered by existing tax conventions one could examine all existing double tax treaties. I choose to refer to the OECD model tax

50 HC 7 January 2015, vol 590, col 100 WH. 51 https://www.gov.uk/government/collections/tax-treaties. 52 OECD (2014), Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris. 53 Compare article 2 of the Tax treaties UK-NL, UK-IE and UK-Lux. 17

convention in order to answer the question if the diverted profits tax would be covered by an existing double tax treaty. Where relevant, reference will be made to a particular tax treaty.

3.2 Interpretation of tax treaties

3.2.1 Interpretation of treaties

The first step in order to determine whether or not the diverted profits tax falls within the scope of existing tax treaties is establishing the rules for interpretation of a double tax treaty. The Vienna Convention on the Law of Treaties( ‘’Vienna Convention’’) applies on all treaties and section 3 of the convention is dedicated to the interpretation of treaties. Although the Vienna Convention only applies to treaties entered into force after the Vienna Convention went in to force for those states, the Vienna Convention consists of customary international law which would have applied to the treaty independently of the convention.54 The rules of interpretation of the Vienna Convention are therefore also applied on treaties concluded after the Vienna Convention went into force and treaties between states that are not a party to the Vienna Convention.55 The relevant passages of articles 31 and 32 of the convention are as follows:

Art. 31 par. 1: A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.

Art. 32: Recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the application of article 31, or to determine the meaning when the interpretation according to article 31: (a) leaves the meaning ambiguous or obscure; or (b) leads to a result which is manifestly absurd or unreasonable.

The OECD model tax convention contains the following interpretation rule for undefined terms:

Art. 3 par. 2: As regards the application of the Convention at any time by a Contracting State, any term not defined therein shall, unless the context otherwise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which the Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State.

The sources which can be used for the interpretation of a tax double tax treaty on the basis of these three articles are the treaty itself and its context, object and purpose and the laws of the contracting states.

54 Vienna Convention article 4. 55 Vogel/Rust, in Reimer & Rust (eds), Klaus Vogel on Double Taxation Conventions, 4th edn (2015), Introduction m.no. 81. 18

3.2.2 OECD Commentary

The OECD model tax convention contains extensive interpretive commentaries to the articles of the model convention. What is the status of the OECD commentaries on the model convention in the interpretation of double tax treaties? The OECD commentaries on the model convention can provide a better understanding of the articles and can be of aid in the interpretation of the model convention.56 Its influence on double tax treaties, however, is not entirely clear. The introduction to the Model Convention states that tax authorities should follow the commentaries when applying and interpreting their double tax conventions. 57 Double tax treaties do not explicitly refer to the OECD commentaries so there is no legal obligation to follow the commentaries. It is generally accepted that the OECD commentaries are an interpretation aid on the basis of articles 31 and 32 of the Vienna Convention. Uncertainty does however exist on the basis of which of these (sub) articles the application of the commentaries is based.58 Brandstetter concludes that in cases where the model convention was followed, the parties have accepted the principles and concept underlying the OECD model tax convention, this including the commentary to the extent that no reservations were made.59 The commentaries to the model convention reflect the opinions of all the members. This then raises the question what the effect of the commentaries is to double tax treaties that are based on the model convention but where one or both of the parties are not member states. The most recent commentaries or the commentaries as they read at the time of the signing of the double tax treaty. Even though the legal status of the commentaries in the interpretation of a double tax treaty may not be clear, judges of many different jurisdictions have referred to the commentaries when interpreting existing double tax treaties.60 Therefore the commentaries are a relevant source when interpreting whether the diverted profits tax will fall within the scope of existing double tax treaties. Another question is which version of the commentaries should be consulted. The commentaries to the OECD model tax convention as they read at the time of signing the treaty or the latest commentaries? The introduction to the

56 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p.14. 57 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p. 7. 58 See Baker, Double Taxation Conventions, Sweet & Maxwell 2001, E-10-E17, Marres & Wattel The legal status of the OECD commentary, European Taxation 2003, p. 225-226 and Engelen: Interpreation of Tax Treaties under International Law, IBFD 2004, chapter 10. 59 Brandstetter, ‘Taxes Covered’: A study of article 2 of the OECD model tax convention, IBFD 2011, p. 6. Similarly: Marres & Wattel: The legal status of the OECD commentary, European Taxation 2003, p. 224. 60 Baker, Double Taxation Conventions, Sweet & Maxwell 2001, E-10 contains a numeration of relevant case law from different jurisdictions. 19

2014 OECD model tax convention says that existing treaties should be as far as possible be interpreted by consulting the most recent commentary. More recent commentary is not relevant when the substance of the article has changed.61 Marres and Wattel argue that only non-substantive changes to the commentary should be consulted as a supplementary means of interpretation. 62 Vogel/Rust state that only the edition of the commentary which was applicable at the time of the treaty’s completion can be binding.63 Since the most recent version of the OECD model tax convention will be consulted in order to answer the central question in this chapter, where relevant the most recent version of the commentaries will be consulted as well.

3.2.3 Case law

There is only limited case law on the interpretation of article 2 of double tax conventions. It should immediately be noticed that case law from one jurisdiction generally has no legal power in other jurisdictions. Case law does however give an insight in the actual practice of article 2 of double tax treaties, and judges refer to legal cases from other jurisdictions in their judgements as well. Brandstetter endorses the view that the international law nature of the interpretation of treaties demands a cross border comparison of case law even though court decisions are not binding judges in other jurisdictions.64

In particular there are three cases on the taxes covered by article 2. The Irish Kinsella case65, and the Australian cases Virgin Holdings66 and Undershaft No 1 and 267. In these cases the companies where charged with capital gains tax, which the states argued were not covered by the existing double tax treaties. A fourth relevant case is Bricom Holdings68, a UK case on the question whether the UK CFC regime was covered by then existing double tax treaties. The judge did not come to answering the question whether the CFC regime constituted a ‘’similar tax’’.

61 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p.15-16. 62 Marres & Wattel The legal status of the OECD commentary, European Taxation 2003, p. 235. 63 Vogel/Rust, in Reimer & Rust (eds), Klaus Vogel on Double Taxation Conventions, 4th edn (2015), Introduction m.no. 105. 64 Brandstetter, ‘Taxes Covered’: A study of article 2 of the OECD model tax convention, IBFD 2011, p. 19-21. 65 Lorraine Kinsella and the Revenue Commissioners 31 July 2007 IEHC 250 10 ITLR 63 (Online) law.ato.gov.au. 66 Virgin Holdings SA v Federal Commissioner of Taxation 10 October 2008 FCA 1503 law.ato.gov.au. 67 Undershaft No 1 Ltd. v Federal Commissioner of Taxation and Undershaft No 2 Ltd. v Federal Commissioner of Taxation 3 February 2009 FCA 41. (online) law.ato.gov.au. 68 Bricom Holdings Ltd. v The Commissioners of Inland Revenue 25 July 1997, S.T.C. 1179 70 T.C. 272 BTC 471. (Online) Westlaw. 20

3.3 OECD model tax convention article 2: Taxes Covered

3.3.1 Article 2

Article 2 of the OECD model tax convention determines the scope to which taxes the model convention applies. The diverted profits tax will have to be covered by an existing tax treaty on the basis of one of the paragraphs of article 2 in order to determine which state is attributed taxation rights on the basis of one of the articles 6 to 22. In establishing whether the diverted profits tax is an income tax that falls under the tax treaty, paragraphs 1 and 2 seem of little help. Combined they describe a tax on income as a tax imposed on income or on elements of income. Paragraph 3 contains a listed of taxes that are covered by the convention and it is not likely that existing tax treaties will contain the diverted profits tax in this list. Paragraph 4 at last states that substantially similar or identical taxes are also covered by the double tax treaty. A more comprehensive elaboration of the paragraphs and the question whether the diverted profits tax is covered by the double tax treaty on the basis of the paragraph now follows.

3.3.2 Paragraph 1

Paragraph 1 defines the scope of application of the convention.69 The convention applies to taxes on income and capital gains imposed on behalf of the state or lower governments and irrespective of the manner in which the taxes are levied. The paragraph gives rise to questions such as; what is income? Can parties exclude certain taxes on income from being covered by the double tax treaty? And are all taxes on income covered by the conventions? It function could also be a contrario meaning that any tax which is not an income tax (or capital gains tax) will not be covered by the convention. For instance value added taxes and inheritance taxes. Because paragraph 2 further defines ‘taxes on income’, the test to see if the diverted profits tax is a tax on income will be carried out there.

3.3.3 Paragraph 2

Paragraph two gives a definition of taxes on income.70 The commentaries on paragraph 2 further elaborate on accessory charges to the tax such as increases and penalties and the

69 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p. 77. 70 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p. 77. 21

difference between ordinary and extraordinary taxes, both of which fall within the scope of the convention.71 The definition of an income tax given by paragraph 2 is: All taxes imposed on total income or on elements of income. The definition of an income tax as a tax on income does not brings us a lot closer to the question which taxes are income taxes. It does not give a closed definition on income.

In the Kinsella judgement the CGT is regarded covered under the convention on the basis of paragraph 2. It is thus possible that the diverted profits tax falls within the scope of the convention based on paragraph 2. For the diverted profits tax to fall within the scope of the convention it is irrelevant whether or not it is imposed on total income or an element of income. It is clear that the diverted profits tax is not a tax on total income. The diverted profits tax only taxes diverted profits. The diverted profits calculated on the basis of the diverted profits tax are under circumstances not ‘real’ income but only a notional amount of profits. In the Bricom Holdings case, where the relevant tax was the British CFC regime, the judge argued that merely using income or elements of income as an element to calculate a notional amount which will be taxed does not involve taxing this income itself.72 On the basis of Bricom it could be argued that the diverted profits tax is not an income tax even though the calculation of the notional amount which will be taxed is calculated with reference to (an element of) income. Almost all taxes consist of some assumptions, notional amounts or fictions. If the taxation of a notional or fictitious amount would not be covered by double tax treaties the application of tax treaties could easily be eroded by the parties. I take the view that taxes that tax a fictional income are not automatically excluded from treaty coverage.73 Even if one could argue that the diverted profits tax is not a tax on (an element of) income because a notional amount is taxed this would not rule out treaty coverage.

Given the broad definition of income under paragraphs 1 and 2 of the model convention it is not unlikely that the diverted profits tax is covered by existing tax treaties on the basis of paragraph 1 and 2. Since paragraph 4 is explicitly aimed at taxes imposed after the signature of the double tax treaties it is yet to soon to come to the conclusion that the diverted profits

71 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p. 77-78. 72 Bricom Holdings Ltd. v The Commissioners of Inland Revenue 25 July 1997, S.T.C. 1179 70 T.C. 272 BTC 471. (Online) Westlaw p5-7. 73 See Brandstetter, ‘Taxes Covered’: A study of article 2 of the OECD model tax convention, IBFD 2011, par. 3.2.1.3 for a more extensive treatment of this subject. 22

tax is covered by existing tax treaties. Paragraph 4 is especially relevant for treaties in which article 2 only consists of paragraphs 3 and 4 of the OECD model tax convention.

3.3.4 Paragraph 3

Paragraph 3 contains an enumeration of the existing taxes to which the convention shall apply. The list is not exhaustive but serves to illustrate the preceding paragraph of the article according to the OECD Commentaries.74 The list contributes to the aim of article 2 of ensuring identification of the Contracting States’ covered taxes.75 Taxes existing at the time of concluding the treaty which qualify as a tax on income but are nonetheless omitted from the list in paragraph 3 are not automatically excluded from the application of the treaty. If a party wants to exclude a tax from the treaty this should be explicitly stated in the treaty. The non-exhaustive character of paragraph 3 combined with the broad description of the taxes covered in paragraphs 1 and 2 makes this inevitable.76 Another way to exclude an existing tax from being covered by the treaty is by excluding paragraphs 1 and 2 treaty and set up an exhaustive list containing the taxes which shall be covered.77 There is no doubt that the diverted profits tax will not be listed in existing double tax treaties drafted in either format.78 The non-exhaustive character of the list does not mean that the convention can apply to new taxes that not have been mentioned in the list because they were non-existing at the time of conclusion of the treaty. The list explicitly contains the wordings ‘’existing taxes.’’ This means that the diverted profits tax cannot fall within an existing double tax treaty on the basis of paragraph 3 in combination with the broad definition of covered taxes in paragraphs 1 and 2.

74 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p. 78. 75 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p. 77. 76 See also Brandstetter, ‘Taxes Covered’: A study of article 2 of the OECD model tax convention, IBFD 2011, p. 5. 77 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p. 78. Parties will omit paragraphs 1 and 2 of the model convention. Paragraphs 3 and 4 of the model convention will take the place of paragraphs 1 and 2 in the double tax treaty. 78 Article 2 of the double tax treaty between the UK and the Netherlands is consistent with article 2 of the OECD model Convention and contains paragraph 1-4. Article 2 of the double tax treaty between the UK and the Republic of Ireland is an example of a treaty which contains an exhaustive list of the taxes covered in combination with paragraph 4 of the OECD model convention. 23

3.3.5 Paragraph 4

A new tax in addition to, or in place of, existing taxes will also be covered by an existing double tax treaty if it is identical or substantial similar to those existing taxes. The new tax will have to be a tax on income or capital gains, otherwise it is excluded by paragraph 1. Whether or not the new tax is an income tax must be tested to the definition given in paragraph 2 see 3.3.3. If paragraph 3 consists of a non-exhaustive list of existing taxes covered by the treaty the obvious starting point is to compare the diverted profits tax to these taxes. Given the non-exhaustive character of the list the diverted profits tax may also be similar to other existing taxes which are covered by the convention (or not explicitly excluded) but not listed, which can also result in the diverted profits tax being covered.

The existing taxes to which the diverted profits tax should be compared are not limited to those listed in paragraph 3. Lang states that even though paragraph 4 seems to refer to the taxes listed in paragraph 3, this does not mean that a new tax may fall under the treaty only if a similar tax was already levied. Even if a tax is not similar to the taxes listed in paragraph 3, a tax might fall within the scope of the treaty.79 In Kinsella the judge carries out an exercise derived from Klaus Vogel’s Double Taxation Conventions. 80 The new tax should be considered with reference to all types of taxes historically developed within the state. The Judge notes that the CGT and the CT and Income tax are part of the same legislation (1997 act). The CGT is computed in a different way than the other taxes in the 1997 act but the judge sees substantial similarities. Logical reasons can justify the legislator’s choice to tax capital gains in a different way than (other) (corporate) income.

If we do want to compare the diverted profits tax to one of the taxes generally listed in paragraph 3 of double tax treaties, the most obvious tax to compare to the diverted profits tax is Corporation Tax.81 The diverted profits tax is a tax on diverted profits of companies and a Corporation tax generally taxes the income of corporations. Persons income taxes and capital gains taxes are far less similar to the diverted profits tax. The first taxes persons while the

79 Lang, “Taxes Covered” – What is a “Tax” according to Article 2 of the OECD Model?, Tax Treaty Monitor (2005) (IBFD online) p.221. 80 Lorraine Kinsella and the Revenue Commissioners 31 July 2007 IEHC 250 10 ITLR 63 (Online) law.ato.gov.au p. 8-9. 81 The list in the OECD model convention is obviously blank because it is up to the parties to a double tax convention to list the existing taxes they ought covered by the treaty. The UK generally lists the income tax, corporation tax, petroleum revenue tax and capital gains tax. 24

diverted profits tax taxes corporations and the latter taxes the capital gains where the diverted profits tax taxes diverted profits.

The diverted profits tax aim is to impose a charge on profits relating to UK revenue that, as a result of artificial arrangements, have been diverted from constituting a UK tax base for corporation tax. Had the artificial arrangements not been in place, the same profits (or at least the profits relating to the revenue) would have been charged with corporation tax in the UK. It can thus be said that a corporation tax and the diverted profits tax share a common tax base. Also, the company confronted with a charge to diverted profits tax has the option to include the profits in a corporation tax assessment.82 A very substantial element of a tax is its tax base. Because the diverted profits tax’s tax base can also be taxed with corporation tax there is a substantial similarity. In Virgin Holdings the Judge argues that if the tax to which the new tax is being compared to, depending on circumstances and time taxes the same object (in that case capital gains), the more readily will a conclusion of substantial similarity be reached.83

There are of course differences between the diverted profits tax and a corporation tax. A difference between the diverted profits tax and the UK corporation tax is the way of imposing a charge (self-assessment v. a charging notice). Other differences are the penalties and the possibilities to challenge a charge. These procedural differences should not withhold the conclusion that taxes are substantially similar. Paragraph 1 explicitly states that taxes on income should be covered by the convention irrespective of the manner in which they are levied.84 Another difference between the corporation tax and the diverted profits tax are the tax rates (20% and 25% respectively). In my opinion tax rates are irrelevant because of three reasons. First, a tax which is covered by the double tax treaty can apply different tax rates in the case of progressive taxes. Second, the tax rate of a tax that is covered by the double tax treaty can change, in which case the similarity of a new tax would depend on the modifications of an existing tax. Third, different tax rates would not be such a substantial difference that speaking of a substantial similarity is ruled out.

Another difference between the diverted profits taxes and corporation tax is that where corporation tax generally applies to most corporations, the diverted profits tax only applies to

82 Finance Act 2015, s 83(3). 83 Virgin Holdings SA v Federal Commissioner of Taxation 10 October 2008 FCA 1503 law.ato.gov.au. p 56. 84 Commentaries elaborate: ‘’The method of levying is equally immaterial: by direct assessment or by deduction at the source, in the form of surtaxes or surcharges, or as additional taxes.’’ 25

a limited group of corporation as a result of the exemptions for SME’s and companies with limited UK related revenue and expenses. It should be noted that other taxes also contain provisions which only apply to certain persons or companies under certain circumstances. The relatively limited scope of the diverted profits tax as a result of the possible tax subjects and the limited tax object; diverted profits, is not such a substantial difference compared to other taxes that any substantial similarity is ruled out.

I would say that the diverted profits tax is a substantially similar tax to the corporation tax, since there is a substantially similarity in the tax base and the taxable persons. The differences between the diverted profits tax and a corporation tax are not such that a substantial similarity between the two is ruled out. Corporation tax is generally a tax covered by taxation treaties, either explicitly listed in paragraph 3 or otherwise on the basis of paragraphs 1 and 2 because it is without doubt a tax on income. The Diverted profits tax is therefore covered by existing double tax treaties on the basis of paragraph 4.

