DIVERTED PROFITS TAX DTC and EU ASPECTS

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1 OXFORD UNIVERSITY CENTRE FOR BUSINESS TAXATION 13 th January 2015 DIVERTED PROFITS TAX DTC and EU ASPECTS Philip Baker QC Field Court Tax Chambers 3 Field Court Gray s Inn London WC1R 5EP Tel:

2 NOTE PB s personal position Political imperative behind the tax reflects popular concern at avoidance of UK tax on profits by MNCs The key now is to get the drafting correct

3 Question: TAX TREATIES How does a State combat tax avoidance which is based on the use of its tax treaties to achieve an unintended result? Typical examples Use of synthetic commissionnaires to avoid the conclusion of contracts Art 5(5) OECD MTC Fragmentation of activities to fall within Art 5(4) NOTE: These are within BEPS Action 6 these are acknowledged as unintended results

4 Possible answers: TAX TREATIES Terminate relevant treaties not very attractive Renegotiate relevant treaties possible, but will take time unless a multilateral instrument is developed Apply a deliberate tax treaty override e.g. s. 62 F (No 2) A 1987 post-padmore Impose a charge on a sum computed by reference to profits the Bricom solution for CFC tax: used quite frequently for anti-avoidance measures Introduce a tax charge which is not covered by the UK s tax treaties the alternative issue in Bricom

5 TAX TREATIES The DPT is not a covered tax it is not a tax expressly covered (which are usually Income Tax, Capital Gains Tax and Corporation Tax). This is not unusual: nor are NICs, Bank Levy, ATED etc. Art 2(4) OECD MTC any identical or substantially similar taxes Very little case law or guidance, other than on capital gains taxes (Kinsella and the Australian Virgin case) none from the UK

6 TAX TREATIES The DPT is it substantially similar to Corporation Tax? Applies only to diverted profits is a specific antiavoidance measure Targets specific scenarios clearly not a tax on general income and arguably not a tax on elements of income (e.g. capital gains) Applies only to a narrow range of corporate taxpayers only Has a different method of charge and procedural rules Has a different rate

7 TAX TREATIES Note under existing principles the UK is not obliged to grant treaty benefits in abusive situations: OECD MTC, Art 1 Comm (since 2003) 9.3 Other States prefer to view some abuses as being abuses of the convention itself, as opposed to abuses of domestic law. These States, however, then consider that a proper construction of tax conventions allows them to disregard abusive transactions, such as those entered into with the view to obtaining unintended benefits under the provisions of these conventions. This interpretation results from the object and purpose of tax conventions as well as the obligation to interpret them in good faith (see Article 31 of the Vienna Convention on the Law of Treaties).

8 TAX TREATIES 9.4 Under both approaches, therefore, it is agreed that States do not have to grant the benefits of a double taxation convention where arrangements that constitute an abuse of the provisions of the convention have been entered into. 9.5 It is important to note, however, that it should not be lightly assumed that a taxpayer is entering into the type of abusive transactions referred to above. A guiding principle is that the benefits of a double taxation convention 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.

9 TAX TREATIES NOTE DPT targeted anti-avoidance measure Cl 2(1)(c) so designed as to ensure [avoided PE] Cl 2(4) main purpose to avoid corporation tax Cl 7(4), (5), (6)(c) designed to secure the tax reduction NOTE BEPS Action Deliverable, para 14 agreement on the inclusion of at least a minimum of anti-avoidance measures in DTCs or domestic law, including the Principal Purpose Rule

10 TAX TREATIES Tax treaties are given effect in UK law only so far as domestic law expressly so provides see s. 6 TIOPA; s. 158 IHTA 1984 the UK s position is well known here No domestic law gives effect to DTCs with respect to the DPT

11 TAX TREATIES Anyone seeking to challenge the cl 2 charge (on an avoided PE), for example, as contrary to a UK DTC would need to show: The DPT is a covered tax or a substantially similar tax That they were entitled to the benefits of the treaty, as properly interpreted in line with the OECD Commentary That they did not have a PE in the UK, when the DTC is correctly applied to their facts and circumstances AND then would fall a cropper that either: The DTC is not given effect with regard to the DPT; or Parliament has enacted an implicit tax treaty override

12 EU LAW More complex as EU tax law is still evolving especially with regard to justifications (not acte claire) Question: Must it be consistent with EU law that a state permits companies to earn significant profits in its territory without paying the Corporation Tax normally due on those profits? NOTE: If it is a problem of EU law for the UK to combat base erosion and profit shifting unilaterally, it must equally be a problem for any BEPS outcome that offers a similar or identical solution on a multilateral basis

13 EU LAW Relevant freedom: Art 49 TFEU freedom of establishment (DPT only applies to control situations in effect, the argument could only be based on a restriction on market access) Art 56 TFEU services So no argument with respect to Third States Note some MNC group members might not be able to satisfy requirements of a genuine establishment note cl 3 charge targets entities or transactions lacking economic substance Note Cl 2 only applies cross-border; Cl 3 is not so limited

