Diverted Profits Tax: Double The Fun?
Milestone’s Plain English Guide to the Diverted Profits Tax
If you have been following this year’s Budget, then you will no doubt be aware that the Government’s controversial new Diverted Profits Tax (DPT) became effective 1 April 2015.
The revised DPT legislation was published last week as part of Finance Bill 2015 and we promised to prepare a number of case studies on the potential implications for key industries and models once the revised legislation had been released.
Today’s case study considers how the new rules may apply to UK property development activity. But, before reading on, firstly take a look at our ‘Plain English’ step-by-step flow charts to help you navigate the new DPT legislation. Download Here.
The Diverted Profits Tax and UK Property Development
The DPT is clearly drafted with multinational groups in mind, such as the likes of Google, Amazon and Starbucks. Nonetheless, it seems the Government is not going to miss the opportunity to raise additional tax revenue by extending the scope of the DPT to UK property development activities, with the legislation now applying to the supply of services, goods and ‘other property’ in the UK.
Alongside our ‘Plain English’ DPT flow charts, this post will also consider how a UK property development structure can be caught by the new DPT provisions, the exemptions that are available and, accordingly, the key steps that should be taken for those with accounting periods on or after 1 April 2015.
Typical UK property development structures
Many of the traditional UK property development structures involve an offshore company typically located in the Channel Islands or Isle of Man (Prop Co) that holds the land and engages a connected UK based property developer (UK Dev Co) to undertake the development. Prop Co is able to sell the UK property with any uplift being free of UK tax where Prop Co does not have a UK permanent establishment (PE). Applying the UK definition of a PE or a relevant treaty definition, it is arguable that Prop Co’s business is merely the holding of land and the development or construction site actually belongs to the UK property development company. As such, Prop Co does not create a UK PE.
The DPT charge – Avoided UK taxable presence
The DPT provision that we are concerned with here, is whether Prop Co has avoided a UK permanent establishment (PE). This is assessed based on whether it is reasonable to assume any activity of Prop Co or the UK Dev Co (or both) is designed to ensure that Prop Co does not, as a result of UK Dev Co’s activities, carry on a supply of services, goods or property in the UK.
Prop Co does not ordinarily have the personnel, skill set or proximity to the UK land to undertake the development itself. As such, it often outsources the entire activity to a developer in the UK.
In circumstances where Prop Co is unable to undertake the development itself, one might argue that the outsourcing of the development to UK Dev Co is not for the purposes of preventing Prop Co carrying on a property development trade in the UK. Nonetheless, it is not inconceivable that HMRC would question why the personnel employed/contracted in UK Dev Co were not employed/contracted by Prop Co. Of course, the reality is that day to day management of the development needs to be undertaken in the UK whether that is by UK Dev Co or an independent development company.
Unfortunately, however, this charging provision is so wide that it is sufficient that HMRC consider it ‘reasonable to assume’ the split of activities between Prop Co and UK Dev Co was ‘designed’ to prevent Prop Co carrying on a property development trade in the UK.
A secondary defence may be that the development activity itself does not form part of the supply of property. It is simply a process that takes place that changes the nature of the property, which consequently enables Prop Co to be in a position to make a supply of property. It could be argued that the activity of supplying property would be Prop Co engaging an independent UK real estate agent to source a purchaser.
It is disappointing that HMRC guidance has not yet been updated (last published with earlier draft legislation on 10 December) as the examples provided are severely lacking in meaningful detail, do not address new terminology or the intention behind the broadened scope or consideration of the real life nuances across different industry sectors.
1. Large companies or groups
Despite the wide drafting of the DPT charging provisions, it only applies to large companies or groups, as per the EU definition. The test is applied on a group basis. A group will not be large where:
- its turnover is ≤ €50m or balance sheet total is ≤ €43m; and
- its number of employees is < 250.
It is likely that many property groups will not be considered large and, therefore, carved out of the DPT rules. Where a property group is close to the turnover or balance sheet limits, it may wish to consider carefully the timing of any disposals.
2. Independent agents
Where UK Dev Co is not connected to Prop Co, the DPT rules do not apply. Broadly, Prop Co and Dev Co will be connected where one participates in the management, control, or capital of the other or both are under common management, control or capital.
3. Limited UK activity
Where sale of property to UK persons is less than £10m in the relevant accounting period, the DPT rules do not apply.
Where sale of property(ies) to UK persons is in excess of £10m, the DPT will still not apply where UK related expenses (of Prop Co, UK Dev Co or any other connected company) are £1m or less. The rules are effectively comparing Prop Co’s revenue with the UK related expenses to catch any disproportionality.
What to do next
If one of the exemptions applies, no DPT charge arises and there are no reporting requirements. However, we recommend to formally document any analysis undertaken and the rationale for conclusions drawn.
Where you do not fall within one of the exemptions listed above, you should undertake a review of your UK activities and relevant related party transactions to assess whether you are within the DPT charge.
Where activities are within the DPT charge, the tax at risk should be calculated and a plan formulated as to how to restructure so as to mitigate the DPT charge.
It may be that with some careful restructuring together with adjusting the transfer pricing methodology and pricing between Prop Co and Dev Co that a DPT charge will not arise. Such restructuring must take place within the first accounting period end falling on or after 1 April 2015. This means that companies with a 30 April year end need to act fast. Companies with a 31 December year end or 31 March have 9 months and 12 months respectively to restructure.
It is important to restructure before the accounting period end as where a taxpayer considers a DPT charge may arise, they must report this to HMRC within 3 months of the accounting period end. HMRC will then make a best estimate of the tax due and the taxpayer must pay over the tax within a further 30 days. Whilst it is possible to agree a revised DPT charge over the following 12 month period, this level of uncertainty may impact a business’s continued growth.
If you are concerned about the implications for your business (or your client’s business), please contact Zoe or Andy to discuss whether the DPT is relevant.
DDI: +44(0) 20 7534 7183
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