3.3.6 Conclusion

Article 2 of double tax treaties based on the OECD model tax convention regulates to which taxes the double tax treaty applies. Paragraph 4 aims to bring a tax imposed after the signing of the treaty under the application of the treaty if the tax is substantially similar to an existing tax that is already covered by the treaty. The diverted profits tax is substantially similar to corporation tax and should thus be covered by double tax treaties on the basis of article 2. This does not mean that the diverted profits tax would not survive a challenge to double tax treaties. There are further implications which will be discussed in the following paragraph.

3.4 Further implications for an appeal to double tax treaties.

3.4.1 UK Law

Under UK law, tax treaties do not have direct effect. The limitation on direct effect of double tax treaties under UK law is not a problem inherent to the diverted profits tax. Other taxes might likewise be not effectively covered by double tax treaties. Neidle elaborates on this aspect of the diverted profits tax and its relationship to double tax treaties.85 The lack of

85 Neidle, The diverted profits tax: flawed by design?, British Tax review, 2015, 2, p. 165-166. 26

direct effect means that a tax payer can only claim the benefits of the double tax treaty if the effects have been incorporated in domestic law. TIOPA 2010 section 6 gives effect to double tax treaties regarding limited UK taxes. The Corporation tax is one of the taxes covered; the diverted profits tax is not. Even if the diverted profits tax falls within the scope of existing UK tax treaties a UK resident can thus not claim the benefits regarding diverted profits tax. A non-UK resident might be able to directly claim the benefits of the tax treaty but will have to rely on outcome of a mutual agreement procedure between his state of residence and the UK. It is unlikely that the UK will agree with allowing benefits regarding diverted profits tax to non-UK residents in a mutual agreement procedure with the other state.

3.4.2 Treaty override

Not granting the tax treaty benefits with an appeal to TIOPA 2010, while the diverted profits tax is covered by double taxation treaties can be regarded as treaty override. A treaty override cannot generally be justified with an appeal to combatting treaty abuse.86 A treaty override does not provide a ground to challenge the legislation to the taxpayer. It is up to the other State that is party to the double tax treaty act against the treaty override.87 It is at this point to soon to establish a treaty override by the UK regarding the diverted profits tax. Other than a general justification of treaty override based on combating tax avoidance, this nature of the legislation might entail that the UK rightfully denies treaty access in the way that no treaty benefits should be granted. In that case there would not be a treaty override.

3.4.3 OECD commentary

In the parliamentary debate on the diverted profits tax held on 7 January 2015 questions were asked about the compatibility with the diverted profits tax and existing UK tax treaties.88 The minister responded to these questions by referring to the limited scope of UK tax treaties under national law (see par. 3.4.1), and the OECD commentaries.89 According to the minister, states can deny treaty benefits where arrangements have a main purpose of securing more favourable tax treatment in circumstances contrary to the object and purpose of that treaty.

86 Vogel/Rust, in Reimer & Rust (eds), Klaus Vogel on Double Taxation Conventions, 4th edn (2015), Introduction m.no. 156-156. 87 Vienna Convention Article 60. 88 HC Deb 7 January 2015, vol 590, col 82 WH. 89 HC Deb 7 January 2015, vol 590, col 100 WH. 27

3.4.3.1 The purpose of double tax conventions

The Minister refers to paragraph 9.5 of the commentary to article 1 of the OECD model tax convention. This paragraph sums up two purposes of the OECD model tax convention. The first purpose of the model convention is to promote the exchanges of goods and services and the movement of capital and persons by eliminating double taxation. The second purpose of tax conventions is to prevent tax avoidance and evasion.90 Here a possible conflict of the two purposes can occur. Especially with anti-abuse legislation governments will prefer the purpose of avoiding tax-avoidance above the purpose of avoiding double taxation.

For the prevention of double taxation it would be desirable that tax treaties also cover the diverted profits tax. Even though the diverted profits tax includes a tax mismatch condition and a credit is given for taxes already paid on the same profits, an appeal to a double tax treaty would be more effective for the taxpayer if the result under the double tax treaty would be that the UK (or any other country that wants to impose a diverted profits tax) has no taxing right under the circumstances of that case.

In the light of the other purpose of double tax treaties, the prevention of tax avoidance and evasion, the result that the diverted profits tax is covered by a double tax convention might be contradictory to its purpose. The OECD commentary acknowledges this unwanted outcome; a state is unlikely to agree to provisions of double tax treaties that would have the effect of allowing abusive transactions what would otherwise be prevented by the provisions and rules of this kind contained in its domestic law.91

3.4.3.2 Treaty coverage in the light of the purpose of double tax treaties

Does the aim of preventing tax avoidance justify a limitation on treaty benefits as regards to the diverted profits tax? It should be noted that the diverted profits tax contains several conditions which aim at ascertaining that the targeted arrangements used by multinationals have a purpose of creating tax benefits. States do not have to grant the benefits of a double tax treaty where arrangements that constitute an abuse of the convention have been entered in

90 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p. 62. 91 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p. 61-62. 28

to.92 The benefits of a double tax treaty should not be available where a main purpose for entering into certain transactions or arrangements was to secure a more favourable tax position and obtaining that more favourable treatment in these circumstances would be contrary to the object and purpose of the relevant provisions.93 The diverted profits tax is in line with aforementioned statements in the OECD commentaries. The UK government thus has a strong case arguing that, although the diverted profits tax might be covered by double tax treaties on the basis of article 2, a company that is charged with diverted profits tax can be denied the treaty benefits.

3.5 Conclusion

The central question in this chapter was: ‘Is the diverted profits tax, which is a new tax, covered by existing tax treaties and should it be covered?’ The answer to the first part of this question is that the diverted profits tax will qualify as a substantially similar tax to an existing tax which is already covered by the double tax treaty. The diverted profits tax is substantially similar to corporation tax and is thus covered by article 2 of the OECD model tax convention and treaties based on this model convention. National limitations on the direct effect of double tax treaties such as in the UK can result in a denial of treaty access in the case of a diverted profits tax charge. Besides the national limitation, the commentaries on the OECD model tax convention provide tax authorities with arguments to deny treaty access in case of a diverted profits tax. This is based on the purpose of double tax treaties to prevent tax- avoidance and evasion. Especially in cases where a tax mismatch is the result of a double tax treaty it is necessary that a taxpayer cannot challenge a charge on the basis of anti-abuse legislation with an appeal to the same double tax treaty. This would otherwise undermine the purpose of double tax treaties.

92 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p. 63. 93 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p. 63. 29

4 EU treaty freedoms

4.1 Overview

The Treaty on the Functioning of the European Union (‘’TFEU’’), contains several fundamental freedoms which are aimed at achieving an internal market. Member States are not allowed to restrict these fundamental freedoms by limiting the access to, or the use of the internal market. In short this means that Member States may not treat internal situations differently to situations where some EU movement is involved, unless there is an objective difference between the situations or the restriction of the freedoms is justified. National tax laws can also breach the fundamental freedoms. Because the direct taxes have not been subject to EU harmonization the direct taxes fall within the competence of the Member States. However, Member States may not impose direct taxes which are not consistent with EU law, including the fundamental freedoms.94 Previously, the UK’s CFC-regime and thin capitalization-regime, both anti-abuse measures have been subject to a challenge to the treaty freedoms.95 Against the background of these previous cases it is no surprise that questions have been asked about the compatibility of the diverted profits tax to EU law and in particular the fundamental freedoms. 96 This is a relevant question for this theses because the effectiveness of the diverted profits tax would be drastically limited if it cannot be applied in EU situations, and possibly in situations between Member States and non-Member states. The central question in this chapter is: Does the diverted profits tax survive a challenge against EU law?

In paragraph 2 it will be examined which fundamental freedom can be invoked by a taxpayer confronted with a charge on diverted profits. Even though more than one freedom might appear to be restricted by the diverted profits tax, based on the case law of the CJEU it can be determined to which freedom a tax should be tested under certain circumstances. This will be analysed with respect to the diverted profits tax. Paragraph 3 and 4 respectively

94 CJEU 13-12-2005, C-446/03 (Marks & Spencer), par. 29. 95 CJEU 12-09-2006, C-196/04 (Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v IRC) (online) on the UK CFC rules. CJEU 13-03-2007, C-524/04 (Test Claimant in the Thin Cap Group Litigation) (online) on the UK Thin Capitalization rules. 96 HC 7 January 2015 Vol. 590, Col. 82WH, Neidle The diverted profits tax: flawed by design?, British Tax review, 2015, 2, 161-165, Self, The UK’s New Diverted Profits Tax: Compliance with EU Law, INTERTAX, volume 43, issue 4, p333-336. And Cussons, The new diverted profits and EU/international law, including BEPS (online taxjournal.com). 30

analyse if the diverted profits tax causes a restriction of the relevant freedom and if there is a justification. The central question in this chapter will be answered in paragraph 5.

4.2 Which freedom applies

4.2.1 Relevant freedoms

The freedom of establishment (art. 49 TFEU), the free movement services (art. 56 TFEU), and the free movement of capital (art. 63 TFEU) are the most obvious fundamental freedoms that might be restricted by the diverted profits tax.

The first question that rises is whether a company charged with diverted profits tax can rely on either of the fundamental freedoms. In order to determine whether the fundamental freedoms or one of them in particular are applicable, only the objective circumstances of the situation are of interest. A subjective reason why a person appeals to the fundamental freedoms is not relevant in establishing whether the person is covered by the fundamental freedoms. This follows from the Centros case where the CJEU decided that: The question of the application of those articles of the treaty is different from the question whether or not a Member State may adopt measures in order to prevent attempts by certain of its nationals to evade domestic legislation.97 This means that the company confronted with a diverted profits tax charge cannot be excluded from the access to the treaty freedoms on the assumption of a tax avoidance motive.

Another question to be asked before it can be established which freedom is applicable is whether the economic substance of the involved company is relevant in order to be able to rely on the treaty freedoms. 98 For access to the free movement of capital no economic substance of the involved parties is required because art. 63 TFEU ties in with the movement of the capital itself. For the freedom of establishment and the free movement of services there is a substance requirement in relation to the party involved.99 The CJEU has formulated 4 cumulative conditions to determine whether there is sufficient economic substance in order to rely on the freedom of establishment or the free movement of services.100 There must be (1) an actual pursuit of economic activity, (2) through a fixed establishment, (3) for an indefinite

97 CJEU 9 -3-1999, C-212/97 (Centros), par. 18. 98 Baker, Diverted profits tax: a partial response, British Tax Review, 2015, 2, p. 169. 99 More extensive see: Weber, Tax avoidance and the EC Treaty Freedoms, Kluwer International Law 2005, par. 2.2.5 and 2.2.6. 100 CJEU 12-09-2006, C-196/04 (Cadbury Schweppes), par. 54. 31

amount of time, (4) in another member state. It depends on the answer to condition 3 whether the freedom of establishment or the free movement of services is applicable.101 It should be noted that the aforementioned sufficient economic substance requirements differ from the insufficient economic substance condition of section 110 of the diverted profits tax which is primarily aimed at the transaction itself and not the parties involved. Based on companies that are within the scope of the diverted profits tax it can be said that companies confronted with the diverted profits tax generally will meet the sufficient economic substance requirements.

4.2.2 Which freedom prevails

In determining whether a certain tax entails a restriction of the fundamental freedoms it is not relevant which freedom is applicable because the CJEU applies the same test in establishing a restriction on either freedom. The same goes for the justifications. 102 For a taxpayer confronted with the diverted profits tax it is thus not relevant whether he can rely on the freedom of establishment, the free movement of capital or the freedom of establishment. This is only relevant when a third country (non-Member State) party is involved.103 Only the free movement of capital applies on situations concerning a Member State and a third country.104 As mentioned in the previous paragraph, whether the freedom of establishment or the free movement of services prevails, depends on the question if the economic activity is pursued for a definite or indefinite amount of time.105 It thus depends on the facts of the specific case. As will follow from the next paragraphs, for the question whether the freedom of establishment or the free movement of capital applies (par. 4.2.2.1), and whether the free movement of services or the free movement of capital applies (par. 4.2.2.2), the specific facts of the case are not always decisive.

4.2.2.1 Freedom of establishment or free movement of capital

Whether the freedom of establishment or the free movement of capital applies depends in principle, on the purpose of the national legislation.106 Legislation aimed at shareholdings which give the shareholder definite influence on the company’s decisions and enable the shareholder to control the company’s activities falls within the scope of the freedom of

101 Weber, Tax avoidance and the EC Treaty Freedoms, Kluwer International Law 2005, p. 35 and 65. 102 Weber, Tax avoidance and the EC Treaty Freedoms, Kluwer International Law 2005, p 81. 103 Terra & Wattel, European Tax law, Kluwer 2012 (student edition), p. 49. 104 TFEU article 63. 105 Weber, Tax avoidance and the EC Treaty Freedoms, Kluwer International Law 2005, p. 35 and 65. 106 CJEU 13-11-2012, C-35/11 (FII-2) par. 90. 32

establishment.107 Any restrictions of the free movement of capital in those cases are an inevitable result of the restriction on the freedom of establishment.108 Legislation which applies to shareholdings acquired without any intention to influence the management and control of that company exclusively fall within the scope of the free movement of capital.109 Only when the national legislation applies on both types of shareholdings the facts of the specific case are relevant when determining which freedom applies.110 The purpose of the diverted profits tax is to make sure that multinational companies pay taxes in the UK on their UK related profits (see par. 2.1.2). The diverted profits tax is thus aimed at groups of companies. This purpose is reflected in section 106 of the diverted profits tax which explains the participation condition. On first sight section 106 of the diverted profits tax does not seem to demand definite influence as is required by the CJEU. The participation condition only mentions direct or indirect participation in the management, control or capital of the company. Not every participation might be substantial enough to speak of definite influence. However, section 106(7) refers to sections 157 to 163 of TIOPA 2010. Section 157(2) of that act does require the company in which the other company participates to be controlled by the participating company. If a person controls a company he has definite influence over the company’s decisions and will be able to determine its activities. The diverted profits tax should therefore be examined in the light of the freedom of establishment.

In cases where the free movement of capital between a Member State and a non-Member state might be applicable the CJEU applies the same test. The purpose of the national legislation decides which freedom applies.111 This means that the free movement of capital between a Member State and a non-Member state can only apply when the legislation is not exclusively aimed at shareholdings which provide the shareholder definite influence and control. This means that in cases concerning a non-Member State the diverted profits tax cannot be challenged with an appeal to the fundamental freedoms of the TFEU.

4.2.2.2 Free movement of services or free movement of capital

In situations where two Member States are involved the CJEU has decided that restrictions on the movement of capital which indirectly result from the restriction of another

107 CJEU 13-11-2012, C-35/11 (FII-2) par. 91. 108 CJEU 13-03-2007, C-524/04 (Test Claimant in the Thin Cap Group Litigation) par. 34. 109 CJEU 13-11-2012, C-35/11 (FII-2) par. 92 110 CJEU 13-11-2012, C-35/11 (FII-2) par. 93-94 111 CJEU 13-11-2012, C-35/11 (FII-2) par. 96. 33

fundamental freedom are not prohibited.112 In cases where the diverted profits tax restricts the freedom of services, for instance royalty payments in relation to IP rights,113 the movement of capital as a result of the payment can only induce an indirect restriction on the free movement of capital.

Situations concerning a non-Member State lead to the same conclusion. The CJEU again looks at the purpose of the tax and which freedom might be restricted.114 The purpose of the diverted profits tax is to prevent the avoidance of having a UK taxable presence and erosion of the tax base by entering into certain arrangements. The diverted profits tax targets these arrangements. Where the arrangements consist of a move of capital this capital movement will be the result of a service following from the targeted arrangement. The service will be the dominant factor in the arrangement and the diverted profits tax thus might restrict the free movement of services rather than the free movement of capital. In situations concerning a non-Member state the company will thus not be able to challenge the diverted profits tax with an appeal to any of the fundament freedoms.115

4.2.3 Conclusion

In cases concerning a party national to a non-Member State the diverted profits tax cannot be challenged with an appeal to the fundament freedoms. In these cases only the free movement of capital might be applicable but as a result of the purpose of the diverted profits tax and based on the decisions of the CJEU in these situations the relevant freedom will either be the freedom of establishment or the free movement of services. Contrary to the free movement of capital these freedoms do not provide protection in cases concerning a party national to a non-Member State. A company charged with diverted profits tax in an EU situation is not denied access to the freedom of movement or the freedom of establishment and can challenge the diverted profits tax to these freedoms. The diverted profits tax might restrict the use of these freedoms.

112 CJEU 28-1-1992, C-204/90 (Bachmann), par. 34. 113 Baker, Diverted profits tax: a partial response, British Tax Review, 2015, 2, p. 168. 114 CJEU 30-10-2006, C-452/04 (Fidium Finanz), par. 34. 115 CJEU 30-10-2006, C-452/04 (Fidium Finanz), par. 49. 34

4.3 Is there a restriction?

The fundamental freedoms are most likely triggered by the diverted profits tax’s rate of 25% as a pose to the UK corporation tax rate of 25%.116 A company that is a national of a Member State of the EU and has used its rights under the TFEU to either establish itself in the UK from another EU country or to provide services to or from the UK, is under circumstances confronted with a tax on diverted profits with a 25% higher tax rate than the usual tax rate under the UK corporation tax which is levied on ‘normal’ profits. For example, the lease payments in the example of paragraph 2.2 will be imposed with a charge on diverted profits at a rate of 25% as appose to the corporation tax charge at a rate of 20% that would have arisen in a UK domestic situation. It can thus be said that the diverted profits tax is a restriction on the freedom of establishment or the free movement of services.