14 EU LAW Assuming (without conceding) that the DPT restricts the freedom of establishment / freedom to provide services (which is not necessarily the case as the company can pay the Corporation tax normally due on its profits) Then the issues of justification and proportionality arise

15 EU LAW - JUSTIFICATIONS The DPT is consistent with the international principle of fiscal territoriality that a state may tax profits arising in its territory See Futura C-250/95 paras 21 and 22 and subsequent cases

16 EU LAW - JUSTIFICATIONS Justifications: combatting tax avoidance Cadbury Schweppes formulation: see Itelcar Case C- 282/12, para. 34 targets wholly artificial arrangements which do not reflect economic reality and whose sole purpose is to avoid the tax normally payable on the profits generated by activities carried out on national territory les montages purement artificiels, dépourvus de réalité économique, dont la seule fin est d éluder l impôt normalement dû sur les bénéfices générés par les activités réalisées sur le territoire national

17 EU LAW - JUSTIFICATIONS Justifications: combatting tax avoidance wholly artificial arrangements does the Court really mean wholly artificial? Cadbury Schweppes uses the wholly artificial formulation, but then accepts that CFC legislation can satisfy the test, so long as tp has opportunity to prove objective facts showing genuine establishment DPT can be seen as a sideways CFC charge DPT: cl 2(4) tax avoidance condition: main purpose test OR mismatch condition (which includes insufficient economic substance condition) DPT: cl 3 entities or transactions lacking economic substance DPT: cl 7 insufficient economic substance conditions

18 EU LAW - JUSTIFICATIONS Justifications: combatting tax avoidance which do not reflect economic reality NB not always included in Court s formulation NOTE: it is the combatted arrangements which must not reflect economic reality E.g artificial avoidance of PE status E.g. How does it reflect economic reality that representatives are restricted from concluding contracts?

19 EU LAW - JUSTIFICATIONS Justifications: combatting tax avoidance whose sole purpose is to avoid the tax normally payable on the profits generated by activities carried out on national territory Cl 2(1)(c) designed to ensure no PE Cl 7(4), (5), (6) (c) designed to secure the tax reduction

20 EU LAW - JUSTIFICATIONS Justifications: combatting tax avoidance Alternative formulation: Marks & Spencer Combatting tax avoidance combined with preservation of the fiscal principle of territoriality Justifications the category is not closed E.g. Felixstowe combatting tax havens! Combatting base erosion and profit shifting? Application of balanced application where the UK is not obliged to give treaty benefits (see above)

21 EU LAW - PROPORTIONALITY Itelcar 37 In that connection, it is apparent from the case-law of the Court that, where rules are predicated on an assessment of objective and verifiable elements for the purposes of determining whether a transaction represents a wholly artificial arrangement entered into for tax reasons alone, they may be regarded as not going beyond what is necessary to prevent tax evasion and avoidance, if, on each occasion on which the existence of such an arrangement cannot be ruled out, those rules give the taxpayer an opportunity, without subjecting him to undue administrative constraints, to provide evidence of any commercial justification that there may have been for that transaction (see, to that effect, Case C-524/04 Test Claimants in the Thin Cap Group Litigation, paragraph 82, and Case C-318/10 SIAT [2012] ECR, paragraph 50).

22 DPT EU LAW - PROPORTIONALITY Initial onus on HMRC in issuing preliminary notice to point to facts to show it is reasonable to assume that the activity was, for example, designed to avoid a PE Cl. 14(3)(a) Cl. 15 Representations Similar obligation on HMRC in a charging notice Cl. 15 (5)(b) Cl. 20 HMRC Review

23 EU LAW - PROPORTIONALITY Effect of application of DPT is to apply normal attribution of profits rules (Cl. 8(3) applying ss CTA 2009) or transfer pricing rules (Cl. 10(3) applying Part 4 TIOPA subject to Cls. 10(5) (7)) Consistent with Itelcar and SGI

24 EU LAW ADDITIONAL POINTS 25% tax vs 20% corporation tax clear incentive element built in: encourages submission of profits to corporation tax at 20% Payment within 30 days of charging notice Contrast quarterly payments of Corporation Tax on profits as estimated Note target companies are MNCs Legitimate expectation Commissionnaire arrangements always expected to have a limited life expectancy BEPS highlights changes expected Note: specific provisions to eliminate double taxation

25 EU LAW To bring a successful challenge under EU law a company would need to show: That it was within the DPT it had designed its arrangements to avoid a PE / obtain an effective tax mismatch outcome and was unable to present objective evidence why it was not within the tax That it was entitled to rely upon the relevant freedom probably freedom of establishment That the tax had a restrictive effect (i.e. it should not be liable to pay the Corporation Tax normally due) That the charge was not justifiable under combatting tax avoidance or preserving territoriality or combatting BEPS / balanced allocation Or the charge was disproportionate AND would have to be willing to proceed to the CJEU (in about five years) as matter is not acte claire

26 OXFORD UNIVERSITY CENTRE FOR BUSINESS TAXATION 13 th January 2015 DIVERTED PROFITS TAX DTC and EU ASPECTS Philip Baker QC Field Court Tax Chambers 3 Field Court Gray s Inn London WC1R 5EP Tel: