Broadening the base – the UK’s proposal for an expanded royalty withholding tax

Published on 8 March 2018

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If the introduction of a first time buyer (in reality first time owner) relief for Stamp Duty Land Tax (SDLT) seized the headlines at the Chancellor’s Budget on 22 November 2017, an additional proposal buried deeply in the voluminous Budget documentation may prove to have an equally significant impact.

Governments around the world have been struggling with both the intellectual and practical problems of taxing the digital economy; the proposed new royalty withholding tax is the UK’s latest attempt to obtain a larger slice of the pie.

Historically, taxable presence has largely been equated with the concept of a Permanent Establishment (PE); however, the US technology giants blazed a trail in being quite capable of generating significant volumes of UK sales without meeting the definition of a PE.

In 2015 therefore, the UK decided to put a stop to this mischief by unilaterally (and somewhat to the chagrin of the OECD) introducing the Diverted Profits Tax (DPT). This legislation among other things imposes a penal tax charge (at an effective rate of 25%) where a PE has been avoided.

However, the tax profession is nothing if not creative: it is therefore interesting to speculate about what might happen if you could structure your UK sales activity in such a way that you sidestep both the creation of a PE and the tentacles of the DPT. Speculate no more – the answer is the new royalty withholding tax.

This new impost is intended to apply from April 2019. An income tax charge will result where a non-UK resident entity with no UK taxable presence (either directly or by virtue of the DPT) makes sales in the UK, and then pays a royalty in connection with the same (directly or indirectly) to an associated enterprise in a low tax jurisdiction.

Interestingly the new tax charge is not in fact limited to royalties; rather it extends to encompass payments for the rights to distribute goods and perform certain services in the UK.

This raises the obvious question of how the new tax charge will interact with the UK’s much trumpeted network of Double Tax Agreements (DTA)? The government is clear that it intends to respect its international obligations, and accordingly the withholding tax will be imposed only where the recipient of the “royalty” is resident either in a non-treaty jurisdiction or in a jurisdiction whose treaty with the UK omits a non-discrimination article.

This is all very well, but whilst the UK’s treaty network is comprehensive, there are gaps. Brazil is a prime example of a major economy that is not, on any definition, a tax haven but which has no DTA with the UK.

Moreover, suppose that a company resident in the Netherlands makes sales in the UK (without a taxable presence), and then pays a royalty to its parent in Brazil. The UK seeks to withhold tax in respect of that royalty under the new provisions; at the same time, however, the Netherlands seeks to tax those profits – as it is perfectly entitled to do on general principles. The consequence will be double taxation, with no immediately apparent resolution; this may not be conducive to expansion of commerce.

If the new provisions increase the risk of double taxation, they foreshadow an increased compliance burden for certain UK companies. HMRC are very well aware that attempting to collect revenue from non-resident entities gives rise to particular practical complications. Accordingly, they propose that any associated UK entity be assigned a reporting obligation in respect of the new charge and be made jointly and severally liable for its payment.

Indeed, the reporting obligation extends to situations in which the tax is not even due; because there is an appropriate DTA in place. This is apparently to enable HMRC to risk assess the effectiveness of the regime.

It is not difficult to sympathise with a UK finance director who is obligated to report the existence of payment of which he may well be unaware, and then sign a Senior Accounting Officer (SAO) certificate to the effect that said reporting is accurate.

There is a wide consensus that the basic architecture of international tax should be reshaped to both reflect modern economic realties and curtail the opportunities for cross border tax avoidance. However, we would argue that this requires a coordinated and multilateral approach, rather than a further unilateral revenue raid from the UK. Indeed, actions such as this risk turning the international fiscal system into “a war of all against all”.

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