4.3.1 Not restrictive because companies have a choice

Baker argues that the diverted profits tax cannot be a restriction on the freedom of establishment because it targets arrangements that have been designed to avoid the UK corporation tax. Had they not been designed this way the company would have been charged with corporation tax and, he adds, it is always open to the group to dismantle their arrangements in place and to pay corporation tax.117 This argument is not in accordance with the decisions of the CJEU. In FII the CJEU decided that the fact that a national scheme is optional does not mean that it is not incompatible with the fundamental freedoms. 118 In Gielen the CJEU decided that the option for the tax payer to be treated as a resident taxable person does not remedy a discrimination. 119 The option for a taxpayer to dismantle its arrangements and pay corporation tax instead of diverted profits tax does not mean there cannot be a restriction of the fundamental freedoms. It however far from certain that the CJEU would declare the diverted profits tax a restriction on the fundamental freedoms just because the tax is designed as an incentive for multinational companies to abandon their arrangements aimed at tax evasion. It is more likely to assume a restriction the fundament freedoms on the basis of the difference in tax rates.

116 See the literature in footnote 87; all authors identify the difference in tax rates as the trigger. 117 Philip Baker, Diverted profits tax: a partial response, British Tax Review, 2015, 2, p. 168. 118 CJEU 12-12-2006, C-446/04 (FII), par. 162. 119 CJEU 18-03-2010, C-440/08 (Gielen), par. 49-51. 35

4.4 Justifications

The diverted profits tax is a restriction on the freedom of establishment and the free movement of services. This does not mean that it is contrary to EU law. A Member state may invoke a justification based on either the TFEU itself or the Rule of Reason developed in case law of the CJEU. The justifications in the TFEU for the freedom of establishment and the free movement of services are limited to grounds of public policy, public security and public health. A justification of the diverted profits tax shall thus have to be based on the case law of the CJEU. The rule of reason developed by the CJEU consists of overriding reasons of public interest. A restrictive measure can only be justified if the measure is proportional to its aim and if it is not more extensive than necessary to achieve that aim.120 If these conditions are met the UK can successfully defend the diverted profits tax in a challenge with EU law.

4.4.1 Wholly artificial arrangements

In the Cadbury Schweppes, Marks and Spencer, Itelcar121, Thin Cap Group Litigation and other cases concerning anti-abuse legislation the CJEU has applied the same test. Anti- abuse legislation can be justified by an overriding reason of public interest: ‘’where it specifically targets wholly artificial arrangements which do not reflect economic reality and the sole purpose of which is to avoid the tax normally payable on the profits generated by activities carried out on the national territory.’’122 It thus depends on which arrangements are targeted by the diverted profits tax and the purpose of those arrangements whether the restriction of the fundamental freedoms caused by the diverted profits tax can be justified.

Neidle and Self argue that the diverted profits tax is not specifically aimed at wholly artificial arrangements.123 This argument claims that the diverted profits tax is not specific enough. Commercial arrangements which are not wholly artificial may fall within the scope of the diverted profits tax. The economic substance condition of section 110 does not prevent these arrangements from being a target. That test is whether the non-tax benefits of the transaction would exceed the financial benefit of a tax reduction as a result of the transaction. The wider scope of the diverted profits tax might however not be a problem when establishing whether a justification applies. In Thin Cap Group Litigation it appears that the

120 CJEU 12-09-2006, C-196/04 (Cadbury Schweppes), par. 47. 121 CJEU 3-10-2013, C-282/12 (Itelcar). 122 CJEU 3-10-2013, C-282/12 (Itelcar), par. 34. 123 Neidle The diverted profits tax: flawed by design?, British Tax review, 2015, 2, p. 164, Self, The UK’s New Diverted Profits Tax: Compliance with EU Law, INTERTAX, volume 43, issue 4, p. 334. 36

CJEU only when answering the question whether the legislation goes beyond what is necessary to attain the objective, applies the test if the legislation is aimed specifically at wholly artificial arrangements.124 That the diverted profits tax has a wider scope than its initial target is thus not a problem as long as the necessity condition will be met.

Another argument is that the diverted profits tax is not aimed at arrangements that are wholly artificial. In Cadbury Schweppes the CJEU states that the fact that none of the exemptions of the legislation applies, that there is a motive of tax avoidance and the fact that targeted arrangements have taken place is not suffice to speak of a wholly artificial arrangement. 125 For entities targeted by CFC legislation this means that it must also be established that the CFC does not reflect economic reality. 126 Applying this rule on the diverted profits tax would mean that the arrangement between the parties has to be wholly artificial. Arrangements are wholly artificial when they do not reflect economic reality and their sole purpose is tax avoidance. The targeted arrangements must, however, have some substance in order to achieve their purpose of tax avoidance. Arrangements consisting of a transfer of assets, payments of royalties or interest, and other arrangements that parties can enter into to achieve a tax benefit necessarily have another purpose than achieving a tax benefit alone. Baker adequately states that a literal interpretation of the phrase wholly artificial arrangements would result in a scope restricted to sham arrangements. 127 It is evident that anti-abuse legislation such as the diverted profits tax is aimed at artificial arrangements. If the scope of an anti-abuse measure appears to be too broad this will lead to problems when applying the proportionality and necessity conditions. Applying the justification for Member States to combat wholly artificial arrangements to strict would have the undesirable effect that proportionate anti-abuse legislation that does not go further than necessary to secure the taxing rights on profits arising from activities on the territory of that Member State cannot tackle arrangements aimed at tax avoidance to which the freedom of establishment applies.

4.4.2 Proportionality of the diverted profits tax

The diverted profits tax imposes a charge on arrangements aimed at avoiding corporation tax by eroding the UK tax base or avoiding a taxable presence. Companies also get the choice

124 CJEU 13-03-2007, C-524/04 (Test Claimant in the Thin Cap Group Litigation) par. 79. 125 CJEU 12-09-2006, C-196/04 (Cadbury Schweppes), par. 63. 126 CJEU 12-09-2006, C-196/04 (Cadbury Schweppes), par. 65. 127 Baker, Diverted profits tax: a partial response, British Tax Review, 2015, 2, p. 170. 37

to, instead of paying the diverted profits tax, abandoning their arrangements and pay corporation tax. In this way the diverted profits tax is an effective way of preventing practices of which the sole purpose is to avoid the tax that is normally payable on profits generated by activities undertaken in the UK. It follows from Itelcar that such legislation is an appropriate means of combating tax evasion and avoidance and thus justifies a restriction on the fundamental freedoms.128

4.4.3 Necessity

In pursuing its aim of preventing tax evasion and avoidance the diverted profits tax may not go further than necessary. In Thin Cap Group Litigation the CJEU formulates two conditions which will have to be met in order for the legislation not to go beyond what is necessary. The first condition is that the taxpayer must be given opportunity, without being subject to undue administrative constraints, to provide evidence of any commercial justification that there may have been for that arrangement.129 The diverted profits tax gives the taxpayer the opportunity to provide counter evidence on two occasions, first after receiving the preliminary charging notice,130 and a second time during the twelve month period after the charging notice has been issued.131 This should be sufficient for the taxpayer to make his case. The second condition is that the re-characterisation of the arrangements is limited to the proportion to which the arrangement in place exceeds what would have been agreed had the relation between parties been one at arm’s length.132 The diverted profits tax is not merely a transfer pricing adjustment but provides the UK taxing rights on diverted profits which would have been profits taxable with UK corporation tax but for the fact that certain arrangements are in place. While the diverted profits tax exceeds the scope of a normal transfer pricing adjustment, the calculation of the diverted profits ties in with established transfer pricing principles. It is however, not possible to state that the second condition has been met. Rather than concluding that the diverted profits tax thus goes beyond what is necessary I would argue that the second condition is unfit to be applied on the diverted profits tax. The second condition refers to an ordinary transfer pricing adjustment and cannot be applied on the diverted profits tax.

128 CJEU 3-10-2013, C-282/12 (Itelcar) par. 25 129 CJEU 13-03-2007, C-524/04 (Test Claimant in the Thin Cap Group Litigation) par. 82. 130 FA 2015 section 94(3). 131 FA 2015 section 102. 132 CJEU 13-03-2007, C-524/04 (Test Claimant in the Thin Cap Group Litigation) par. 83. 38

In Itelcar the CJEU states that the tax must also make it possible to determine their scope with sufficient precision in order to meet with requirements of legal certainty.133 Rules of law must be clear, precise and predictable as regards their effects. Cussons and Neidle believe that the diverted profits tax does not meet with this requirement as a result of the uncertainty of the interpretation that must be given to the newly introduced terms, such as ‘’just and reasonable’’, ‘’design test’’ and ‘’relevant alternative provision’’. 134 Although these are newly introduced terms they are not necessarily unclear or unprecise. The consequences set out in the legislation and the published guidance do not let any ambiguity exist as to which arrangements fall within the scope of the diverted profits tax. As a result the diverted profits tax is not contradictory to the requirements of legal certainty as expressed in Itelcar.

4.5 Conclusion

Companies that are confronted with a charge on diverted profits can either rely on the freedom of establishment or the free movement of services. This means that in situations where an entity national to a non-Member State is involved in the arrangements, no appeal to the fundamental freedoms can be made. In EU situations the diverted profits tax restricts the freedom of establishment and the free movement of services. This restriction is however justified. The diverted profits tax is suitable to tackle tax avoidance via artificial arrangements and does not go further than necessary in doing so. The only uncertainty is how the CJEU will assess the diverted profits tax in relation with the conditions regarding necessity as set out in Thin Cap Group Litigation, as the diverted profits tax is more than just a re-characterization of an arrangement to what would have been agreed between parties at arm’s length. The case law of the CJEU enables Member State to tackle tax avoidance via wholly artificial arrangements which is exactly what the diverted profits tax does. It can be concluded that the effectiveness of the diverted profits tax is not limited by the fundamental freedoms of the TFEU.

133 CJEU 3-10-2013, C-282/12 (Itelcar) par. 44. 134 Cussons, The new diverted profits and EU/international law, including BEPS. (Taxjournal.com) and Neidle, The diverted profits tax: flawed by design? British Tax review, 2015, 2, 165. 39

5 The diverted profits tax and the BEPS project

5.1 Introduction and overview

Since the OECD published its report Addressing Base Erosion and Profit Shifting in 2013, the BEPS problems have dominated the international tax agenda. After the publication of the report the OECD and the G20 set up an action plan consisting of 15 points to tackle the BEPS problem. Final reports on these 15 action plans have been published in October 2015 and contain the measures that will have to be implemented in order to ensure that profits will be reported for tax purposes where the economic activity takes place and where value is created. This aforementioned aim of the BEPS project corresponds to the aim of the diverted profits tax to make multinational companies pay tax in the UK on the profits that are attributable to their UK activity.

It is no surprise that questions have been asked about the compatibility of the diverted profits tax and the (then expected) outcome of the BEPS project. Those questions and arguments will be discussed in paragraph 2. Paragraph 3 will elaborate on the most obvious example of the overlap between the BEPS project and the diverted profits tax; their aim to prevent the artificial avoidance of the PE status. In paragraph 4 the differences between the outcome of the BEPS project and the diverted profits tax will be discussed. In paragraph 5 the main question of this chapter will be answered which is: Is the diverted profits tax an effective measure to tackle BEPS in the light of the OECD BEPS project?

5.2 Comments made on the diverted profits tax in relation to the BEPS project

During the parliamentary debate held on the diverted profits tax the concern was raised that the unilateral approach of the UK to tackle BEPS by introducing the diverted profits tax would have a negative effect on the international outcome of the OECD BEPS project.135 Another concern was that the UK government introduced the diverted profits tax because it had no confidence in the outcome of the BEPS project to be sufficient to tackle the problems it addresses.136 The minister responded to these concerns stating that the diverted profits tax is entirely consistent with the principles of the BEPS project and that it complements the ongoing international efforts.137 Moreover, the government did not feel that the BEPS project

135 HC Deb 7 January 2015, vol 590, col 80WH. 136 HC Deb 7 January 2015, vol 590, col 93WH. 137 HC Deb 7 January 2015, vol 590, col 100WH. 40

would not work, with the diverted profits tax the government has simply gone further to tackle the BEPS problems which is complementary to the BEPS projects. 138 From this statement it can be derived that it has not been the government’s intention to implement the diverted profits tax as a temporary measure awaiting the outcome and implementation of measures of the BEPS project.

OECD director Pascal Saint-Amans has also responded to the diverted profits tax in an inquiry into corporate tax avoidance by the Australian Economics Reference Committee. Saint-Amans implicated that the UK government has been supporting base erosion and profit shifting by companies, and that it introduced the diverted profits tax before the General Election because it wanted to show that it does combat tax avoidance. The director further feared that unilateral action by the UK might cause other countries to act unilateral as well, which is contrary to the multilateral approach of the BEPS project.139

The UK government does however have a valid point taking measures against tax avoidance without awaiting the outcome of the BEPS project. Even though the final reports have now been published it will take some time before the recommended measures will be implemented in the various tax jurisdictions. It will depend on how these measures will be implemented whether the diverted profits tax on its own has a future.

5.3 The BEPS action plan and the diverted profits tax

The overlap between the BEPS project and the diverted profits tax particularly occurs on the subject of artificial avoidance of the PE status. BEPS action plan 7 has been dedicated to prevention of the artificial avoidance of the PE status. 140 The section 86 charge of the diverted profits tax has the same aim. The approach of the diverted profits tax and the recommended measures of the BEPS action plan to prevent the artificial avoidance of the PE status will be discussed with reference to one of the examples attached to the final report on BEPS action plan 1.

138 HC Deb 7 January 2015, vol 590, col 98WH. 139 Economic Reference Committee 09-04-2015, Corporate Tax Avoidance (http://parlinfo.aph.gov.au). 140 OECD, Preventing the Artificial Avoidance of Permanent Establishment Status, Action 7 - 2015 Final Report. 41

5.3.1 The Google Tax

BEPS action plan 1 focuses on the tax challenges of the digital community and especially internet companies. The final report on action plan 1 contains an example of a multinational internet company that derives its revenue from advertisement sales. 141 A comparison to Google is easy to be made.142 In the media the diverted profits tax was quickly coined the ‘Google Tax’ because it addresses the type of tax avoidance US tech multinationals such as Google have been accused of.143

Figure 1144

For the diverted profits tax the arrangements on the level of SCo and TCo, and the direct tax consequences in State S are the most relevant. When assumed that State S is the UK, SCo’s activities consist of technical support and marketing and promotion in relation to UK clients. SCo receives a fee on cost-plus basis from TCo. TCo is the counterparty to all

141 The complete exampled is attached to this thesis in annex 2. 142 Final report on action plan 1 Annex B.2. 143 House of Commons, Committee of Public Accounts, 10 June 2013, Tax Avoidance-Google. 144 © OECD (2015), Addressing the Tax Challenges of the Digital Economy, Action 1 - 2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, p. 173. 42

contracts concluded with UK costumers, which will be concluded online. Based on the assumption that the income of SCo consists of only the fee it receives from TCo it will have a minimal taxable income in the UK. The UK cannot impose a charge with Corporation Tax on the profits of TCo relating to the revenue derived from the UK because TCo has no PE in the UK under the current international tax laws. The result is that the UK has no satisfying taxing powers over the profits of the multinational group relating to UK revenue.

The UK’s answer to the problem is the diverted profits tax. The UK will impose a charge on the basis of section 86 on the profits relating to the UK revenue that would have arisen if SCo would have qualified as a PE of TCo. Three conditions will have to be met. Firstly, the activities of SCo and TCo must be designed in order to avoid that TCo would carry on a trade in the UK for corporation tax purposes. Secondly, none of the exemptions may be applicable. Thirdly, the arrangements must have a main purpose of tax avoidance (See paragraph. 2.3).

According to the final report on action plan 1 of the BEPS project the answer to the problem is modifying the definition of the PE in bilateral tax treaties.145 Arrangements such as in the example, where a subsidiary of a foreign company engages with the customer but does not conclude contracts, should result in a PE of the foreign company. The profits resulting from the revenue related to the PE can then be charged with corporation tax in that country. The measures that need to be taken to prevent the artificial avoidance of the PE status are part of action plan 7.

5.3.2 Action plan 7

The recommendations in action plan 7 are aimed at four types of avoidance of the PE status. Avoidance through commissionaire arrangements, avoidance through the specific activity exemptions, avoidance by splitting up contracts and strategies for selling insurance in a state without having a PE in that state. A more extensive treatment of the proposed measures to tackle the avoidance of the PE status will follow below.

Avoidance through commissionaire arrangements and the strategies for selling insurance without having a PE should be tackled by modification of paragraphs 5 and 6 of article 5 of the OECD model tax convention and modifications to the commentaries on article 5.146 The

145 OECD, Addressing the Tax Challenges of the Digital Economy, Action 1 - 2015 Final Report, p. 88. 146 OECD, Preventing the Artificial Avoidance of Permanent Establishment Status, Action 7 - 2015 Final Report, p. 15 and 44. 43

changes should reflect the policy that: ‘’where the activities that an intermediary exercises in a country are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, that enterprise should be considered to have a sufficient taxable nexus in that country unless the intermediary is performing these activities in the course of an independent business.’’147 In short the proposed changes have the result that where a person, who is acting in a contracting state on behalf of an enterprise, habitually concludes contracts or habitually plays a principles role leading to the conclusion of the contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that contracting state.148 The conditions to qualify as an independent agent are also strengthened. One cannot qualify as an independent agent if he acts almost exclusively on behalf of an enterprise to which he is closely related. The parties are closely related when one controls the other or when both parties are under control of the same persons or enterprises.149

Avoidance through the specific activity exemptions should be tackled by modifying paragraph 4 of article 5 of the OECD Model convention. Paragraph 4 contains the special activities which are exempted. Where the current exemptions of subparagraphs a) to d) automatically apply if no other activity takes place in a fixed place of business, the application should be limited to activities with a preparatory or auxiliary character.150 In addition, a new anti-fragmentation rule must be introduced in paragraph 4.1 of article 5. This should prevent companies from fragmenting their operations into smaller operations which may qualify as exempted preparatory or auxiliary activities carried out in different places of business belonging to closely related parties.151

Avoiding a PE by splitting-up contracts can be tackled by national anti-abuse legislation or the principle purpose test which will be added to the OECD model tax convention, as well as an anti-avoidance rule that will be added to the commentaries.152

147 OECD, Preventing the Artificial Avoidance of Permanent Establishment Status, Action 7 - 2015 Final Report, p. 15. 148 OECD, Preventing the Artificial Avoidance of Permanent Establishment Status, Action 7 - 2015 Final Report, p. 16 149 OECD, Preventing the Artificial Avoidance of Permanent Establishment Status, Action 7 - 2015 Final Report, p. 16 -17. 150 OECD, Preventing the Artificial Avoidance of Permanent Establishment Status, Action 7 - 2015 Final Report, p. 28. 151 OECD, Preventing the Artificial Avoidance of Permanent Establishment Status, Action 7 - 2015 Final Report, p. 39 -41. 152 OECD, Preventing the Artificial Avoidance of Permanent Establishment Status, Action 7 - 2015 Final Report, p. 42. 44

5.4 Differences

5.4.1 Difference in the prevention method

It follows clearly from the example in the preceding paragraph that the diverted profits tax and the BEPS action plan use a different approach in preventing the artificial avoidance of the PE status. The BEPS action plan proposes measures that prevent the avoidance taking place. By chancing the exemptions that have given rise to abuse and updating treaty provisions that have been overtaken by the economic development and in particular the development of a digital economy, the arrangements used by multinationals should no longer give rise to BEPS. The diverted profits tax takes a different approach and restores the taxing power in cases where arrangements have led to base erosion an profits shifting. The diverted profits tax for instance does not result in an actual PE being established. That the diverted profits tax will prevent the artificial avoidance of the PE status is the result of the higher tax rate of the diverted profits tax as appose to the Corporation Tax. This however requires companies to abandon their current structures and arrangements, where under the measures of the BEPS action plan current structures will automatically qualify as a PE.

5.4.2 Differences in scope

The BEPS action plan is a compressive plan to tackle base erosion and profits shifting. The BEPS action plan takes a multilateral approach to ensure that tax is paid in the countries where activity takes place and value is created. Though aimed at the taxation of business profits, the BEPS action plan does not take into account only corporation taxes but for instance also VAT. The diverted profits tax on the other hand is aimed at restoring the taxing power of one state, the avoidance of the UK Corporation Tax and it consists of various exemptions such as all loan relationships. Besides, a unilateral anti-avoidance measure only tackles part of the BEPS problem as shown by the various BEPS problems in the complete example referred to in paragraph 5.3.

The definite outcome of the BEPS project is far from certain. The proposed measures, once implemented will have to proof themselves. It is plausible that companies will keep seeking and find ways to avoid paying taxes in the countries where they derive their revenue from. If the measures as proposed in the BEPS action plans turn out to be insufficient, a new time consuming process will have to follow. The diverted profits tax, which has a broad scope in the way that it targets all arrangements aimed at tax avoidance will give the UK 45

government an instrument to tackle arrangements that turn out to be ‘’BEPS-project proof’’.153 It is therefore not to be expected that the UK government will withdraw the diverted profits tax as soon as the BEPS project measures have been implemented.

5.4.3 Difference in time

The first OECD report on BEPS was published in 2013. The measures proposed in the final reports which were published in 2015 will now have to be implemented. Many of the proposed measures require modifications to the OECD commentaries and the update of the OECD model tax convention itself. Where updates of the OECD commentaries might have effect on the applicability of bilateral double tax treaties which are based on the model convention (see paragraph 3.2.2) this cannot be said for the update of the OECD model tax convention itself. Modifications to the model convention will take years to be implemented in new bilateral double tax treaties. It is therefore that the OECD has proposed to implement a multilateral instrument to modify existing bilateral tax treaties. 154 This would mean a significant improvement of the time it takes to implement the measures compared to bilateral renegotiation of all existing tax treaties. The estimated opening time for signing the instrument is 31 December 2016. Compared to the legislative process of the diverted profits tax it takes rather long to implement the BEPS action plan measures. The diverted profits tax was announced in December 2014 and applies on financial years commencing on or after April 2015. Would the UK government have waited for the BEPS project outcome and the implementation of the proposed measures, the avoidance of UK corporation tax could have continued in the meantime.

5.5 Conclusion

In the light of the multilateral efforts to tackle base erosion and profits shifting by the OECD it is justified to ask questions why a country would take unilateral action to secure its own taxing rights without awaiting the outcome of the BEPS action plan. There is an overlap in the arrangements that the BEPS project and the diverted profits tax aim to prevent. However, the approach the diverted profits tax and the BEPS project take to tackle for instance the artificial avoidance of the PE status is different. The BEPS project aims to modify tax treaties in order to prevent the abuse. The diverted profits tax imposes a charge on

153 Picotto uses internet retail company Amazon as an example in: Piccioto, The UK’s Diverted Profits Tax: An admission of Defeat or a Pre-Emptive Strike?, Tax Notes International, January 19 2015, 239, p. 242. 154 OECD, Developing a Multilateral Instrument to Modify Bilateral Tax Treaties, Action 15 - 2015 Final Report. 46 profits relating to UK related revenue as if there were a PE. The difference is thus that the diverted profits tax cures the symptoms and the BEPS project cures the root of the problem. The other main difference is that the diverted profits tax is a unilateral measure and that the BEPS project is based on international cooperation. The BEPS project allows for anti-abuse legislation to tackle some problems, but implementing the diverted profits tax in every jurisdiction would not eliminate the outdated principles of international tax law which give rise to BEPS problems in the first place. The diverted profits tax would therefore not be an effective instrument in the light of the purpose of the BEPS project.

47

6 Conclusion

The main research question in this thesis is: Is the diverted profits tax an effective measure to ensure that multinational companies pay a fair share of tax in the countries where their revenue arises?

From a UK point of view the diverted profits tax will be an effective measure to make sure that multinational companies will pay UK tax on their profits relating to UK revenue. The diverted profits tax targets the arrangements that these companies have in place to avoid having a UK taxable presence or to minimise their UK tax base. The aim of the diverted profits tax is to either impose a charge on these diverted profits or to persuade companies to abandon their arrangements and take their UK related profits into an assessment to UK corporation tax. If companies do not choose to abandon their arrangements aimed at tax avoidance, the diverted profits tax will be an effective way to eliminate the tax benefits of those arrangements.

The scale in which tax avoidance by multinational companies takes place is mainly a consequence of the differences between the different national tax jurisdictions. Perhaps more important than the national aspects of tax avoidance by multinational companies are therefore the aspects of international tax law, EU law and multilateral efforts to tackle tax avoidance.

Bilateral double tax treaties play a central role in questions of international tax law. The diverted profits tax is covered by the existing tax treaties on the basis of article 2 of double tax treaties that are based on the OECD model tax convention because it is a substantially similar tax to a corporation tax. It would however be contrary to the purpose of double tax treaties if companies charged with diverted profits tax could challenge this charge with an appeal to a treaty. Double taxation treaties aim to prevent tax-avoidance and evasion, a charge on diverted profits particularly rises in relation to arrangements aimed at tax avoidance. National limitations on treaty access and the OECD commentaries to the model convention provide tax authorities arguments to deny a taxpayer access to double tax treaties to challenge the diverted profits tax.

In the EU the direct taxes have not been subject to harmonization. Although the direct taxes are thus within the competence of the Member States, they may not impose direct taxes which are not consistent with the internal market. The fundamental freedoms of the TFEU may not be restricted by national tax measures unless this restriction is justified. Anti-abuse

48 legislation such as the diverted profits tax can result in a restriction of the freedom of establishment or the free movement of services but is justified where it specifically targets wholly artificial arrangements the purpose of which is tax avoidance. Because the diverted profits tax is suitable to tackle tax avoidance via artificial arrangements and does not go further than necessary in doing so, it is not contrary to EU law.

National anti-avoidance legislation is usually aimed at restoring the taxing rights of a state on profits relating to its own jurisdiction. The BEPS project initiated by the OECD takes a multilateral approach in tackling tax avoidance. By modifying tax treaties and updating definitions and practices it aims to tackle the root of the problem that enables multinational companies to avoid taxes. The diverted profits tax merely tackles some of the occasions on which tax avoidance takes place, and only in one jurisdiction at a time. To rig every tax jurisdiction with a diverted profits tax would thus not be the answer to tax avoidance by multinational companies.

To answer the main research question. The diverted profits tax is not an effective measure to ensure that multinational companies pay a fair share of tax in the countries where their revenue arises.

49

Bibliography

Literature

Baker, P., Double Taxation Conventions, Sweet & Maxwell, London 2001 (3rd edition).

Baker, P., Diverted profits tax: a partial response, British Tax Review 2015, 2, 167-171.

R.P.C.W.M. Brandsma et al., Studenteneditie 2013-2014, Cursus Belastingrecht (Europees Belastingrecht). Brandstetter, P., ‘Taxes Covered’: A study of article 2 of the OECD model tax convention, IBFD 2011 [IBFD online].

Cussons, P., The new diverted profits and EU/international law, including BEPS. [online taxjournal.com].

Engelen, F.A., Interpreation of Tax Treaties under International Law, IBFD 2004.

Lang, “Taxes Covered” – What is a “Tax” according to Article 2 of the OECD Model?, Tax Treaty Monitor (2005), p.216-223. [IBFD online].

Marres, O.C.R. & Wattel, P.J., The legal status of the OECD commentary, European Taxation 2003 p. 222-233. [IBFD online].

Neidle, The diverted profits tax: flawed by design?, British Tax review, 2015, 2, 147-166.

Piccioto, The UK’s Diverted Profits Tax: An admission of Defeat or a Pre-Emptive Strike?, Tax Notes International, January 19 2015, 239 [online].

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Self, H., give beps a chance. [online taxjournal.com].

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50

Weber, D.M., Tax avoidance and the EC Treaty Freedoms, Kluwer International Law 2005.

Table of Cases

Court of Appeal (Civil Division) (United Kingdom) 25-07-1997, Bricom Holdings Ltd. v The Commissioners of Inland Revenue, S.T.C. 1179 70, T.C. 272, BTC 471. [Online via Westlaw]. High Court (Ireland), 31-07-2007, Lorraine Kinsella and the Revenue Commissioners, IEHC 250 10, ITLR 63 [Online via law.ato.gov.au].

Federal Court, Sydney (Australia) 10-10-2008, Virgin Holdings SA v Federal Commissioner of Taxation, FCA 1503 [online via law.ato.gov.au].

Federal Court, Sydney (Australia) 03-02-2009, Undershaft No 1 Ltd. v Federal Commissioner of Taxation and Undershaft No 2 Ltd. v Federal Commissioner of Taxation, FCA 41. [online via law.ato.gov.au].

CJEU 28-01-1992, C-204/90 (Bachmann).

CJEU 09-03-1999, C-212/97 (Centros).

CJEU 13-12-2005, C-446/03 (Marks & Spencer).

CJEU 12-09-2006, C-196/04 (Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v IRC).

CJEU 30-10-2006, C-452/04 (Fidium Finanz).

CJEU 12-12-2006, C-446/04 (Test Claimants in the FII Group Litigation) (FII).

CJEU 13-03-2007, C-524/04 (Test Claimant in the Thin Cap Group Litigation).

CJEU 18-03-2010, C-440/08 (Gielen).

CJEU 13-11-2012, C-35/11 (Test Claimants in the FII Group Litigation) (FII-2).

CJEU 03-10-2013, C-282/12 (Itelcar).

51

84 Finance Act 2015 (c. 11) Part 2 — Excise duties and other taxes

(6) Subsections (1) to (4) are to be ignored for the purpose of determining the amount of any pre-commencement instalment payment. (7) If there is at least one instalment payment, in respect of the total liability of E for the accounting period, which under the Instalment Payment Regulations is treated as becoming due and payable on or after 1 April 2015 (“post- commencement instalment payments”), the amount of that instalment payment, or the first of them, is to be increased by the adjustment amount. (8) If there are no post-commencement instalment payments, a further instalment payment, in respect of the total liability of E for the accounting period, of an amount equal to the adjustment amount is to be treated as becoming due and payable on 30 April 2015. (9) “The adjustment amount” is the difference between— (a) the aggregate amount of the pre-commencement instalment payments determined in accordance with subsection (6), and (b) the aggregate amount of those instalment payments determined ignoring subsection (6) (and so taking account of subsections (1) to (4)). (10) In the Instalment Payment Regulations— (a) in regulations 6(1)(a), 7(2), 8(1)(a) and (2)(a), 9(5), 10(1), 11(1) and 13, references to regulation 4A, 4B, 4C, 4D, 5, 5A or 5B of those Regulations are to be read as including a reference to subsections (5) to (9) (and in regulation 7(2) “the regulation in question”, and in regulation 8(2) “that regulation”, are to be read accordingly), and (b) in regulation 9(3), the reference to those Regulations is to be read as including a reference to subsections (5) to (9). (11) In section 59D of TMA 1970 (general rule as to when corporation tax is due and payable), in subsection (5), the reference to section 59E is to be read as including a reference to subsections (5) to (10). (12) In this section— “the chargeable period” is to be construed in accordance with paragraph 4 or (as the case may be) 5 of Schedule 19 to FA 2011; “the Instalment Payment Regulations” means the Corporation Tax (Instalment Payments) Regulations 1998 (S.I. 1998/3175); and references to the total liability of E for an accounting period are to be construed in accordance with regulation 2(3) of the Instalment Payment Regulations.

PART 3

DIVERTED PROFITS TAX

Introduction and overview

77 Introduction to the tax (1) A tax (to be known as “diverted profits tax”) is charged in accordance with this Part on taxable diverted profits arising to a company in an accounting period. (2) Taxable diverted profits arise to a company in an accounting period only if one or more of sections 80, 81 and 86 applies or apply in relation to the company for that period. Finance Act 2015 (c. 11) 85 Part 3 — Diverted profits tax

78 Overview of Part 3 (1) Sections 80 and 81 relate to cases involving entities or transactions which lack economic substance. (2) In these cases— (a) sections 82 to 85 deal with the calculation of taxable diverted profits (and ensure appropriate account is taken of any transfer pricing adjustments already made), and (b) section 96 deals with the estimation of those profits when initially imposing a charge. (3) Section 86 relates to cases where, despite activity being carried on in the United Kingdom, a company avoids carrying on its trade in the United Kingdom in circumstances where— (a) provision is made or imposed which involves entities or transactions lacking economic substance, or (b) there are tax avoidance arrangements. (4) In these cases— (a) sections 88 to 91 deal with the calculation of taxable diverted profits, and (b) section 97 deals with the estimation of those profits when initially imposing a charge. (5) There is an exception from section 86 for cases involving limited UK-related sales or expenses (see section 87). (6) Key terms used in this Part are defined in sections 106 to 114. (7) Other provisions in this Part— ensure HMRC are notified of companies potentially within the scope of the tax (see section 92); deal with the process for imposing a charge to diverted profits tax (see sections 93 to 97); deal with payment of the tax and make provision about credits given for other tax paid on the same profits (see sections 98 to 100); and provide for reviews of, and appeals against, decisions to impose a charge to diverted profits tax (see sections 101 and 102).

Charge to tax

79 Charge to tax (1) A charge to diverted profits tax is imposed for an accounting period by a designated HMRC officer issuing to the company a charging notice in accordance with section 95 or a supplementary charging notice in accordance with section 101(8). (2) The amount of tax charged by a notice is the sum of— (a) 25% of the amount of taxable diverted profits specified in the notice, and (b) the interest (if any) on the amount within paragraph (a) determined under subsection (4). 86 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

(3) But if, and to the extent that, the taxable diverted profits are adjusted ring fence profits or notional adjusted ring fence profits, and determined under section 84 or 85, subsection (2)(a) has effect in relation to those profits as if the rate specified were 55% rather than 25%. (4) The interest mentioned in subsection (2)(b) is interest at the rate applicable under section 178 of FA 1989 for the period (if any) which— (a) begins 6 months after the end of the accounting period to which the charge relates, and (b) ends with the day the notice imposing the charge to tax is issued. (5) In this section— “adjusted ring fence profits” has the same meaning as in section 330 of CTA 2010 (supplementary charge in respect of ring fence trades); “notional adjusted ring fence profits”, in relation to the company, means the total of— (a) profits within section 85(5)(a), to the extent that (assuming they were profits of the company chargeable to corporation tax) they would have been adjusted ring fence profits, and (b) any amounts of relevant taxable income of a company (“CC”) within section 85(4)(b) or (5)(b), to the extent that (assuming those amounts were profits of CC chargeable to corporation tax) they would have been adjusted ring fence profits of CC.

Involvement of entities or transactions lacking economic substance

80 UK company: involvement of entities or transactions lacking economic substance (1) This section applies in relation to a company (“C”) for an accounting period if— (a) C is UK resident in that period, (b) provision has been made or imposed as between C and another person (“P”) (whether or not P is UK resident) by means of a transaction or series of transactions (“the material provision”), (c) the participation condition is met in relation to C and P (see section 106), (d) the material provision results in an effective tax mismatch outcome, for the accounting period, as between C and P (see sections 107 and 108), (e) the effective tax mismatch outcome is not an excepted loan relationship outcome (see section 109), (f) the insufficient economic substance condition is met (see section 110), and (g) C and P are not both small or medium-sized enterprises for that period. (2) For the purposes of subsection (1)(b) provision made or imposed as between a partnership of which C is a member and another person is to be regarded as provision made or imposed as between C and that person. Finance Act 2015 (c. 11) 87 Part 3 — Diverted profits tax

81 Non-UK company: involvement of entities or transactions lacking economic substance (1) This section applies in relation to a company (“the foreign company”) for an accounting period if— (a) it is non-UK resident in that period, (b) by reason of the foreign company carrying on a trade in the United Kingdom through a permanent establishment in the United Kingdom (“UKPE”), Chapter 4 of Part 2 of CTA 2009 (non-UK resident companies: chargeable profits) applies to determine the chargeable profits of the foreign company for that period, and (c) section 80 would apply to UKPE for that period were it treated for the purposes of section 80 and sections 106 to 110— (i) as a distinct and separate person from the foreign company (whether or not it would otherwise be so treated), (ii) as a UK resident company under the same control as the foreign company, and (iii) as having entered into any transaction or series of transactions entered into by the foreign company to the extent that the transaction or series is relevant to UKPE. (2) For the purposes of subsection (1)(c)(iii) a transaction or series of transactions is “relevant” to UKPE only if, and to the extent that, it is relevant, for corporation tax purposes, when determining the chargeable profits of the foreign company attributable (in accordance with sections 20 to 32 of CTA 2009) to UKPE. (3) Where section 1313(2) of CTA 2009 (UK sector of the continental shelf: profits of foreign company deemed to be profits of trade carried on by the company in the UK through a permanent establishment in the UK) applies to treat profits arising to a company as profits of a trade carried on by the company in the United Kingdom through a permanent establishment in the United Kingdom, this Part applies as if the company actually carried on that trade in the United Kingdom through that permanent establishment. (4) In this section “control” is to be construed in accordance with section 1124 of CTA 2010.

