UNIVERSITEIT VAN AMSTERDAM
The Diverted Profits Tax
Thesis for the Master Fiscaal recht: Internationaal en Europees belastingrecht Vincent O'Donoghue
10215026 February 2016
ii Contents Contents ... ii List of abbreviations ... vi 1 Introduction ... 1 1.1 A new tax ... 1
1.2 Main research question ... 1
1.3 Supportive questions ... 1
2 The Diverted Profits Tax ... 3
2.1 Overview ... 3
2.1.1 The creation of the diverted profits tax ... 3
2.1.2 Aim of the diverted profits tax ... 3
2.2 Entities or transactions which lack economic substance ... 4
2.2.1 Section 80 ... 5
2.2.2 Section 81 ... 6
2.2.3 Calculation of the profits ... 6
2.2.4 Estimation of the profits ... 7
2.3 Artificial avoidance of a Permanent Establishment in the United Kingdom ... 8
2.3.1 Section 86 ... 8
2.3.2 Calculation of the taxable diverted profits ... 9
2.3.3 Estimation of the profits ... 10
2.4 Exceptions ... 10
2.4.1 Small or medium-sized enterprises ... 10
2.4.2 Loan relationships ... 11
2.4.3 Companies with limited sales or expenses in the UK ... 11
2.4.4 Transfer pricing adjustment ... 11
iii
2.5.1 Duty to notify ... 12
2.5.2 The Charge ... 12
2.6 Comments ... 13
2.6.1 Scope too limited ... 13
2.6.2 Uncertainty ... 14
2.6.3 Existing legislation ... 15
2.7 Effectiveness ... 16
3 Double tax treaties ... 17
3.1 Overview ... 17
3.2 Interpretation of tax treaties ... 18
3.2.1 Interpretation of treaties ... 18
3.2.2 OECD Commentary ... 19
3.2.3 Case law ... 20
3.3 OECD model tax convention article 2: Taxes Covered ... 21
3.3.1 Article 2 ... 21 3.3.2 Paragraph 1 ... 21 3.3.3 Paragraph 2 ... 21 3.3.4 Paragraph 3 ... 23 3.3.5 Paragraph 4 ... 24 3.3.6 Conclusion ... 26
3.4 Further implications for an appeal to double tax treaties. ... 26
3.4.1 UK Law ... 26
3.4.2 OECD commentary ... 27
3.5 Conclusion ... 29
4 EU treaty freedoms... 30
iv
4.2 Which freedom applies ... 31
4.2.1 Relevant freedoms ... 31
4.2.2 Which freedom prevails ... 32
4.2.3 Conclusion ... 34
4.3 Is there a restriction? ... 35
4.3.1 Not restrictive because companies have a choice ... 35
4.4 Justifications ... 36
4.4.1 Wholly artificial arrangements ... 36
4.4.2 Proportionality of the diverted profits tax ... 37
4.4.3 Necessity ... 38
4.5 Conclusion ... 39
5 The diverted profits tax and the BEPS project ... 40
5.1 Introduction and overview ... 40
5.2 Comments made on the diverted profits tax in relation to the BEPS project .... 40
5.3 The BEPS action plan and the diverted profits tax ... 41
5.3.1 The Google Tax ... 42
5.3.2 Action plan 7 ... 43
5.4 Differences ... 45
5.4.1 Difference in the prevention method ... 45
5.4.2 Differences in scope ... 45 5.4.3 Difference in time... 46 5.5 Conclusion ... 46 6 Conclusion ... 48 Bibliography ... 50 Literature ... 50 Table of Cases ... 51
v Annex 1: Finance Act 2015 Part 3 - Diverterd profits tax
vi List of abbreviations
BEPS Base erosion and profit shifting CFC Controlled foreign company
CJEU Court of Justice of the European Union HMRC Her Majesty's Revenue & Customs
OECD Organization for Economic Cooperation and Development PE Permanent Establishment
SME Small or medium-sized enterprises
TFEU Treaty on the Functioning of the European Union TIOPA Taxation (International and Other Provisions) Act UK United Kingdom
1 1 Introduction
1.1 A new tax
In 2015 the United Kingdom has introduced the diverted profits tax. This new tax was announced against the background of widespread outrage caused by the revelation of corporate structures and tax arrangements of multinational companies which result in a very low tax burden compared to the large revenues and profits of these companies in the UK. With the diverted profits tax the British government attempts to ensure that companies will pay an appropriate amount of tax on their UK revenue. In short, the diverted profits tax imposes a charge at a rate of 25% on the profits that have been derived from the UK in order to avoid the UK corporation tax.
