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By James J. Tobin, Esq.1
Ernst & Young LLP, New York, NY
For the last several years I have been discussing with clients the attractiveness of the United Kingdom as an investment location and potentially as a headquarters location. The U.K. government was touting its tax policy as very much open for business. In addition to a variety of relative commercial advantages over other European locations, its tax regime had grown increasingly competitive over recent years. Its corporate tax rate was reduced to 20% and indeed as this article is going to press is going down to 18%. It boasts an attractive patent box regime with a reduced tax rate of 10%. It introduced a beneficial territorial tax regime with respect to foreign profits and updated its CFC rules in a quite reasonable way.
No wonder a number of U.K. multinationals that had inverted out of the United Kingdom in fact came back. Indeed, a number of U.S. and other non-U.K. multinationals moved their parent domiciles to the United Kingdom and many more increased their regional headquarters and management activities in the United Kingdom. I even spent three happy years in London witnessing the changing landscape.
Hence my disappointment (and perhaps disillusionment) with the recently proposed and quickly enacted Diverted Profits Tax (DPT). Seems to me the U.K. government has fallen prey to populist rhetoric with regard to global tax planning, leading it to pass legislation that likely will not raise significant revenue2 but will cause investors and advisors to think twice about the sustainability of the "open for business" aspects of U.K. tax policy. To say "closed for business" would be an overreaction, but there is no doubt in my mind that this changes what was a very positive momentum.
The impetus for the DPT was public concern about well-known multinationals having significant income in low- or zero-taxed locations and a market presence in the United Kingdom that paid little U.K. tax. My immediate reaction to such a situation is to point out that, in the complex global environment and multi-country tax system in which we all live, it is also often the case that companies with consolidated losses incur tax in many countries where they operate and that many companies suffer losses on investments gone awry in low- or no-tax locations. Such business realities are never acknowledged in the tax avoidance rhetoric, which is unfortunate. Perhaps businesses, and we as their advisors, are not effectively communicating this message. Perhaps governments and journalists don't believe it. Or perhaps they just don't care. Nonetheless, in today's BEPS world, low/no taxed income is a fair focus for increased transparency and potential audit scrutiny. But the DPT goes well beyond that. And in my mind it goes too far.
To briefly review the key DPT provisions that have been widely reported upon:
Perhaps even more worrying is the process for reporting with respect to this new tax. A corporate group must notify HM Revenue & Customs (HMRC) within six months after its first accounting period subject to DPT (which became effective April 1, 2015) whether the group meets the conditions for potential application of the tax. HMRC is then in a position to issue an estimated assessment of DPT based on certain assumptions, which can include an assumption of a 30% disallowance of certain related intercompany expenses. There would then be a 12-month review period to determine any actual DPT tax liability and any potential refund or topping up of the estimated assessment.
So in case it's not obvious, here's what I really don't like about the DPT:
Overall my confidence in the United Kingdom as "open for business" with a fair and competitive tax regime definitely has been shaken – as has my hope for more coordinated country action on BEPS rather than unilateral inconsistent actions. Our EY tracking of BEPS-inspired local country actions – legislation, regulations, or enforcement aimed at BEPS concerns – is now over 150 actions in over 50 countries around the world. And the final reports soon to be issued by the OECD on Action 7 and the other Actions will provide countries with more options and alternatives to consider adapting to their own particular preferences. It is beyond a worrying trend. And putting a real strain on my generally optimistic nature.
This commentary also will appear in the August 2015 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Katz, Plambeck, and Ring, 908 T.M., U.S. Income Taxation of Foreign Corporations, Nauheim and Scott, 938 T.M., U.S. Income Tax Treaties — Income Not Attributable to a Permanent Establishment, Goddard, Anderson and Moore, 7400 T.M., Business Operations in the United Kingdom, and in Tax Practice Series, see ¶7130, Foreign Persons — Effectively Connected Income, ¶7160, U.S. Income Tax Treaties.
The revenue estimate is £1.5 billion over five years. This represents a very small percentage of corporate tax revenue. Moreover, I suspect this number is overstated and, in any event, may well be less than the cumulative costs of compliance and lost U.K. business.
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