Calculation of taxable diverted profits: section 80 or 81 cases

82 Calculation of taxable diverted profits in section 80 or 81 case: introduction (1) If section 80 or 81 applies in relation to a company (“the relevant company”) for an accounting period— (a) no taxable diverted profits arise, in relation to the material provision in question, if section 83 applies, and (b) in other cases, section 84 or 85 applies to determine the taxable diverted profits in relation to that material provision. (2) But see also section 96 for how a designated HMRC officer estimates those profits when issuing a preliminary notice under section 93 or a charging notice under section 95. (3) Subsections (4) to (9) define some key expressions used in sections 83 to 85 and this section. 88 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

(4) “The material provision” has the same meaning as in section 80. (5) “The relevant alternative provision” means the alternative provision which it is just and reasonable to assume would have been made or imposed as between the relevant company and one or more companies connected with that company, instead of the material provision, had tax (including any non-UK tax) on income not been a relevant consideration for any person at any time. (6) For the purposes of subsection (5), making or imposing no provision is to be treated as making or imposing an alternative provision to the material provision. (7) “The actual provision condition” is met if— (a) the material provision results in expenses of the relevant company for which (ignoring Part 4 of TIOPA 2010 (transfer pricing)) a deduction for allowable expenses would be allowed in computing— (i) in a case where section 80 applies, its liability for corporation tax for the accounting period, and (ii) in a case where section 81 applies, its chargeable profits attributable (in accordance with sections 20 to 32 of CTA 2009) to UKPE, and (b) the relevant alternative provision— (i) would also have resulted in allowable expenses of the relevant company of the same type and for the same purposes (whether or not payable to the same person) as so much of the expenses mentioned in paragraph (a) as results in the effective tax mismatch outcome mentioned in section 80(1)(d), but (ii) would not have resulted in relevant taxable income of a connected company for that company’s corresponding accounting period. (8) “Relevant taxable income” of a company for a period is— (a) income of the company, for the period, which would have resulted from the relevant alternative provision and in relation to which the company would have been within the charge to corporation tax had that period been an accounting period of the company, less (b) the total amount of expenses which it is just and reasonable to assume would have been incurred in earning that income and would have been allowable expenses of the company for that period. (9) “Connected company” means a company which is or, if the relevant alternative provision had been made, would have been connected with the relevant company.

83 Section 80 or 81 cases where no taxable diverted profits arise (1) Where section 80 or 81 applies in relation to a company for an accounting period, no taxable diverted profits arise to the company in that period in relation to the material provision in question if— (a) the actual provision condition is met, and (b) either— (i) there are no diverted profits of that company for the accounting period, or (ii) the full transfer pricing adjustment has been made. Finance Act 2015 (c. 11) 89 Part 3 — Diverted profits tax

(2) “Diverted profits” of the company for the accounting period means an amount— (a) in respect of which the company is chargeable to corporation tax for that period by reason of the application of Part 4 of TIOPA 2010 (transfer pricing) to the results of the material provision, and (b) which, in a case where section 81 applies, is attributable (in accordance with sections 20 to 32 of CTA 2009) to UKPE. (3) “The full transfer pricing adjustment” is made if all of the company’s diverted profits for the accounting period are taken into account in an assessment to corporation tax included, before the end of the review period, in the company’s company tax return for the accounting period.

84 Section 80 or 81: calculation of profits by reference to the actual provision (1) This section applies where— (a) section 80 or 81 applies in relation to a company for an accounting period, (b) the actual provision condition is met, and (c) section 83 (cases where no taxable diverted profits arise) does not apply for that period. (2) In relation to the material provision in question, the taxable diverted profits that arise to the company in the accounting period are the amount (if any)— (a) in respect of which the company is chargeable to corporation tax for that period by reason of the application of Part 4 of TIOPA 2010 (transfer pricing) to the results of the material provision, (b) which, in a case where section 81 applies, is attributable (in accordance with sections 20 to 32 of CTA 2009) to UKPE, and (c) which is not taken into account in an assessment to corporation tax which is included before the end of the review period in the company’s company tax return for that accounting period.

85 Section 80 or 81: calculation of profits by reference to the relevant alternative provision (1) This section applies where— (a) section 80 or 81 applies in relation to a company (“the relevant company”) for an accounting period, and (b) the actual provision condition is not met. (2) The taxable diverted profits that arise to the relevant company in the accounting period in relation to the material provision in question are determined in accordance with subsections (3) to (5). (3) Subsection (4) applies if the actual provision condition would have been met but for the fact that the relevant alternative provision would have resulted in relevant taxable income of a company for that company’s corresponding accounting period. (4) The taxable diverted profits that arise to the relevant company in the accounting period are an amount equal to the sum of— (a) the amount described in section 84(2), and 90 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

(b) the total amount of any relevant taxable income of a connected company, for that company’s corresponding accounting period, which would have resulted from the relevant alternative provision. (5) If subsection (4) does not apply, the taxable diverted profits that arise to the relevant company in the accounting period are the sum of— (a) the notional additional amount (if any) arising from the relevant alternative provision, and (b) the total amount (if any) of any relevant taxable income of a connected company, for that company’s corresponding accounting period, which would have resulted from the relevant alternative provision, (6) In subsection (5) “the notional additional amount” means the amount by which— (a) the amount in respect of which the company would have been chargeable to corporation tax for that period had the relevant alternative provision been made or imposed instead of the material provision, exceeds (b) the amount— (i) in respect of which the company is chargeable to corporation tax for that period by reason of the application of Part 4 of TIOPA 2010 (transfer pricing) to the results of the material provision, (ii) which, in a case where section 81 applies, is attributable (in accordance with sections 20 to 32 of CTA 2009) to UKPE, and (iii) which is taken into account in an assessment to corporation tax which is included before the end of the review period in the company’s company tax return for that accounting period.

Avoidance of a UK taxable presence

86 Non-UK company avoiding a UK taxable presence (1) This section applies in relation to a company (“the foreign company”) for an accounting period if— (a) the company is non-UK resident in that period, (b) it carries on a trade during that period (or part of it), (c) a person (“the avoided PE”), whether or not UK resident, is carrying on activity in the United Kingdom in that period in connection with supplies of services, goods or other property made by the foreign company in the course of that trade, (d) section 87 (exception for companies with limited UK-related sales or expenses) does not operate to prevent this section applying in relation to the foreign company for the accounting period, (e) it is reasonable to assume that any of the activity of the avoided PE or the foreign company (or both) is designed so as to ensure that the foreign company does not, as a result of the avoided PE’s activity, carry on that trade in the United Kingdom for the purposes of corporation tax (whether or not it is also designed to secure any commercial or other objective), (f) the mismatch condition (see subsection (2)) or the tax avoidance condition (see subsection (3)) is met or both those conditions are met, (g) the avoided PE is not excepted by subsection (5), and Finance Act 2015 (c. 11) 91 Part 3 — Diverted profits tax

(h) the avoided PE and the foreign company are not both small or medium- sized enterprises for that period. (2) “The mismatch condition” is that— (a) in connection with the supplies of services, goods or other property mentioned in subsection (1)(c) (or in connection with those supplies and other supplies), arrangements are in place as a result of which provision is made or imposed as between the foreign company and another person (“A”) by means of a transaction or series of transactions (“the material provision”), (b) the participation condition is met in relation to the foreign company and A (see section 106), (c) the material provision results in an effective tax mismatch outcome, for the accounting period, as between the foreign company and A (see sections 107 and 108), (d) the effective tax mismatch outcome is not an excepted loan relationship outcome (see section 109), (e) the insufficient economic substance condition is met (see section 110), and (f) the foreign company and A are not both small or medium-sized enterprises for the accounting period. (3) “The tax avoidance condition” is that, in connection with the supplies of services, goods or other property mentioned in subsection (1)(c) (or in connection with those supplies and other supplies), arrangements are in place the main purpose or one of the main purposes of which is to avoid or reduce a charge to corporation tax. (4) In subsection (1)(e) the reference to activity of the avoided PE or the foreign company includes any limitation which has been imposed or agreed in respect of that activity. (5) The avoided PE is “excepted” if— (a) activity of the avoided PE is such that, as a result of section 1142 or 1144 of CTA 2010, the foreign company would not be treated as carrying on a trade in the United Kingdom in the accounting period through a permanent establishment in the United Kingdom by reason of that activity, and (b) in a case where— (i) section 1142(1) of that Act applies, but (ii) the avoided PE is not regarded for the purposes of section 1142(1) of that Act as an agent of independent status by virtue of section 1145, 1146 or 1151 of that Act, the foreign company and the avoided PE are not connected at any time in the accounting period. (6) Where the foreign company is a member of a partnership— (a) for the purposes of subsection (1)— (i) a trade carried on by the partnership is to be regarded as a trade carried on by the foreign company, and (ii) supplies made by the partnership in the course of that trade are to be regarded as supplies made by the foreign company in the course of that trade, and 92 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

(b) for the purposes of subsection (2)(a) provision made or imposed as between the partnership and another person is to be regarded as made between the foreign company and that person. (7) In this section “arrangements” includes any agreement, understanding, scheme, transaction or series of transactions (whether or not legally enforceable).

87 Exception for companies with limited UK-related sales or expenses (1) Section 86 does not apply to the foreign company for an accounting period if one or both of the following conditions is or are met. (2) The first condition is that, for the accounting period, the total of— (a) the UK-related sales revenues of the foreign company, and (b) the UK-related sales revenues of companies connected with the foreign company, does not exceed £10,000,000. (3) The second condition is that the total of— (a) the UK-related expenses of the foreign company incurred in the accounting period, and (b) the UK-related expenses of companies connected with the foreign company incurred in that period, does not exceed £1,000,000. (4) But if the accounting period is a period of less than 12 months, the amounts specified in subsections (2) and (3) are to be reduced proportionally. (5) In this section— “the foreign company” has the same meaning as in section 86; “UK activity” means activity carried on in the United Kingdom in connection with supplies of services, goods or other property made by the foreign company in the course of the trade mentioned in section 86(1)(b); “UK-related expenses”, of a company, means the expenses of that company which relate to UK activity; “UK-related sales revenues” means— (a) in the case of the foreign company, the sales revenues of that company from UK-related supplies, and (b) in the case of a company connected with the foreign company, the sales revenues of the first mentioned company to the extent that they— (i) are from UK-related supplies, and (ii) are trading receipts which are not taken into account in calculating the profits of that company which are chargeable to corporation tax; “UK-related supplies” means supplies of services, goods or other property which are made— (a) by the foreign company or a company connected with the foreign company, and (b) relate to UK activity. Finance Act 2015 (c. 11) 93 Part 3 — Diverted profits tax

(6) For the purposes of this section “revenues” or “expenses” of a company, in the relevant accounting period, are amounts which, in accordance with generally accepted accounting practice (“GAAP”), are recognised as revenue or (as the case may be) expenses in the company’s profit and loss account or income statement for that period. (7) Where a company does not draw up accounts for the relevant accounting period in accordance with GAAP, the reference in subsection (6) to any amounts which in accordance with GAAP are recognised as revenue or expenses in the company’s profit and loss account or income statement for the relevant accounting period is to be read as a reference to any amounts which would be so recognised if the company had drawn up such accounts for the relevant accounting period. (8) “Generally accepted accounting practice” is to be construed in accordance with section 1127 of CTA 2010. (9) The Treasury may by regulations, made by statutory instrument, substitute a different figure for the figure for the time being specified in subsection (2) or (3). (10) Regulations under this section are subject to annulment in pursuance of a resolution of the House of Commons.

Calculation of taxable diverted profits: section 86 cases

88 Calculation of taxable diverted profits in section 86 case: introduction (1) If section 86 applies for an accounting period, section 89, 90 or 91 applies to determine the taxable diverted profits of the foreign company. (2) But see also section 97 for how a designated HMRC officer estimates those profits when issuing a preliminary notice under section 93 or a charging notice under section 95. (3) Subsections (4) to (12) define some key expressions used in sections 89 to 91 and this section. (4) “The foreign company” has the same meaning as in section 86. (5) “The notional PE profits”, in relation to an accounting period, means the profits which would have been the chargeable profits of the foreign company for that period, attributable (in accordance with sections 20 to 32 of CTA 2009) to the avoided PE, had the avoided PE been a permanent establishment in the United Kingdom through which the foreign company carried on the trade mentioned in section 86(1)(b). (6) “The material provision” has the same meaning as in section 86. (7) “The relevant alternative provision” means the alternative provision which it is just and reasonable to assume would have been made or imposed as between the foreign company and one or more companies connected with that company, instead of the material provision, had tax (including any non-UK tax) on income not been a relevant consideration for any person at any time. (8) For the purposes of subsection (7), making or imposing no provision is to be treated as making or imposing an alternative provision to the material provision. 94 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

(9) “The actual provision condition” is met if— (a) the material provision results in expenses of the foreign company for which (ignoring Part 4 of TIOPA 2010 (transfer pricing)) a deduction for allowable expenses would be allowed in computing what would have been the notional PE profits for the accounting period, and (b) the relevant alternative provision— (i) would also have resulted in allowable expenses of the foreign company of the same type and for the same purposes (whether or not payable to the same person) as so much of the expenses mentioned in paragraph (a) as results in the effective tax mismatch outcome mentioned in section 86(2)(c), but (ii) would not have resulted in relevant taxable income of a connected company for that company’s corresponding accounting period. (10) “Relevant taxable income” of a company for a period is— (a) income of the company, for the period, which would have resulted from the relevant alternative provision and in relation to which the company would have been within the charge to corporation tax had that period been an accounting period of the company, less (b) the total amount of expenses which it is just and reasonable to assume would have been incurred in earning that income and would have been allowable expenses of the company for that period. (11) “Connected company” means a company which is or, if the relevant alternative provision had been made, would have been connected with the foreign company. (12) “The mismatch condition” has the same meaning as in section 86.

89 Section 86: calculation of profits where only tax avoidance condition is met (1) This section applies where— (a) section 86 applies for an accounting period, and (b) the mismatch condition is not met. (2) The taxable diverted profits that arise to the foreign company in the accounting period by reason of that section applying are an amount equal to the notional PE profits for that period.

90 Section 86: mismatch condition is met: calculation of profits by reference to the actual provision (1) This section applies where— (a) section 86 applies for an accounting period, (b) the mismatch condition is met, and (c) the actual provision condition is met. (2) The taxable diverted profits that arise to the foreign company in the accounting period, in relation to the material provision in question, are an amount equal to the notional PE profits for that period. Finance Act 2015 (c. 11) 95 Part 3 — Diverted profits tax

91 Section 86: mismatch condition is met: calculation of profits by reference to the relevant alternative provision (1) This section applies where — (a) section 86 applies for an accounting period, (b) the mismatch condition is met, and (c) the actual provision condition is not met. (2) The taxable diverted profits that arise to the foreign company in the accounting period, in relation to the material provision in question, are determined in accordance with subsections (3) to (5). (3) Subsection (4) applies if the actual provision condition would have been met but for the fact that the relevant alternative provision would have resulted in relevant taxable income of a company for that company’s corresponding accounting period. (4) The taxable diverted profits that arise to the foreign company in the accounting period are an amount equal to the sum of— (a) the notional PE profits for the accounting period, and (b) the total amount of any relevant taxable income of a connected company, for that company’s corresponding accounting period, which would have resulted from the relevant alternative provision. (5) If subsection (4) does not apply, the taxable diverted profits that arise to the foreign company in the accounting period are the sum of— (a) what would have been the notional PE profits of the foreign company for that period had the relevant alternative provision been made or imposed instead of the material provision, and (b) the total amount of any relevant taxable income of a connected company, for that company’s corresponding accounting period, which would have resulted from the relevant alternative provision.

Duty to notify if within scope

92 Duty to notify if potentially within scope of tax (1) Where a company meets the requirements in subsection (3) or (4) in relation to an accounting period of the company, the company must notify an officer of Revenue and Customs to that effect. This is subject to subsections (7) and (8). (2) A notification under subsection (1) must be made— (a) in writing, and (b) within the period of 3 months beginning at the end of the accounting period to which it relates (“the notification period”). See also subsection (9) for provision about the content of notifications. (3) A company meets the requirements of this subsection if— (a) section 80 or 81 applies in relation to the company for the accounting period, and (b) in that period, the financial benefit of the tax reduction is significant relative to the non-tax benefits of the material provision. (4) A company meets the requirements of this subsection if— 96 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

(a) section 86 applies in relation to the company for the accounting period, and (b) where that section applies by reason of the mismatch condition being met, in that period the financial benefit of the tax reduction is significant relative to the non-tax benefits of the material provision. (5) For the purposes of subsections (3) and (4), this Part has effect subject to the following modifications— (a) in section 80, ignore subsection (1)(f), (b) in section 86, for subsection (1)(e) substitute— “(e) the foreign company is not, as a result of the avoided PE’s activity, within the charge to corporation tax by reason of the foreign company carrying on a trade in the United Kingdom,”, (c) in subsection (2) of that section, ignore paragraph (e), and (d) in subsection (3) of that section, for “the main purpose or one of the main purposes of which is to avoid or reduce a charge to corporation tax” substitute “that result in the reduction of a charge to corporation tax in consequence of which there is an overall reduction in the amount of tax (including foreign tax) that would otherwise have been payable in respect of the activity mentioned in subsection (1)(c)”. (6) In subsections (3)(b) and (4)(b), “non-tax benefits” means financial benefits other than— (a) the financial benefit of the tax reduction, and (b) any financial benefits which derive (directly or indirectly) from any reduction, elimination or delay of any liability of any person to pay any tax (including any non-UK tax). (7) The duty under subsection (1) does not apply in relation to an accounting period of the company (“the current period”)— (a) if, at the end of the notification period, it is reasonable (ignoring the possibility of future adjustments being made in accordance with Part 4 of TIOPA 2010 (transfer pricing)) for the company to conclude that no charge to diverted profits tax will arise to the company for the current period, (b) if, before the end of the notification period, an officer of Revenue and Customs has confirmed that the company does not have to notify an officer in relation to the current period because— (i) the company, or a company which is connected with it, has provided HMRC with sufficient information to enable a designated HMRC officer to determine whether or not to give a preliminary notice under section 93 to the first mentioned company in respect of the accounting period, and (ii) HMRC has examined that information (whether in the course of an enquiry made into a return or otherwise and whether in relation to diverted profits tax or otherwise), (c) if, at the end of the notification period, it is reasonable for the company to conclude that sub-paragraphs (i) and (ii) of paragraph (b) apply, or (d) if— (i) the immediately preceding accounting period of the company is a period in respect of which notification was given under subsection (1), or not required to be given by virtue of paragraph (b) or (c) or this paragraph, and Finance Act 2015 (c. 11) 97 Part 3 — Diverted profits tax

(ii) at the end of the notification period for the current period, it is reasonable for the company to conclude that there has been no change in circumstances which is material to whether a charge to diverted profits tax may be imposed for the current period. (8) The Commissioners for Her Majesty’s Revenue and Customs may also direct that the duty under subsection (1) does not apply in relation to an accounting period in other circumstances specified in the direction. (9) A notification under subsection (1) must— (a) state whether the obligation to notify arises by reason of section 80, 81 or 86 (as modified by subsection (5)) applying in relation to the company for the accounting period; (b) if it states that section 86 applies, state the name of the avoided PE; (c) if it states that section 80 or 81 applies, contain a description of the material provision in question and the parties between whom it has been made or imposed; (d) if it states that section 86 applies— (i) state whether or not the mismatch condition is met, and (ii) if it is met, contain a description of the material provision in question and the parties between whom it has been made or imposed.

Process for imposing charge

93 Preliminary notice (1) If a designated HMRC officer has reason to believe that— (a) one or more of sections 80, 81 and 86 applies or apply in relation to a company for an accounting period, and (b) as a result, taxable diverted profits arise to the company in the accounting period, the officer must give the company a notice (a “preliminary notice”) in respect of that period. (2) See sections 96 and 97 for provision about the calculation of taxable diverted profits for the purposes of a preliminary notice. (3) A preliminary notice must— (a) state the accounting period of the company to which the notice applies; (b) set out the basis on which the officer has reason to believe that one or more of sections 80, 81 and 86 applies or apply in relation to the company for that accounting period; (c) explain the basis on which the proposed charge is calculated, including— (i) how the taxable diverted profits to which the proposed charge would relate have been determined, (ii) where relevant, details of the relevant alternative provision (see section 82(5) or 88(7)) by reference to which those profits have been determined, and (iii) how the amount of interest comprised in that charge in accordance with section 79(2)(b) would be calculated, (d) state who would be liable to pay the diverted profits tax; 98 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

(e) explain how interest is applied in accordance with section 101 of FA 2009 (late payment interest on sums due to HMRC) if the diverted profits tax is not paid, the period for which interest is charged and the rate at which it is charged. (4) Where the designated HMRC officer has insufficient information to determine or identify any of the matters set out in subsection (3), it is sufficient if the preliminary notice sets out those matters determined to the best of the officer’s information and belief. (5) Subject to subsection (6), a preliminary notice may not be issued more than 24 months after the end of the accounting period to which it relates. (6) Where— (a) notification under section 92 has not been received by an officer of Revenue and Customs in respect of an accounting period of a company within the period specified in subsection (2)(b) of that section, and (b) a designated HMRC officer believes, in relation to that accounting period, that an amount of diverted profits tax that ought to have been charged under this Part has not been charged, a designated HMRC officer may issue to the company a preliminary notice in respect of that tax within the period of 4 years after the end of the accounting period. (7) Where a preliminary notice is issued to a company, the officer must give a copy of the notice— (a) if the notice is issued on the basis that section 81 applies, to UKPE, and (b) if the notice is issued on the basis that section 86 applies, to the avoided PE.

94 Representations (1) This section applies where a designated HMRC officer gives a preliminary notice, in respect of an accounting period, to a company under section 93 (and that notice is not withdrawn). (2) The company has 30 days beginning with the day the notice is issued to send written representations to the officer in respect of the notice. (3) Representations made in accordance with subsection (2) are to be considered by the officer only if they are made on the following grounds— (a) that there is an arithmetical error in the calculation of the amount of the diverted profits tax or the taxable diverted profits or an error in a figure on which an assumption in the notice is based; (b) that the small or medium-sized enterprise requirement is not met; (c) that in a case where the preliminary notice states that section 80 or 81 applies— (i) the participation condition is not met, (ii) the 80% payment test is met, or (iii) the effective tax mismatch outcome is an excepted loan relationship outcome; (d) that in a case where the preliminary notice states that section 86 applies— Finance Act 2015 (c. 11) 99 Part 3 — Diverted profits tax

(i) section 87 (exception for companies with limited UK-related sales or expenses) operates to prevent section 86 from applying for the accounting period, or (ii) the avoided PE is “excepted” within the meaning of section 86(5); (e) that in a case where the preliminary notice states that section 86 applies and that the mismatch condition (within the meaning of section 86(2)) is met, the condition is not met because— (i) the participation condition is not met, (ii) the 80% payment test is met, or (iii) the effective tax mismatch outcome is an excepted loan relationship outcome (within the meaning of section 109(2)). (4) But, unless they are representations under subsection (3)(a) in respect of arithmetical errors, nothing in subsection (3) requires the officer to consider any representations if, and to the extent that, they relate to— (a) any provision of Part 4 of TIOPA 2010 (transfer pricing), or (b) the attribution of profits of a company to a permanent establishment in the United Kingdom through which the company carries on a trade (including any notional attribution made for the purposes of section 89, 90 or 91). (5) “The small or medium-sized enterprise requirement” is— (a) where the notice was issued on the basis that section 80 or 81 applies, the requirement in section 80(1)(g), and (b) where the notice was issued on the basis that section 86 applies to the company, the requirement in subsection (1)(h) or (2)(f) of that section. (6) “The participation condition” means— (a) where the notice was issued on the basis that section 80 or 81 applies, the condition in section 80(1)(c), and (b) where the notice was issued on the basis that section 86 applies to the company, the condition in subsection (2)(b) of that section. (7) “The 80% payment test” means the requirement in section 107(3)(d).

95 Charging notice (1) This section applies where a designated HMRC officer has given a company a preliminary notice under section 93 in relation to an accounting period. (2) Having considered any representations in accordance with section 94, the officer must determine whether to— (a) issue a notice under this section (a “charging notice”) to the company for that accounting period, or (b) notify the company that no charging notice will be issued for that accounting period pursuant to that preliminary notice, and must take that action before the end of the period of 30 days immediately following the period of 30 days mentioned in section 94(2). (3) A notification under subsection (2)(b) does not prevent a charging notice being issued for the same accounting period pursuant to any other preliminary notice the person may be given in respect of that period. 100 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

(4) See sections 96 and 97 for provision about the calculation of taxable diverted profits for the purposes of a charging notice. (5) A charging notice must— (a) state the amount of the charge to diverted profits tax imposed by the notice; (b) set out the basis on which the officer considers that section 80, 81 or 86 applies; (c) state the accounting period of the company to which the notice applies; (d) set out an explanation of the basis on which the charge is calculated, including— (i) how the taxable diverted profits to which the charge relates have been determined, (ii) where relevant, details of the relevant alternative provision (see section 82(5) or 88(7)) by reference to which those profits have been determined, and (iii) how the amount of interest comprised in the charge under section 79(2)(b) has been calculated; (e) state who is liable to pay the diverted profits tax; (f) state when the tax is due and payable; (g) explain how interest is applied in accordance with section 101 of FA 2009 (late payment interest on sums due to HMRC) if the diverted profits tax is not paid, the period for which interest is charged and the rate at which it is charged. (6) Where a charging notice is issued to a company, the officer must give a copy of the notice— (a) if the notice is issued by reason of section 81 applying, to UKPE, and (b) if the notice is issued by reason of section 86 applying, to the avoided PE.

96 Section 80 or 81 cases: estimating profits for preliminary and charging notices (1) Where taxable diverted profits arising to a company in an accounting period fall to be determined under section 84 or 85, for the purposes of issuing a preliminary notice under section 93 or a charging notice under section 95 the taxable diverted profits to be specified in the notice, in relation to the material provision in question, are determined in accordance with this section. (2) The taxable diverted profits are such amount (if any) as the designated HMRC officer issuing the notice determines, on the basis of the best estimate that can reasonably be made at that time, to be the amount calculated in accordance with sections 84 or 85 (as the case may be). But this is subject to subsections (4) to (6). (3) For the purposes of this section, “the inflated expenses condition” is met if— (a) the material provision results in expenses of the company for which a deduction has been taken into account by the company in computing— (i) in a case where section 80 applies, its liability for corporation tax for the accounting period, and (ii) in a case where section 81 applies, its chargeable profits attributable (in accordance with sections 20 to 32 of CTA 2009) to UKPE, Finance Act 2015 (c. 11) 101 Part 3 — Diverted profits tax

(b) the expenses result, or a part of the expenses results, in the effective tax mismatch outcome mentioned in section 80(1)(d), and (c) in consequence of paragraphs (a) and (b), the designated HMRC officer issuing the notice considers that the relevant expenses might be greater than they would have been if they had resulted from provision made or imposed as between independent persons dealing at arm’s length. (4) Subsection (5) applies where the designated HMRC officer issuing the notice considers that— (a) the inflated expenses condition is met, and (b) it is reasonable to assume that section 84 or 85(4) applies. (5) Where this subsection applies, the best estimate made by the officer in accordance with subsection (2) is to be made on the assumption that— (a) so much of the deduction mentioned in subsection (3)(a) as relates to the relevant expenses is reduced by 30%, and (b) in relation to the relevant expenses, Part 4 of TIOPA 2010 (transfer pricing) is ignored. (6) But— (a) if the deduction for the expenses taken into account by the company in computing its liability for corporation tax takes account of an adjustment required by Part 4 of TIOPA 2010 (transfer pricing) which is reflected in the company’s company tax return prior to the issue of the charging notice, and (b) as a result that deduction is less than it would otherwise have been, the reduction required by subsection (5)(a) is reduced (but not below nil) to take account of that adjustment. (7) For the purposes of this section, sections 83(3) and 84(2)(c) have effect as if (in each case) the words “before the end of the review period” were omitted. (8) The Treasury may by regulations, made by statutory instrument, substitute a different percentage for the percentage for the time being specified in subsection (5)(a). (9) Regulations under this section are subject to annulment in pursuance of a resolution of the House of Commons. (10) In this section— “the material provision” has the same meaning as in section 80; “the relevant expenses” means so much of the expenses mentioned in subsection (3)(a) as result in the effective tax mismatch outcome as mentioned in subsection (3)(b).

97 Section 86 cases: estimating profits for preliminary and charging notices (1) Where taxable diverted profits arising to the foreign company in an accounting period fall to be determined under section 89, 90 or 91, for the purposes of issuing a preliminary notice under section 93 or a charging notice under section 95 the taxable diverted profits to be specified in the notice are determined instead in accordance with this section. (2) The taxable diverted profits are such amount as the designated HMRC officer issuing the notice determines, on the basis of the best estimate that can 102 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

reasonably be made at that time, to be the amount calculated in accordance with section 89, 90 or 91 (as the case may be). But this is subject to subsections (4) and (5). (3) For the purposes of subsection (4), “the inflated expenses condition” is met if— (a) the mismatch condition is met, (b) the material provision results in expenses of the foreign company for which (ignoring Part 4 of TIOPA 2010 (transfer pricing)) a deduction for allowable expenses would be allowed in computing the notional PE profits of the foreign company for the accounting period, (c) the expenses result, or a part of the expenses results, in the effective tax mismatch outcome mentioned in section 86(2)(c), and (d) in consequence of paragraphs (a) to (c), the designated HMRC officer issuing the notice considers that the relevant expenses might be greater than they would have been if they had resulted from provision made or imposed as between independent persons dealing at arm’s length. (4) Subsection (5) applies where the designated HMRC officer issuing the notice considers that— (a) the inflated expenses condition is met, and (b) it is reasonable to assume that section 90 or 91(4) applies. (5) Where this subsection applies, the best estimate made by the officer in accordance with subsection (2) is to be made on the assumption that— (a) so much of the deduction mentioned in subsection (3)(b) as relates to the relevant expenses is reduced by 30%, and (b) in relation to the relevant expenses, Part 4 of TIOPA 2010 (transfer pricing) is ignored. (6) The Treasury may by regulations, made by statutory instrument, substitute a different percentage for the percentage for the time being specified in subsection (5)(a). (7) Regulations under this section are subject to annulment in pursuance of a resolution of the House of Commons. (8) In this section— (a) “the relevant expenses” means so much of the expenses mentioned in subsection (3)(b) as result in the effective tax mismatch outcome as mentioned in section 86(2)(c), and (b) “the foreign company”, “the material provision” and “the mismatch condition” have the same meaning as in section 86.

Payment and recovery of tax

98 Payment of tax (1) This section applies where a charging notice is issued to a company. (2) Diverted profits tax charged by the notice must be paid within 30 days after the day the notice is issued. (3) The company is liable to pay the tax. (4) The payment of the tax may not be postponed on any grounds, and so the diverted profits tax charged by the charging notice remains due and payable Finance Act 2015 (c. 11) 103 Part 3 — Diverted profits tax

despite any review being conducted under section 101 or any appeal in respect of the notice. (5) In Schedule 16— (a) Part 1 contains provision treating a liability of a non-UK resident company to pay diverted profits tax as if it were also a liability of its UK representative; (b) Part 2 contains provision enabling unpaid diverted profits tax due from a non-UK resident company to be recovered from a related company.

99 Diverted profits tax ignored for tax purposes (1) In calculating income, profits or losses for any tax purpose— (a) no deduction, or other relief, is allowed in respect of diverted profits tax, and (b) no account is to be taken of any amount which is paid (directly or indirectly) by a person for the purposes of meeting or reimbursing the cost of diverted profits tax. (2) An amount paid as mentioned in subsection (1)(b) is not to be regarded for the purposes of the Corporation Tax Acts as a distribution (within the meaning of CTA 2010).

100 Credit for UK or foreign tax on same profits (1) Subsection (2) applies where a company has paid— (a) corporation tax, or (b) a tax under the law of a territory outside the United Kingdom which corresponds to corporation tax, which is calculated by reference to profits of the company (“the taxed profits”). (2) Such credit as is just and reasonable is allowed in respect of that tax against any liability which either— (a) that company has to diverted profits tax in respect of the taxed profits, or (b) another company has to diverted profits tax in respect of taxable diverted profits arising to that other company which are calculated by reference to amounts which also constitute all or part of the taxed profits. (3) Subsection (4) applies where a company has paid— (a) the CFC charge within the meaning of Part 9A of TIOPA 2010 (controlled foreign companies) (see section 371VA), or (b) a tax under the law of a territory outside the United Kingdom (by whatever name known) which is similar to the CFC charge, which is calculated by reference to profits of another company (“the CFC profits”). (4) Such credit as is just and reasonable is allowed in respect of that charge or tax against any liability which a company has to diverted profits tax in respect of taxable diverted profits arising to that other company which are calculated by reference to amounts which also constitute all or part of the CFC profits. (5) But nothing in this section allows a credit, against a liability to diverted profits tax, for an amount of tax or charge which was paid after the end of— 104 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

(a) the review period in respect of the charging notice which imposed the charge to diverted profits tax, or (b) where the charge to diverted profits tax was imposed by a supplementary charging notice, the review period within which that notice was issued. (6) For the purposes of subsection (1), any withholding tax paid on payments made to a person is (unless it is refunded) to be treated— (a) as tax within paragraph (a) or (b) of that subsection, and (b) as paid by that person (and not the person making the payment). (7) For the purposes of subsection (6), an amount of withholding tax paid on payments made to a person is refunded if and to the extent that— (a) any repayment of tax, or any payment in respect of a credit for tax, is made to any person, and (b) that repayment or payment is directly or indirectly in respect of the whole or part of the amount of that withholding tax.

Review and appeals

101 HMRC review of charging notice (1) Where a charging notice is issued to a company for an accounting period, a designated HMRC officer, within the review period— (a) must carry out a review of the amount of diverted profits tax charged on the company for the accounting period, and (b) may carry out more than one such review. (2) Subject to subsection (13), “the review period” means the period of 12 months beginning immediately after the period of 30 days mentioned in section 98(2). (3) Subsection (4) applies if— (a) the company has paid (in full) the amount of diverted profits tax charged by the charging notice, and (b) the officer is satisfied that the total amount of diverted profits tax charged on the company for that period is excessive having regard to sections 83, 84, 85, 89, 90 and 91 (calculation of taxable diverted profits). (4) The officer may, during the review period, issue to the company an amending notice which amends the charging notice so as to— (a) reduce the amount of taxable diverted profits to which the notice relates, and (b) accordingly, reduce the charge to diverted profits tax imposed on the company in respect of the accounting period. (5) More than one amending notice may be issued to the company in respect of the charging notice. (6) Where an amending notice is issued, any tax overpaid must be repaid. (7) Subsection (8) applies if a designated HMRC officer is satisfied that the total amount of diverted profits tax charged on the company for the accounting period is insufficient having regard to sections 83, 84, 85, 89, 90 and 91 (calculation of taxable diverted profits). Finance Act 2015 (c. 11) 105 Part 3 — Diverted profits tax

(8) The officer may, during the review period, issue a notice (a “supplementary charging notice”) to the company imposing an additional charge to diverted profits tax on the company in respect of the accounting period on taxable diverted profits which— (a) arise to the company for that period, and (b) are not already the subject of a charge to diverted profits tax. (9) Only one supplementary charging notice may be issued to the company in respect of a charging notice. (10) No supplementary charging notice may be issued during the last 30 days of the review period. (11) Subsections (3) to (6) (amending notices) apply in relation to a supplementary charging notice as they apply to the charging notice. (12) Section 95(5) (content of charging notice) and section 98 (payment of tax) apply in relation to a supplementary charging notice as they apply in relation to a charging notice. (13) If either of the following events occurs before the end of the period of 12 months referred to in subsection (2), the review period ends at the time of that event. The events are— (a) that following the issuing of a supplementary charging notice, the company notifies HMRC that it is terminating the review period; (b) that a designated HMRC officer and the company agree (in writing) that the review period is to terminate. (14) When determining on a review whether the total amount of taxable diverted profits charged on the company for an accounting period is excessive or insufficient— (a) the designated HMRC officer must not take any account of section 96 or (as the case may be) section 97 (which apply only for the purposes of the officer estimating the taxable diverted profits for the purposes of issuing a preliminary notice or charging notice), and (b) nothing in section 94 applies to restrict the representations which the officer may consider. (15) Where a supplementary charging notice or an amending notice is issued to a company, the officer must give a copy of the notice— (a) if the charging notice was issued by reason of section 81 applying, to UKPE, and (b) if the charging notice was issued by reason of section 86 applying, to the avoided PE.