1.2 Main research question
Governments, the European Commission, the general public and news media show increased attention for the amount of tax that multination companies pay in the countries where their revenue arises and the way that they are taxed. The diverted profits tax is a new development in the current attention for the tax positions of multinational companies. Besides the effect that the diverted profits tax will have in the UK, its outcome might also be interesting for other countries that are considering legislative measures to tackle tax avoidance. This gives rise to the following main research question of this thesis:
Is the diverted profits tax an effective measure to ensure that multinational companies pay a fair share of tax in the countries where their revenue arises?
1.3 Supportive questions
The answer to the main research question depends on four underlying questions. Since its announcement the diverted profits tax has been a much discussed subject in tax journals. There are four recurring questions that can be derived from the parliamentary debate and the publications on the subject.
First, the diverted profits tax itself will be described in chapter 2. What does it aim to achieve, who will be confronted with the tax and on what base is the tax calculated. Central question in this chapter is whether the diverted profits tax will be effective in achieving its
2 aim from a UK point of view. Second, in chapter three the question will be answered whether a company that is charged with diverted profits tax will be able to claim relieve under existing double tax treaties. If this is the case it could have a negative influence on the effectiveness of the diverted profits tax since a charge will only arise in cross border situations. The third question, central to chapter 4 relates to cross border situations in the European Union. The fundamental freedoms of the TFEU might be restricted in cases where the diverted profits tax charges a company from a Member State with UK related revenue. Finally in chapter 5 the diverted profits tax is discussed in the light of the OECD BEPS action plan. The diverted profits tax and the BEPS action plan share the same underlying base erosion and profits shifting issues. Not only is the unilateral approach the UK has taken in anticipation of the outcome of the BEPS project remarkable in the light of a multilateral approach on tackling tax avoidance. If the diverted profits tax is not in accordance with the recommended measures of the BEPS project it is not an example of effective anti-abuse legislation for other countries. Based on the outcome of chapters 2 to 5 the answer to the main research question will be formulated in chapter 6.
3 2 The Diverted Profits Tax
2.1 Overview
The diverted profits tax is a new tax introduced in the United Kingdom in order to halt two types of tax avoidance. This chapter describes the working of the diverted profits tax and sets out the comments made on the legislative proposal and the diverted profits tax. The central question is whether the diverted profits tax in the way that is it is enacted will be effective legislation in order to put a stop to the tax avoidance it is aimed at. The creation of the tax and its aim will be set out in this paragraph. How the diverted profits tax tries to achieve its aim –its working- will be described in paragraphs 2.2 and 2.3. There are some exceptions to the scope of the diverted profits tax which are set out in paragraph 2.4. The effectuation of the tax via a charging notice is described in paragraph 2.5. As one can expect from a new tax the diverted profits tax has been subject to both parliamentary and academic debate. The comments made are set out in paragraph 2.6. In paragraph 2.7 a conclusion is made as to whether the diverted profits tax will be effective from a UK legal perspective in achieving its aim.
2.1.1 The creation of the diverted profits tax
The diverted profits tax was first announced in the 2014 Autumn Statement by Chancellor of the Exchequer George Osborne. The tax is described as a tax to counter the use of aggressive tax planning to avoid paying tax in the UK, using artificial arrangements to divert UK profits overseas.1 After draft legislation was published in December 2014, it has been debated in parliament in a special debate on 7 January 2015 and on 25 March 2015 as part of the Finance Act 2015.2 Results of a consultation have slightly altered the diverted profits tax as appose to the draft. The diverted profits tax is enacted 31 March 2015 as part of the Finance Act 2015.
2.1.2 Aim of the diverted profits tax
The diverted profits tax’s aim is to make multinational companies pay tax in the UK on the profits they make which are attributable to UK activity. The tax is thus founded upon the
1 2014 Autumn Statement p.60 (http://www.gov.uk/government/publications).
