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Budget 2018: Change in Definition of Permanent Establishment & Amendments to Diverted Profits Tax
If an overseas business has a UK Permanent Establishment (PE), the profits of the business that are attributable to that PE, either directly or indirectly, are chargeable to UK tax. The business is required to register the PE with Companies House and HMRC in the UK and to submit annual accounts and tax returns respectively to these bodies.
Due to this significant impact, it is therefore imperative to determine whether a UK PE is created by an overseas company performing work in the UK, ideally before the work commences.
A PE is defined by UK legislation (based on the OECD definition) as where a company has:
• a fixed place of business in a territory (including a place of management, branch, workshop, office or factory) through which the business of the company is wholly or partly carried on; or
• an agent acting on behalf of the company and habitually exercises in a territory, authority to do business on behalf of the company.
A fixed place of business is very broadly defined in legislation. In order to constitute a fixed place of business, there must be a geographical place with a certain degree of permanence that the business is carried on through.
There is no minimum time for a fixed place of business to become a PE, but generally, a place of business will not be treated as a PE where it exists for less than 6 months and is not a recurring place of business.
An agent habitually exercising his authority to do business on behalf of the company (dependent agent), is someone who has the authority (actual or implied) to conclude binding contracts in the name of the business.
No UK PE exists if the activities are preparatory or auxiliary to the work of the company as a whole, or if the work is carried on through an independent agent acting in the course of the agent’s business.
Certain preparatory or auxiliary activities, such as storing the company’s products, purchasing goods, or collecting information for the non-resident company, are classed as exempt activities and do not create a permanent establishment.
The change is to ensure that businesses cannot take advantage of the exemptions by splitting up their activities between different locations and related companies.
From 1 January 2019, a non-UK resident company will be denied the PE exemption for these activities if they are part of a fragmented business operation, for example if:
• that company, either alone or with related entities, whether foreign or UK, carries on a cohesive business operation, either at the same place, or at different places in the UK
• at least one of them has a PE where complementary functions are carried on
• the activities together would create a PE if they were in a single company
This is most likely to affect non-resident manufacturing and distribution businesses that structure their UK operations to minimise their UK tax footprint.
The UK decided to adopt this change in its tax treaties. It has given effect to the change through the BEPS multilateral instrument which was signed in June 2017, and which entered into force for the UK on 1 October 2018.
This legislative change puts into UK domestic law the proposals of the OECD in their Base Erosion and Profit Shifting (BEPS) project. You can read more details on the BEPS project here.
Diverted Profits Tax (DPT) was introduced in Finance Act 2015 and is intended to counteract contrived arrangements used by large groups (typically multinational enterprises) to artificially divert profits from the UK.
The DPT rules counter two types of arrangements used by large groups. Firstly, situations where a company with a UK taxable presence uses arrangements lacking economic substance to artificially divert profits from the UK to low tax jurisdictions.
Secondly, situations where a person carries on activities in the UK for a foreign company that are designed to artificially avoid creating a UK PE, and thereby a UK taxable presence, of that foreign company.
The new changes, announced in the Budget which have effect on and after 29 October 2018, have been introduced to:
• close a tax planning opportunity, whereby Corporation Tax amendments can be made to a company’s return after the review period has ended and the DPT time limits have expired
• make clear, in line with the stated policy intention, that diverted profits will only be taxed under either the DPT or Corporation Tax rules, but not both
• extend the ‘review period’, the time during which HMRC and the company are encouraged to work collaboratively to determine the extent of diverted profits, from 12 to 15 months
• extend a company’s right to amend their Corporation Tax return during the first 12 months of the extended 15 month review period, but only for the purposes of including the diverted profits into a Corporation Tax charge
• make clear that diverted profits liable to DPT can be reduced by amendment to the company’s Corporation Tax return during the first 12 months of the review period
These amendments come in as the UK government strives to be in line with the BEPS action plan on countering harmful tax practices more effectively by ensuring businesses create substance over form and justify their economic reasons for structuring of group companies.
If you have any queries surrounding PE or any of the topics touched upon above whether as an adviser or a client then please do not hesitate to get in touch. You can also read more help and advice relating to the 2018 Budget below.
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