102 Appeal against charging notice or supplementary charging notice (1) A company to which a charging notice or a supplementary charging notice is issued may appeal against the notice. (2) Notice of an appeal must be given to HMRC, in writing, within 30 days after the end of the review period (see section 101(2) and (13)). (3) The notice of appeal must specify the grounds of appeal. 106 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

(4) For the purposes of an appeal, sections 96 and 97 (which apply only for the purposes of the officer estimating the taxable diverted profits for the purposes of issuing a preliminary notice or charging notice) are to be ignored when determining whether the taxable diverted profits in respect of which a charge is imposed have been correctly calculated. (5) On an appeal under this section the Tribunal may— (a) confirm the charging notice or supplementary charging notice to which the appeal relates, (b) amend that charging notice or supplementary charging notice, or (c) cancel that charging notice or supplementary charging notice. (6) For the purposes of Part 5 of TMA 1970 (appeals etc), an appeal under this section is to be treated as if it were an appeal under the Taxes Acts (within the meaning of that Act), and for that purpose references in that Part to an assessment include a charging notice or supplementary charging notice under this Part. (7) Subsection (6) is subject to section 98(4) (no postponement of payment of tax pending appeal etc).

Administration of tax

103 Responsibility for collection and management The Commissioners for Her Majesty’s Revenue and Customs are responsible for the collection and management of diverted profits tax.

104 Penalties etc (1) Schedule 56 to FA 2009 (penalty for failure to make payments on time) is amended as follows. (2) In the Table at the end of paragraph 1, after item 6ZA insert—

“6ZB Diverted profits Amount of The date when, tax diverted profits in accordance tax payable with section under Part 3 of 98(2) of FA FA 2015 2015, the amount must be paid”

(3) In paragraph 3 (amount of penalty: occasional amounts and amounts in respect of periods of 6 months or more), after sub-paragraph (1)(a) insert— “(aa) a payment of tax falling within item 6ZB in the Table,”. (4) Schedule 41 to FA 2008 (penalties: failure to notify etc) is amended as follows. (5) In the Table in paragraph 1, after the entry for corporation tax insert— Finance Act 2015 (c. 11) 107 Part 3 — Diverted profits tax

“Diverted profits tax Obligation under section 92 of FA 2015 (duty to notify if within scope of diverted profits tax).”

(6) In paragraph 7 (meaning of “potential lost revenue”), after sub-paragraph (4) insert— “(4A) In the case of a relevant obligation relating to diverted profits tax, the potential lost revenue is the amount of diverted profits tax for which P would be liable at the end of the period of 6 months beginning immediately after the accounting period assuming— (a) a charge to diverted profits tax had been imposed on P on the taxable diverted profits arising to P for the accounting period, and (b) that tax was required to be paid before the end of that period of 6 months.”

105 Information and inspection powers etc (1) In Schedule 23 to FA 2011 (data-gathering powers), in paragraph 45(1) (taxes to which powers apply), after paragraph (c) insert— “(ca) diverted profits tax,”. (2) In Schedule 36 to FA 2008 (information and inspection powers), in paragraph 63(1) (taxes to which powers apply), after paragraph (c) insert— “(ca) diverted profits tax,”.

Interpretation

106 “The participation condition” (1) This section applies for the purposes of sections 80 and 86(2). (2) In this section “the first party” and “the second party” mean— (a) where this section applies for the purposes of section 80, C and P (within the meaning of section 80) respectively, and (b) where this section applies for the purposes of section 86(2), the foreign company and A (within the meaning of section 86) respectively. (3) The participation condition is met in relation to the first party and the second party (“the relevant parties”) if— (a) condition A is met in relation to the material provision so far as the material provision is provision relating to financing arrangements, and (b) condition B is met in relation to the material provision so far as the material provision is not provision relating to financing arrangements. (4) Condition A is that, at the time of the making or imposition of the material provision or within the period of 6 months beginning with the day on which the material provision was made or imposed— (a) one of the relevant parties was directly or indirectly participating in the management, control or capital of the other, or 108 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

(b) the same person or persons was or were directly or indirectly participating in the management, control or capital of each of the relevant parties. (5) Condition B is that, at the time of the making or imposition of the material provision— (a) one of the relevant parties was directly or indirectly participating in the management, control or capital of the other, or (b) the same person or persons was or were directly or indirectly participating in the management, control or capital of each of the relevant parties. (6) In this section “financing arrangements” means arrangements made for providing or guaranteeing, or otherwise in connection with, any debt, capital or other form of finance. (7) For the purposes of this section— (a) section 157(2) of TIOPA 2010 (“direct participation”) applies, and (b) sections 158 to 163 of that Act (“indirect participation” in management, control or capital of a person) apply as if in those sections— (i) references to section 148(2) of that Act included references to subsection (4) of this section, (ii) references to paragraph (a) or (b) of section 148(2) of that Act included (respectively) references to paragraph (a) or (b) of subsection (4) of this section, (iii) references to section 148(3) of that Act included references to subsection (5) of this section, and (iv) references to paragraph (a) or (b) of section 148(3) of that Act included (respectively) references to paragraph (a) or (b) of subsection (5) of this section.

107 “Effective tax mismatch outcome” (1) This section applies for the purposes of sections 80 and 86(2). (2) In this section “the first party” and “the second party” mean— (a) where this section applies for the purposes of section 80, C and P (within the meaning of section 80) respectively, and (b) where this section applies for the purposes of section 86(2), the foreign company and A (within the meaning of section 86) respectively. (3) The material provision results in an effective tax mismatch outcome as between the first party and the second party for an accounting period of the first party if— (a) in that accounting period, in relation to a relevant tax, it results in one or both of— (i) expenses of the first party for which a deduction has been taken into account in computing the amount of the relevant tax payable by the first party, or (ii) a reduction in the income of the first party which would otherwise have been taken into account in computing the amount of a relevant tax payable by the first party, (b) the resulting reduction in the amount of the relevant tax which is payable by the first party exceeds the resulting increase in relevant Finance Act 2015 (c. 11) 109 Part 3 — Diverted profits tax

taxes payable by the second party for the corresponding accounting period of the second party, (c) the results described in paragraphs (a) and (b) are not exempted by subsection (6), and (d) the second party does not meet the 80% payment test. (4) In this Part, references to “the tax reduction” are to the amount of the excess mentioned in subsection (3)(b). (5) It does not matter whether the tax reduction results from the application of different rates of tax, the operation of a relief, the exclusion of any amount from a charge to tax, or otherwise. (6) The results described in subsection (3)(a) and (b) are exempted if they arise solely by reason of— (a) contributions paid by an employer under a registered pension scheme, or overseas pension scheme, in respect of any individual, (b) a payment to a charity, (c) a payment to a person who, on the ground of sovereign immunity, cannot be liable for any relevant tax, or (d) a payment to an offshore fund or authorised investment fund— (i) which meets the genuine diversity of ownership condition (whether or not a clearance has been given to that effect), or (ii) at least 75% of the investors in which are, throughout the accounting period, registered pension schemes, overseas pension schemes, charities or persons who cannot be liable for any relevant tax on the ground of sovereign immunity. (7) “The 80% payment test” is met by the second party if the resulting increase in relevant taxes payable by the second party as mentioned in subsection (3)(b) is at least 80% of the amount of the resulting reduction in the amount of the relevant tax payable by the first party as mentioned in subsection (3)(b). (8) In this section— “authorised investment fund” means— (a) an open-ended investment company within the meaning of section 613 of CTA 2010, or (b) an authorised unit trust within the meaning of section 616 of that Act; “employer” has the same meaning as in Part 4 of FA 2004 (see section 279(1) of that Act); “genuine diversity of ownership condition” means— (a) in the case of an offshore fund, the genuine diversity of ownership condition in regulation 75 of the Offshore Funds (Tax) Regulations 2009 (S.I. 2009/3001), and (b) in the case of an authorised investment fund, the genuine diversity of ownership condition in regulation 9A of the Authorised Investment Fund (Tax) Regulations 2006 (S.I. 2006/ 964); “offshore fund” has the same meaning as in section 354 of TIOPA 2010 (see section 355 of that Act); “overseas pension scheme” has the same meaning as in Part 4 of FA 2004 (see section 150(7) of that Act); 110 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

“registered pension scheme” has the same meaning as in that Part (see section 150(2) of that Act); “relevant tax” means— (a) corporation tax on income, (b) a sum chargeable under section 330(1) of CTA 2010 (supplementary charge in respect of ring fence trades) as if it were an amount of corporation tax, (c) income tax, or (d) any non-UK tax on income. (9) See section 108 for further provision about the determination of the tax reduction and the 80% payment test.

108 Provision supplementing section 107 (1) For the purposes of section 107(3)(b) and (7), the resulting reduction in the first party’s liability to a relevant tax for an accounting period is— ATR where— A is the sum of— (a) if there are expenses within section 107(3)(a)(i), the lower of the amount of the expenses and the amount of the deduction mentioned in that provision, and (b) any reduction in income mentioned in section 107(3)(a)(ii), and TR is the rate at which, assuming the first party has profits equal to A chargeable to the relevant tax for the accounting period, those profits would be chargeable to that tax. (2) For the purposes of section 107(3)(b) and (7), the resulting increase in relevant taxes payable by the second party for the corresponding accounting period is any increase in the total amount of relevant taxes that would fall to be paid by the second party (and not refunded) assuming that— (a) the second party’s income for that period, in consequence of the material provision were an amount equal to A, (b) account were taken of any deduction or relief (other than any qualifying deduction or qualifying loss relief) taken into account by the second party in determining its actual liability to any relevant tax in consequence of the material provision, and (c) all further reasonable steps were taken— (i) under the law of any part of the United Kingdom or any country or territory outside the United Kingdom, and (ii) under double taxation arrangements made in relation to any country or territory, to minimise the amount of tax which would fall to be paid by the second party in the country or territory in question (other than steps to secure the benefit of any qualifying deduction or qualifying loss relief). (3) The steps mentioned in subsection (2)(c) include— (a) claiming, or otherwise securing the benefit of, reliefs, deductions, reductions or allowances, and (b) making elections for tax purposes. Finance Act 2015 (c. 11) 111 Part 3 — Diverted profits tax

(4) For the purposes of this section, any withholding tax which falls to be paid on payments made to the second party is (unless it is refunded) to be treated as tax which falls to be paid by the second party (and not the person making the payment). (5) For the purposes of this section, an amount of tax payable by the second party is refunded if and to the extent that— (a) any repayment of tax, or any payment in respect of a credit for tax, is made to any person, and (b) that repayment or payment is directly or indirectly in respect of the whole or part of the amount of tax payable by the second party, but an amount refunded is to be ignored if and to the extent that it results from qualifying loss relief obtained by the second party. (6) Where the second party is a partnership, in section 107 and this section— (a) references to the second party’s liability to any tax (however expressed) include a reference to the liabilities of all members of the partnership to the tax, (b) references to any tax being payable by the second party (however expressed) include a reference to tax being payable by any member of the partnership, and (c) references to loss relief obtained by the second party include a reference to loss relief obtained by any member of the partnership, and subsection (4) applies to any member of the partnership as it applies to the second party. (7) In this section— “the first party” and “the second party” have the same meaning as in section 107; “qualifying deduction” means a deduction which— (a) is made in respect of actual expenditure of the second party, (b) does not arise directly from the making or imposition of the material provision, (c) is of a kind for which the first party would have obtained a deduction in calculating its liability to any relevant tax had it incurred the expenditure in respect of which the deduction is given, and (d) does not exceed the amount of the deduction that the first party would have so obtained; “qualifying loss relief” means— (a) any means by which a loss might be used for corporation tax purposes to reduce the amount in respect of which the second party is liable to tax, and (b) in the case of a non-UK resident company, any corresponding means by which a loss corresponding to a relevant CT loss might be used for the purposes of a non-UK tax corresponding to corporation tax to reduce the amount in respect of which the second party is liable to tax, (and in paragraph (b) “relevant CT loss” means a loss which might be used as mentioned in paragraph (a)); “relevant tax” has the same meaning as in section 107. 112 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

109 “Excepted loan relationship outcome” (1) This section applies for the purposes of sections 80 and 86(2). (2) The effective tax mismatch outcome is an “excepted loan relationship outcome” if the result described in section 107(3)(a) arises wholly from— (a) anything that, if a company within the charge to corporation tax were party to it, would produce debits or credits under Part 5 of CTA 2009 (loan relationships and deemed loan relationships) (“a loan relationship”), or (b) a loan relationship and a relevant contract (within the meaning of Part 7 of that Act (derivative contracts)) taken together, where the relevant contract is entered into entirely as a hedge of risk in connection with the loan relationship.

110 “The insufficient economic substance condition” (1) This section applies for the purposes of sections 80 and 86(2). (2) In this section “the first party” and “the second party” mean— (a) where this section applies for the purposes of section 80, C and P (within the meaning of section 80) respectively, and (b) where this section applies for the purposes of section 86(2), the foreign company and A (within the meaning of section 86) respectively. (3) The insufficient economic substance condition is met if one or more of subsections (4), (5) and (6) apply. (4) This subsection applies where— (a) the effective tax mismatch outcome is referable to a single transaction, and (b) it is reasonable to assume that the transaction was designed to secure the tax reduction, unless, at the time of the making or imposition of the material provision, it was reasonable to assume that, for the first party and the second party (taken together) and taking account of all accounting periods for which the transaction was to have effect, the non-tax benefits referable to the transaction would exceed the financial benefit of the tax reduction. (5) This subsection applies where— (a) the effective tax mismatch outcome is referable to any one or more of the transactions in a series of transactions, and (b) it is reasonable to assume that the transaction was, or the transactions were, designed to secure the tax reduction, unless, at the time of the making or imposition of the material provision, it was reasonable to assume that, for the first party and the second party (taken together) and taking account of all accounting periods for which the transaction or series was to have effect, the non-tax benefits referable to the transaction or transactions would exceed the financial benefits of the tax reduction. (6) This subsection applies where— (a) a person is a party to the transaction, or to any one or more of the transactions in the series of transactions, to which section 80(1)(b) or section 86(2)(a) refers, and Finance Act 2015 (c. 11) 113 Part 3 — Diverted profits tax

(b) it is reasonable to assume that the person’s involvement in the transaction or transactions was designed to secure the tax reduction, unless one or both of the conditions in subsection (7) is or are met. (7) Those conditions are— (a) that, at the time of the making or imposition of the material provision, it was reasonable to assume that, for the first party and the second party (taken together) and taking account of all accounting periods for which the transaction or series was to have effect, the non-tax benefits referable to the contribution made to the transaction or series by that person, in terms of the functions or activities that that person’s staff perform, would exceed the financial benefit of the tax reduction; (b) that, in the accounting period— (i) the income attributable to the ongoing functions or activities of that person’s staff in terms of their contribution to the transaction or transactions (ignoring functions or activities relating to the holding, maintaining or protecting of any asset from which income attributable to the transaction or transactions derives), exceeds (ii) the other income attributable to the transaction or transactions. (8) For the purposes of subsection (7) a person’s staff include— (a) any director or other officer of the person, (b) if the person is a partnership, any individual who is a member of the partnership, and (c) externally provided workers in relation to the person. (9) For the purposes of subsections (4)(b), (5)(b) and (6)(b)— (a) when determining whether it is reasonable to assume— (i) that a transaction was, or transactions were, designed to secure the tax reduction, or (ii) that a person’s involvement in a transaction or transactions was designed to secure the tax reduction, regard must be had to all the circumstances, including any liability for any additional tax that arises directly or indirectly as a consequence of the transaction or transactions, and (b) a transaction or transactions, or a person’s involvement in a transaction or transactions, may be designed to secure the tax reduction despite it or them also being designed to secure any commercial or other objective. (10) In this section— “externally provided worker” has the meaning given by section 1128 of CTA 2009, but as if in that section for “company” (in each place) there were substituted “person”; “non-tax benefits” means financial benefits other than— (a) the financial benefit of the tax reduction, and (b) any other financial benefits which derive (directly or indirectly) from the reduction, elimination, or delay of any liability of any person to pay any tax; “tax” includes non-UK tax. 114 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

111 “Transaction” and “series of transactions” (1) In this Part “transaction” includes arrangements, understandings and mutual practices (whether or not they are, or are intended to be, legally enforceable). (2) References in this Part to a series of transactions include references to a number of transactions each entered into (whether or not one after the other) in pursuance of, or in relation to, the same arrangement. (3) A series of transactions is not prevented by reason only of one or more of the matters mentioned in subsection (4) from being regarded for the purposes of this Part as a series of transactions by means of which provision has been made or imposed as between any two persons. (4) Those matters are— (a) that there is no transaction in the series to which both those persons are parties, (b) that the parties to any arrangement in pursuance of which the transactions in the series are entered into do not include one or both of those persons, and (c) that there is one or more transactions in the series to which neither of those persons is a party. (5) In this section “arrangement” means any scheme or arrangement of any kind (whether or not it is, or is intended to be, legally enforceable).

112 Treatment of a person who is a member of a partnership (1) This section applies where a person is a member of a partnership. (2) Any references in this Part to the expenses, income or revenue of, or a reduction in the income of, the person includes a reference to the person’s share of (as the case may be) the expenses, income or revenue of, or a reduction in the income of, the partnership. (3) For this purpose “the person’s share” of an amount is determined by apportioning the amount between the partners on a just and reasonable basis.