4 principle to align taxing rights to economic activity.3 In short this is achieved by imposing a tax (the diverted profits tax) on diverted profits at a rate of 25%. The diverted profits being the profits that are attributable to UK activity but have been diverted in such a way that they cannot be taxed in the UK. The Diverted profits tax is aimed at two distinct types of arrangements used by multinational companies to avoid paying taxes on UK profits. One is the use of artificial arrangements involving entities or transactions which lack economic substance (paragraph 2.2). The other is the artificial avoidance of having a permanent establishment in the UK despite activity being carried on in the UK (paragraph 2.3).
2.2 Entities or transactions which lack economic substance
A UK company or a foreign company with a permanent establishment in the UK that is involved in arrangements using entities or transaction lacking economic substance in order to exploit tax mismatches is targeted by section 80 and 81 respectively. An example derived from the guidance published by HMRC illustrates the targeted arrangements as follows.4 Company A is parent to a group consisting of Company B, which is either a UK resident or qualifies as a permanent establishment of Company A in the UK, and Company C, which is located in a country where it is not subject to tax. Company C receives a capital injection of Company A and uses this to purchase a machine. Company C then leases the machine on a basis of operating lease to Company B. All further activity of Company C only consists of
3 HC Deb 25 March 2015, vol. 594, col 1466.
5 owning the machine and the connected administration. The lease payments of Company B will be deducted from its income for UK corporation tax and the payments received by Company C will not be taxed. It is these cases that are targeted by section 80 and 81. The calculation of the taxable diverted profit in this example is described in paragraph 2.2.5. 2.2.1 Section 80
Section 80 is aimed at a company that is a UK resident within the meaning of the Corporation Tax Acts5 and that is involved in entities or transactions lacking economic substance which erode the companies’ UK tax base. Target of the diverted profits tax is ‘’the material provision’’. The material provision is a provision between the company and another person by means of transaction or series of transaction.6 The term provision is derived from the UK transfer pricing rules7 and according to HMRC’s International Manual includes ‘’arrangements, understandings and mutual practices whether or not they are, or are intended to be, legally enforceable’’.8
One of the parties – the UK company or the other person has to participate directly or indirectly in the management, control or capital of the other party or the same person has to directly or indirectly participate in the management, control or capital of both of the parties. If so, the participation condition is met.9 The material provision then has to result in an ‘’effective mismatch outcome’’. In short there is an effective mismatch outcome when the material provision results in expenses for the company for which a deduction of taxes has been taken or a reduction in income of the company, as a result of which the relevant payable amount of tax by the company is reduced. If the reduction of the relevant payable amount of tax by the company exceeds the increase in relevant taxes by the other person there is an effective tax mismatch outcome.10 Relevant taxes are UK corporation tax, income tax, a supplementary charge in respect of ring fence trades or any non-UK tax on income.11 The last test of section 80(1) is the insufficient economic substance condition. For this condition the effective tax mismatch outcome must be the result of one or more transactions of which it is reasonable to assume that they were designed to secure the tax reduction.12 This is the case if the financial benefit of the tax reduction exceeds the non-tax
5
Finance Act 2015, s 114(1).
6 Finance Act 2015, s 80(1)(b).
7 HMRC Diverted Profits tax: Interim Guidance, p.12.
8 HMRC INTM412050: Transfer pricing: legislation: rules: meaning of “provision” and “transaction”. 9
Finance Act 2015, s 106 and 80(1)(c).
10 Finance Act 2015, s 80(1)(d), s 107 and s 108. 11 Finance Act 2015, s 107(8).
6 benefits of the transaction. The involvement of a person in the transaction of whom the non-tax benefits of his involvement do not in terms of functions or activities exceed the financial benefit of the tax reduction also results in the insufficient economic substance condition being met. If the abovementioned conditions are met the company will have to notify HMRC (see paragraph 2.5.1) unless one or more exemptions are applicable (see paragraph 2.4). 2.2.2 Section 81
Section 81 applies to a foreign company which is not UK resident but carries on a trade in the UK trough a permanent establishment (‘’UKPE’’). The diverted profits tax applies to the UKPE if it qualifies as a section 80 company had it been a separate person from the foreign company. For section 81 cases the same tests and conditions apply as for section 80 cases (paragraph 2.2.2).
2.2.3 Calculation of the profits
If section 80 or 81 applies to a company the profits are calculated in accordance with section 84 or 85 depending on whether the actual provision condition is met. The actual provision condition is set out in section 82(7) and is met if the material provision results in deductible expenses for the company or the UKPE and the relevant alternative provision, as a result of the effective tax mismatch outcome would not result in relevant taxable income for a connected company. The relevant alternative provision is the provision that would have been made if tax on income had not been a relevant consideration for any of the parties.13 If the actual provision condition is met the diverted profits are calculated according to section 84. The taxable diverted profits are the amount that results from the material provision adjusted to at arm’s length pricing. Section 85 applies when the actual provision condition is not met. The taxable diverted profits are the income on the basis of section 84 and the amount of income of a connected company which would have resulted from the relevant alternative provision in case the actual provision condition is not met because the relevant alternative provision results in income for a connected company.14 If subsection 4 does not apply, the taxable diverted profits are the notional additional amount arising from the relevant alternative provision and the total amount of income of a connected company which would have resulted from the relevant alternative provision. The notional additional amount being
13 Finance Act 2015, s 82(5). 14 Finance Act 2015, s 85(3),(4).
7 the amount by which the chargeable profits under the corporation tax that would have risen had the relevant alternative provision been made, exceeds the amount that has been taken into account in an assessment to corporation tax as a result of the material provision.15
2.2.4 Estimation of the profits
When an HMRC officer issues a preliminary or charging notice (see paragraph 2.5.2), he determines the taxable diverted profits by estimating the amount in accordance with section 96. When estimating the profits for the preliminary or charging notice, the officer can adjust deducted expenses if he considers the deducted expenses greater than they would have been had the material provision been at arm’s length. When issuing the preliminary or charging notice the deducted expenses are reduced at a fixed rate of 30%. The fixed rate of 30% only applies on the estimation. During the review period it is considered whether the 30% adjustment is a correct transfer pricing adjustment. Instead of a fixed rate the deducted expenses are then adjusted to at arm's length. During the review period the charge based on the estimation of the diverted profits can be adjusted after calculation of the diverted profits in accordance with sections 94 and 95.
2.2.5 Example
The taxable diverted profits in the case of the aforementioned example in paragraph 2.2 could be calculated as follows. UK resident company B leases a machine from connected company C, resident to a low tax jurisdiction. The yearly lease payments are 150 and are deducted from the income of Company B of 155. This results in a profit for B of 5. The lease payments are not taxable income for company C. Instead of the operating lease construction, company B could have bought the machine itself, and for instance - disregarding the correct capital allowances available to B - would have had deductible expenses of only 100. Under the relevant alternative provision company B would have had taxable profits of 55 and company C would not have had any profits relating to the relative alternative provision. In this case the taxable diverted profits are calculated on the basis of section 85(5) and are the profits resulting from the relevant alternative provision less the 'normal' profits of company B. The taxable diverted profits of company B would be 50.
8 2.3 Artificial avoidance of a Permanent Establishment in the United Kingdom
The other types of arrangements that fall within the scope of the diverted profits tax are those that can be qualified as arrangements aimed at artificially avoiding the creation of a permanent establishment in the UK. An example derived from the guidance published by HMRC illustrates the targeted arrangements as follows.16 Company A is parent to a multinational group and additionally its activity consists of research and development. Company B is located in a European country and manufactures the products. Company C is located in a low tax European company and concludes all sales and contracts with customers in Europe. A UK company, Company D which is not part of the group engages with UK customers in sales support activities for which Company C pays a fee on a cost-plus basis. But as said all contracts are concluded by Company C. The diverted profits tax will tax the profits that would have been attributable to Company D had it been a permanent establishment of the foreign company, if it turns out that the above mentioned structure qualifies as artificial avoidance. The calculation of the taxable diverted profit in this example is described in paragraph 2.3.4.
2.3.1 Section 86
Section 86 is aimed at the artificial avoidance of a Permanent Establishment in the United Kingdom. A person, whether or not UK resident that carries on activity in the UK in connection with the supplies of services, goods or other property made by a foreign company
9 in the course of its trade, falls within the scope of section 86 and is called the avoided PE.17 It has to be reasonable to assume that the activity of the avoided PE or the foreign company is designed to avoid the foreign company from carrying on a trade in the UK for the purposes of corporation tax.18 Section 86(1)(f) introduces the mismatch condition and the tax avoidance condition of which at least one has to be met. The mismatch condition differs from the mismatch condition in section 80. The material provision must be between the foreign company and another person and must be connected to the activities of the avoided PE.19 The tax avoidance condition requires arrangements to be in place of which the main purpose is to avoid or reduce a charge to corporation tax. 20 Arrangements can be agreements, understandings, schemes, or transactions.21
2.3.2 Calculation of the taxable diverted profits
The taxable diverted profits are calculated according to either section 89, 90 or 91. The criteria to determine the applicable section are set out in section 88. It mainly depends on whether or not the mismatch condition of section 86(2) and the actual provision condition of section 88(9) are met. The actual provision condition is met if the material provision results in expenses of the foreign company which would have been notional PE profits and the relevant alternative provision would also have resulted in expenses of the foreign company but would not be relevant income for the connected company. The notional PE profits are defined in subsection 5 and are the profits which would have been PE profits had the avoided PE been a UKPE. The notional PE profits depend on the attribution of profits to the PE based on the existing rules for attribution of section 20 to 32 of CTA 2009.22 The relevant alternative provision is the provision that would have been made between the foreign company and another company had tax not been relevant. Depending on the outcome, the taxable diverted profits are (what would have been) the notional PE profits or if calculated based on section 91, the relevant taxable income of a company as a result of the relevant alternative provision.
17 Finance Act 2015, s 81(1)(a),(b),(c). 18 Finance Act 2015, s 81(1)(e). 19
Finance Act 2015, s 86(2).
20 Finance Act 2015, s 86(3). 21 Finance Act 2015, s 86(7) . 22 Finance Act 2015, s 88(5).
10 2.3.3 Estimation of the profits
For the purpose of issuing a preliminary or charging notice the HMRC officer estimates the taxable diverted profits in accordance with section 89, 90 or 91. In estimating the taxable diverted profits the HMRC officer can deduce the expenses that would be allowable expenses in computing the notional PE profits by 30% if he considers the deducted expenses not at arm's length. During the review period the adjustment based on the fixed rate will be adjusted to the correct transfer pricing adjustment.
2.3.4 Example
The taxable diverted profits in the case of the aforementioned example in paragraph 2.3 would be calculated as follows.23 The UK sales supports D engages with UK customers on a cost plus basis resulting in a very limited UK tax base of 1. The European Sales company C concludes all contracts with UK Customers. The UK related profit of C is 200 of which a 100 in fees is paid to D. The diverted profits are the notional PE profits, the profits which would have been attributable to a UK PE hadn't one been avoided. The activity of C in relation to the UK sales is very limited and based on the existing rules for attribution most of the profits of C should be attributable to the avoided PE. Instead of 50% of the UK profits of 200 only 2% should be attributed to company C, resulting in 48% being attributable to the avoided PE.24 The taxable diverted profits are therefore 96.
2.4 Exceptions
The diverted profits tax contains several exceptions of which the exception for small or medium-sized enterprises (‘’SME’s’’), certain loan relationships and the exception for companies with limited sales and expenses in the UK are the most important. The exceptions for SME’s and foreign companies with limited UK-related sales and expenses are in line with the tax’s aim at large multinational companies.
2.4.1 Small or medium-sized enterprises
Small or medium-sized enterprises are exempted from application of the diverted profits tax in sections 80(1)(g) and 86(1)(h). Whether a company qualifies as an SME is determined
23 HMRC Diverted Profits Tax: Interim Guidance, p.34. 24 HMRC Diverted Profits Tax: Interim Guidance, p.34.
11 in accordance with section 172 of TIOPA 2010.25 The definition is based on the recommended definition by the European Commission.26 In contrast to the EU definition a company does not qualify as an SME if it is a large-sized enterprise for a single accounting period instead of the recommended two consecutive accounting periods.27 In the case of a possible section 80 charge both the UK company and the other person have to be an SME. The same goes for the avoided PE and the foreign company in section 86 cases.