113 “Accounting period” and “corresponding accounting period” (1) In this Part references to an accounting period of a company are to an accounting period of the company for the purposes of corporation tax. (2) Subsection (3) applies where— (a) a non-UK resident company (“FC”) is not within the charge to corporation tax, (b) a person, whether or not UK resident, is carrying on activity in the United Kingdom in connection with supplies of services, goods or other property made by FC in the course of a trade carried on by FC, and (c) it is reasonable to assume that any of the activity of that person or FC (or both) is designed so as to ensure that FC does not, as a result of that person’s activity, carry on that trade in the United Kingdom for the purposes of corporation tax (whether or not it is also designed to secure any commercial or other objective). Finance Act 2015 (c. 11) 115 Part 3 — Diverted profits tax

(3) For the purposes of this Part, FC is assumed to have such accounting periods for the purposes of corporation tax as it would have had if it had carried on a trade in the United Kingdom through a permanent establishment in the United Kingdom by reason of the activity of the person mentioned in subsection (2)(b). (4) For the purposes of subsection (2)— (a) the reference in that subsection to activity of the person includes any limitation which has been imposed or agreed in respect of that activity; (b) where FC is a member of a partnership— (i) a trade carried on by the partnership is to be regarded as a trade carried on by FC, and (ii) supplies made by the partnership in the course of that trade are to be regarded as supplies made by FC in the course of that trade. (5) Where the designated HMRC officer has insufficient information to identify, in accordance with subsection (3), the accounting periods of FC, for the purposes of this Part the officer is to determine those accounting periods to the best of the officer’s information and belief. (6) Where a company (“C1”) does not have an actual accounting period which coincides with the accounting period of another company (“the relevant accounting period”) (whether by reason of having no accounting periods or otherwise), in this Part— (a) references to the corresponding accounting period of C1 in relation to the relevant accounting period are to the notional accounting period of C1 that would coincide with the relevant accounting period, and (b) such apportionments as are just and reasonable are to be made to determine the income or tax liability of C1 for that corresponding accounting period.

114 Other defined terms in Part 3 (1) In this Part— “allowable expenses” means expenses of a kind in respect of which a deduction would be allowed for corporation tax purposes; “the avoided PE” has the same meaning as in section 86; “company” has the same meaning as in the Corporation Tax Acts (see section 1121 of CTA 2010); “connected” is to be read in accordance with sections 1122 and 1123 of CTA 2010; “designated HMRC officer” means an officer of Revenue and Customs who has been designated by the Commissioners for Her Majesty’s Revenue and Customs for the purposes of diverted profits tax; “HMRC” means Her Majesty’s Revenue and Customs; “non-UK resident” has the same meaning as in the Corporation Tax Acts (see section 1119 of CTA 2010); “non-UK tax” has the meaning given by section 187 of CTA 2010; “the notional PE profits” has the meaning given by section 88(5); “partnership” includes— (a) a limited liability partnership to which section 1273 of CTA 2009 applies, and 116 Finance Act 2015 (c. 11) Part 3 — Diverted profits tax

(b) an entity established under the law of a territory outside the United Kingdom of a similar character to a partnership, and “member” of a partnership is to be read accordingly; “permanent establishment”, in relation to a company, has the meaning given by Chapter 2 of Part 24 of CTA 2010 (and accordingly section 1141(1) of that Act has effect, for the purposes of this Part, as if the reference to the Corporation Tax Acts included a reference to this Part); “small or medium-sized enterprise” means a small enterprise, or a medium-sized enterprise, within the meaning of section 172 of TIOPA 2010; “the review period” has the meaning given by section 101; “the tax reduction” has the meaning given by section 107(4); “UK resident” has the same meaning as in the Corporation Tax Acts (see section 1119 of CTA 2010); “UKPE” has the same meaning as in section 81. (2) For the purposes of this Part a tax may correspond to corporation tax even though— (a) it is chargeable under the law of a province, state or other part of a country, or (b) it is levied by or on behalf of a municipality or other local body.

Final provisions

115 Application of other enactments to diverted profits tax (1) In section 206(3) of FA 2013 (taxes to which the general anti-abuse rule applies), after paragraph (d) insert— “(da) diverted profits tax,”. (2) In paragraph 7 of Schedule 6 to FA 2010 (enactments to which definition of “charity” in Part 1 of that Schedule applies) omit the “and” after paragraph (h) and after paragraph (i) insert “, and (j) diverted profits tax.” (3) In section 1139 of CTA 2010 (definition of “tax advantage” for the purposes of provisions of the Corporation Tax Acts which apply this section), in subsection (2), omit the “or” at the end of paragraph (da) and after paragraph (e) insert “, or (f) the avoidance or reduction of a charge to diverted profits tax.” (4) In section 178 of FA 1989 (setting rates of interest), in subsection (2), omit the “and” before paragraph (u) and after that paragraph insert “, and (v) section 79 of FA 2015.” (5) In section 1 of the Provisional Collection of Taxes Act 1968 (temporary statutory effect of House of Commons resolutions affecting income tax, purchase tax or customs or excise duties), in subsection (1), after “the bank levy,” insert “diverted profits tax,”.

116 Commencement and transitional provision (1) This Part has effect in relation to accounting periods beginning on or after 1 April 2015. Finance Act 2015 (c. 11) 117 Part 3 — Diverted profits tax

(2) For the purposes of this Part, if an accounting period of a company begins before and ends on or after 1 April 2015 (“the straddling period”)— (a) so much of that accounting period as falls before 1 April 2015 and so much of it as falls on or after that date are treated as separate accounting periods, and (b) where it is necessary to apportion amounts for the straddling period to the different parts of that period, that apportionment is to be made on a just and reasonable basis. (3) For the purposes of any accounting period which ends on or before 31 March 2016, section 92 has effect as if in subsection (2)(b) of that section the reference to 3 months were a reference to 6 months. (4) This Part does not apply in relation to any profits arising to a Lloyd’s corporate member which are— (a) mentioned in section 220(2) of FA 1994 (Lloyd’s underwriters: accounting period in which certain profits or losses arise), and (b) declared in the calendar year 2015 or a later calendar year, to the extent that those profits are referable, on a just and reasonable basis, to times before 1 April 2015. (5) In subsection (4) “Lloyd’s corporate member” means a body corporate which is a member of Lloyd’s and is or has been an underwriting member.

PART 4

OTHER PROVISIONS

Anti-avoidance

117 Disclosure of tax avoidance schemes Schedule 17 contains amendments relating to the disclosure of tax avoidance schemes.

118 Accelerated payments and group relief Schedule 18 contains provision about the relationship between accelerated payments and group relief.

119 Promoters of tax avoidance schemes Schedule 19 contains provision about promoters of tax avoidance schemes.

120 Penalties in connection with offshore matters and offshore transfers (1) Schedule 20 contains provisions amending— (a) Schedule 24 to FA 2007 (penalties for errors), (b) Schedule 41 to FA 2008 (penalties for failure to notify), and (c) Schedule 55 to FA 2009 (penalties for failure to make returns etc). (2) That Schedule comes into force on such day as the Treasury may by order appoint. ANNEX B. TYPICAL TAX PLANNING STRUCTURES IN INTEGRATED BUSINESS MODELS – 171

OpCo is treated as a transparent entity for tax purposes in State R, the income of RCo Regional OpCo is treated as having been earned directly by RCo Regional Holding and is therefore treated as active income taxable in State R only when paid to RCo. This result would also be reached if State R imposed tax only on a territorial basis and did not have CFC rules.

VAT consequences • With respect to value added tax (VAT), the treatment of the business-to-business (B2B) transactions is relatively straightforward, with the VAT levied either through the supplying business charging the tax or the recipient business self-assessing it. The input tax levied would generally be recoverable by the businesses through the input tax credit mechanism. • The VAT treatment of the supplies to private consumers (business-to-consumer (B2C)) in State S will generally be different for supplies of physical products and supplies of digital products. Supplies by RCo Regional OpCo of physical goods stored in SCo’s warehouse to consumers in State S would be subject to VAT in State S. State S may allow SCo to account for State S VAT on behalf of RCo Regional OpCo (e.g. as a fiscal representative). If the physical products would be shipped to consumers in State S from abroad, e.g. from State T, then these supplies would be zero rated in the exporting state and would be subject to VAT at the time of importation into State S. Depending on the value of the goods and the thresholds operated by State S, they may qualify for a VAT exemption under the relief for importations of low value goods. Also the supplies of digital products to final consumers in State S should in principle be subject to VAT in State S, in accordance with the destination principle. However, State S will have considerable difficulty enforcing the payment of the VAT on these supplies, as the supplier is not resident in State S and collecting the tax from the final consumers is ineffectual. While certain jurisdictions operate a mechanism requiring non-resident suppliers to register and remit the tax on supplies to resident private consumers, it is recognised that it is often challenging for tax authorities to enforce compliance with such requirements.

B.2. Internet advertising

8. The RCo Group provides a number of Internet services (e.g. search engines) to customers worldwide. Many of these online services are offered free of charge to consumers, whose use of the online services provides the RCo Group with a substantial amount of data, including location-based data, data based on online behaviour, and data based on personal information provided by users. Over the course of many years of data collection, refinement, processing, and analysis, the RCo Group has developed a sophisticated algorithm that targets advertisements to those users who are most likely to be interested in the products advertised. RCo Group derives substantially all of its revenues from the sale of advertising through its online platform, for a fee that is generally based on the number of users who click on each advertisement. 9. The technology used in providing the advertisement services, along with the various algorithms used to collect and process data in order to target potential buyers were developed by staff of RCo, the parent company of the Group situated in State R. The rights to exploit this technology in the T/S region are owned by a dual resident subsidiary of the group,

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XCo. The latter company is incorporated in State T but effectively managed in State X. The technology rights for the T/S region were acquired by XCo under a cost-sharing arrangement whereby XCo agreed to make a “buy in” payment equal to the value of the existing technology and to share the cost of future enhancement of the transferred technology on the basis of the anticipated future benefit from the use of the technology in the T/S region. In practice, XCo does not actually perform any supervision of the development activities carried out by RCo in State R. 10. XCo licenses all of the rights in the technology used to operate the platform to a foreign subsidiary resident in State Y, YCo. The latter then sublicenses the technology to TCo, a company organised and resident in State T, earning a small “spread” between the royalties it receives and the royalties it pays on to XCo. YCo and TCo are hybrid entities that are treated as corporations for tax purposes in State Y and State T, but as transparent for tax purposes in State R. The physical presence of XCo in State X is minimal, both in terms of personnel and tangible assets (equipment, premises, etc.). In fact, neither XCo nor YCo has any employees on its payroll, and each company’s activities are limited to board meetings taking place in an “office hotel” where the company regularly rents different offices. 11. TCo acts as the regional headquarters for the RCo group’s operations in the T/S region, and employs a substantial number of people in managing the group’s activities in that region. It operates the websites offering free online services to consumers in the T/S region, and serves as the legal counterparty for all sales of advertising in the T/S region. However the servers that host these websites may be placed throughout the region and/ or located in State R and operated by RCo. Dependent on the time of the day, different members of the group may be responsible the maintenance of the website and fixing any network issues in the region. 12. Advertisement services contracts with TCo can be concluded electronically through TCo’s websites on the basis of standard agreements, the terms of which are generally set by RCo. Advertisers located in the T/S region that wish to purchase advertising targeting users of RCo’s products can thus do so directly through a website operated by TCo without having any interaction with the personnel located in State T. This advertising is available to local businesses in the T/S region, whether they are targeting customers in the T/S region or customers elsewhere. 13. For larger markets and in order to deal with key clients, the group has established a number of local subsidiaries. To promote the purchase of such advertising by businesses active in the T/S region, TCo has local affiliates, such as SCo, a company resident in State S, whose purpose is to promote the RCo family of products, including in particular the advertising services offered in the region. Local subsidiaries like SCo provide education and technical consulting to users and potential advertising clients, as well as marketing support in order to generate demand for the RCo advertising services. Local staff members have substantial and ongoing one-on-one interaction with local businesses, particularly the largest customers in the local market, many of which end up purchasing advertising. Compensation for the staff is partially based on the number of advertising contracts concluded between TCo and customers in State S and the income generated by TCo from the clients they support. In consideration for its promotion activities and technical support, TCo pays SCo a fee covering its expenses plus a mark-up. In general, customers supported by local affiliates such as SCo have no interaction with TCo staff. 14. The structure used by the RCo Group can be depicted as shown in Figure B.2.

ADDRESSING THE TAX CHALLENGES OF THE DIGITAL ECONOMY – © OECD 2015 ANNEX B. TYPICAL TAX PLANNING STRUCTURES IN INTEGRATED BUSINESS MODELS – 173

Figure B.2. Internet advertising

Performs research & development. Operates Websites/Online services. RCo (State R) Developed pre-existing IP.

Buy-in payment for pre-existing IP. Rights to IP Contractual payments for IP from new R&D.

XCo (Board Meetings: State X Licence Incorporation: State T)

Royalty

Sub-licence

YCo TCo Operates State T/S websites (State Y) (State T) Counterparty to contracts Royalty

Advertising fees Fee (cost-plus basis)

Technical Support Marketing Sco Promotion (State S)

State S Clients

15. The manner in which RCo’s business activity is structured has significant consequences from a tax perspective. Due to contractual arrangements among the different group companies, the bulk of the Group’s income is allocated to State X, and only minimal taxable profits are allocated to State S, State R, and State T. More specifically, the following paragraphs describe the consequences that would arise in the different States concerned.

Direct tax consequences in state S • SCo is allocated minimal taxable income, based on the position that SCo’s functions are limited to those of a service provider. • All revenues from sales of advertising in State S, including advertising purchased by State S residents and other regional customers, are treated as the revenues of TCo. The lack of authority for SCo staff to legally conclude contracts and the use of standardised contracts and on line contract acceptance by TCo result in TCo not being considered to have a PE in State S. As a result, State S does not tax the profits derived from these activities either because it has no right to do so under its domestic law or because the relevant double tax treaty prevents it from doing so in the absence of a PE of TCo in State S to which the income is attributable.

ADDRESSING THE TAX CHALLENGES OF THE DIGITAL ECONOMY – © OECD 2015 174 – ANNEX B. TYPICAL TAX PLANNING STRUCTURES IN INTEGRATED BUSINESS MODELS

Direct tax consequences in state T • State T imposes corporate tax on the profits earned by TCo from its various activities in the T/S region. TCo’s income, however, is almost entirely offset by the royalty paid to YCo for its sublicense of the technology used by TCo to provide Internet services. • This payment is not subject to withholding under the relevant double tax treaty. • State T does not impose corporate income tax on XCo, due to it not being a resident under State T’s domestic legislation.

Direct tax consequences in state Y • State Y imposes corporate income tax on the profits of YCo, but those profits are limited to a small “spread” between the royalties received by YCo and the royalties paid by YCo to XCo. • State Y does not impose any withholding on the payment of royalties under its domestic law.

Direct tax consequences in state X • State X does not impose a corporate income tax.

Direct tax consequences in state R • State R imposes corporate income tax on the profits derived by RCo, notably the buy-in payment received in consideration for the transfer of pre-existing technology to XCo and the annual payments received under the cost sharing arrangement. However, because of the absence of a significant track record of RCo’s performance at the time of the transaction, RCo may take the position that the value of those intangibles was very low, so that the actual amount of gain subject to corporate tax in State R would be very small. Further, the annual payment – compensation for the costs supported by RCo for developing the intangibles without any markup – could potentially be at a rate much lower than the amount of royalties received by XCo. Finally, depending on the domestic law of State R, RCo may be entitled to R&D tax credits for a significant fraction of its expenditures, thereby further reducing its tax liability for corporate tax purposes. • Under its controlled foreign company (CFC) rules, State R would under some circumstances treat royalties received by XCo as passive income subject to current taxation in the hands of RCo. However, because YCo and TCo are considered for tax purposes as transparent entities in State R, the latter’s CFC rules would disregard the royalty transactions concluded between XCo, YCo and TCo. The income of YCo and TCo would be considered as having been earned directly by XCo, and would be treated as active income that would be taxable in State R only when paid to RCo.

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VAT consequences • With respect to VAT, the treatment of the B2B transactions is relatively straightforward with the VAT levied either through the supplying business charging the tax or the recipient business self-assessing it. The input tax levied would generally be recoverable by the businesses through the input tax credit mechanism. The exception would be where the business is engaged in making exempt supplies and therefore not entitled to recover the tax. • The online services provided free of charge by TCo to consumers in the S/T region have in principle no VAT consequences, unless it is considered that TCo is providing consumers with Internet services for non-monetary consideration, in which case the customers’ State may claim VAT on the fair market value of that consideration.

B.3. Cloud computing

16. The RCo Group is a developer of software (online games) which it operates on servers around the world and makes available to customers through various client interfaces in exchange for subscription fees. 17. The software itself, along with all technology associated with processing payment and maintaining security of customer data, was developed principally by engineers of RCo, a company resident in State R. In addition, RCo remotely co-ordinates marketing and selling activities in the various regions to minimise costs, maintain consistency among its various businesses and websites, and improve efficiency. Those co-ordination services are provided to regional operating lower-tier subsidiaries in return for a management service fee covering related expenses plus a markup. 18. RCo transferred the employees responsible for the management of the technology used in operating the client interfaces to PE Y, a foreign branch of RCo situated in State Y. RCo provides the rights to use the software and knowledge associated with the cloud computing services to various regional subsidiaries through licensing and sub-licensing arrangements. 19. TCo is a regional operating subsidiary of RCo resident in State T. Even though State T’s market is small in relation to RCo’s business, TCo employs a substantial number of people to operate the websites used to sell access to RCo’s hosted software in the T/S region, which includes State S and other States. TCo has obtained under a public tender in State S all the licenses required to exercise certain regulated activities (online gaming). Contracts with customers in State S are concluded electronically through TCo’s websites on the basis of standard agreements, the terms of which are set by RCo. TCo manages all payment processing and security associated with permitting access to the hosted software. Fees paid by the subscribers are collected through local bank accounts. In addition, TCo’s personnel perform all required localisation of the software for use in markets in the State S. TCo operates a “server farm” located in State T, which is used as the primary datacentre to run the software, process customer transactions, and store customer data. Mirror servers owned by third parties (ISPs) are also regularly used in other locations around the world to ensure the most efficient possible access at all times by customers, as well as to decrease the risk of loss of data. 20. To promote demand for the use of RCo’s hosted software in State S, a very significant market for RCo’s business, TCo has a local subsidiary, SCo, whose stated purpose is to

ADDRESSING THE TAX CHALLENGES OF THE DIGITAL ECONOMY – © OECD 2015