2.4.2 Loan relationships
The diverted profits tax is not aimed at loan relationships and both the section 80 and 86 charges consist of an exception for loan relationships by referring to section 109. The deductible expenses or the reduction of income deriving from the material provision resulting in an effective tax mismatch outcome as described in section 107(3) may arise from a loan relationship. These results are exempted if the arrangements in place would qualify as a loan relationship or derivative contract within the meaning of part 5 or part 7 of the Corporation Tax Act 2009 respectively.
2.4.3 Companies with limited sales or expenses in the UK
Foreign companies with limited sales or expenses in the UK are exempted from the section 86 charge. To fall within the scope of the exception in section 87 the UK-related sales revenues of the foreign company and its connected companies must not exceed £10.000.000, or UK-related expenses of the company and its connected companies must not exceed £1.000.000.
2.4.4 Transfer pricing adjustment
The transfer pricing adjustment is not an actual exemption but does have as a result that diverted profits will not be subject to diverted profits tax. For the section 80 and 81 charge no diverted profits arise if the full transfer pricing adjustment of section 83 is made and the actual provision condition is met.28 By taking the calculated diverted profit into account in an assessment to corporation tax the full transfer pricing adjustment condition is met. A
25 Finance Act 2015, s 114(1). 26
Commission Recommendation 2003/361/EC.
27 Commission Recommendation 2003/361/EC, annex article 4(2) and HMRC Diverted Profits tax: Interim
Guidance.
12 company can thus escape the higher tax rate of the diverted profits tax and instead of paying 25% diverted profits tax pay 20% corporation tax.
2.5 Charging notice 2.5.1 Duty to notify
A company has the duty to notify an HMRC officer within three months after an accounting period if section 80 or 81 applies in connection with a material provision and the financial benefit of the tax reduction is significant relative to the non-tax benefits.29 Similarly a notification must be made if section 86 applies.30 No notification has to be made if it is reasonable for the company to conclude that no charge will arise, or that HMRC has been provided with significant information to decide on giving a preliminary notice. The notification must contain a statement as to which sections apply as well as a description of the material provision and its parties.31 HMRC requests companies to disclose additional information such as a worldwide group structure and detailed information about intellectual property and related payments connected to activity in the UK is.32
2.5.2 The Charge
An HMRC officer must give a company a preliminary notice within 24 months after the accounting period in which he believes diverted profits arise. The preliminary notice must state on which sections the charge is based and contain a clarification of the determination of the profits. After receiving the preliminary notice the company has 30 days to make representation on limited grounds set out in section 94(3). After this 30 day period the HMRC officer has another 30 days to give a charging notice or notify the company that no charging notice will be issued.33 The tax then must be paid within another 30 days period despite any review or appeal. This means that the tax is to be paid before an appeal can be made. Within the twelve-month review period the HMRC officer must review the charge to see if the charged diverted profits tax is excessive or insufficient.34 If the charge was excessive the amount of taxable diverted profits is to be reduced. If the amount of taxable diverted profits
29 Finance Act 2015, s 92(3). 30 Finance Act 2015, s 92(4). 31
Finance Act 2015, s 92(9).
32 HMRC Diverted Profits tax: Interim Guidance, 68-69. 33 Finance Act 2015, s 95(2).
13 was insufficient the officer issues a supplementary charging notice. The company can appeal against the charging notice within 30 days after the 12 month review period has ended. 2.6 Comments
The diverted profits tax has been subject of parliamentary debate on two occasions. In a debate held on 7 January 2015 the Economic Secretary of the Treasury responded to some of the concerns raised by Members of Parliament. Though the proposed diverted profits tax legislation was in general positively received, some comments have been made. From the first announcement of the tax, tax-advisory companies and commentators in legal journals have also commented on the tax. The concerns raised and questions asked will be set out below. Questions about a possible challenge of the DPT to EU law and tax treaties and the BEPS project will be handled in the respective chapters dedicated to these subjects.
2.6.1 Scope too limited
The diverted profits tax has been accused of having a too limited scope to be an adequate measure against tax avoidance. One of the remarks is that the exemption for SME’s makes it possible for smaller groups to maintain arrangements aimed at avoiding corporation tax without facing the 25% diverted profits tax rate. The minister justifies the limitation of the scope to large multinational companies because particularly those companies are guilty of aggressive tax planning.35 Limiting the scope with a reference to the existing SME criterion increases certainty for companies as it provides a clear line if the diverted profits tax might apply on the arrangements a company is involved in.
The exclusion of loan relationships has been called a flaw in the design of the diverted profits tax.36 In the parliamentary debate it was also stated that financing arrangements with excessive interest payments on intercompany loans are one of the most used ways of diverting profits.37 The minister was then asked why these arrangements have been exempted from the diverted profits tax.38 According to the minister loan relationships have been
35
HC Deb 7 January 2015, vol 590, col 97WH.
36 HC Deb 25 March 2015, vol 594, col 1435. 37 HC Deb 7 January 2015, vol 590, col 90 WH. 38 HC Deb 7 January 2015, vol 590, col 91 WH.
14 excluded because these problems will be looked at separately.39 Perhaps existing transfer pricing principles and anti-abuse legislation are sufficient to tackle these arrangements.
The limitation of the scope of the diverted profits tax inevitably means a limitation of the possible yield of the tax. The estimated yield of the diverted profits tax is about 350 million GBP per annum.40 In the parliamentary debate it has been stated that this number could be much higher.41 It needs to be understood though that the diverted profits tax itself does not necessarily has a budgetary incentive. The tax might also result in companies abandoning their artificial arrangements and include their UK earnings in an assessment to UK corporation tax. This will also contribute to the diverted profits tax achieving its aim of making multinational companies pay their fair share of tax in the UK. The fact that the diverted profits tax is not a legislative answer to all types of tax avoidance does not mean it will not succeed in tackling some of the arrangements that multinational companies have in place.
2.6.2 Uncertainty
The diverted profits tax is technically difficult legislation. The tax has a layered structure and consists of various conditions some of which are designed especially for the diverted profits tax. A wide range of arrangements potentially fall within the scope of the diverted profits tax and will have to be tested against the conditions of sections 80 or 86. The wide scope of the tax and the unfamiliar conditions might cause uncertainty for multinational companies with UK-related revenue whether a charge will arise. As Baker argues, the uncertainty for companies is relatively limited given the tax advisors they employ or consult.42 Moreover, tax laws are not known for their simplicity and especially anti-abuse legislation often contains both detailed as well as broadly formulated provisions. I doubt whether simplicity should be preferred over fairness, by which I mean that those who aggressively avoid the ‘’normal’’ tax rules should not complain when they meet difficult anti-avoidance rules introduced by the legislator as a reaction to this practice. Along with the new legislation extensive guidance has been published by HMRC which expresses the view of how HMRC will apply the new rules. The minister has emphasized on the fact ‘’that
39
HC Deb 7 January 2015, vol 590, col 102WH.
40 2014 Autumn Statement p. 64.
41 HC Deb 25 March 2015, vol 594, col 1435.
15 calculation of the charge follows well-established transfer pricing principles’’ and that ‘’those principles are widely understood and routinely applied by businesses.’’43
Another concern regarding the draft legislation relates to the duty to notify when a company is potentially in scope of the diverted profits tax.44 The notification duty would not only be an excessive burden for companies to comply with, it was also feared that HMRC would receive too many notifications. The final legislation has been changed and the interim guidance published by HMRC contains several exemptions on the basis of which companies are not required to send a notification.45 However, the exemption from the duty to notify does not discharge a company from its potential liability to diverted profits tax. HMRC can still decide to give a company a preliminary notice.
2.6.3 Existing legislation
HMRC might have tried to tackle the arrangements targeted by the diverted profits tax by using existing anti-abuse legislation. Piccioto mentions other countries that have interpreted the substance requirements of the PE status in such a way that they could constitute a PE.46 Neidle addresses the same option and discusses that the artificial avoidance of a UKPE with an appeal to double tax treaties could have been argued by HMRC.47 Both writers acknowledge that this approach would inevitably result in legal cases. Neidle and Self both see a purpose for the General Anti Avoidance Rule in tackling the problem.48 The new diverted profits tax legislation will give HMRC a stronger stance against the artificial avoidance of a PE status, even if a charge or the diverted profits tax itself will be tested in the court. It is beyond the scope of this thesis to elaborate on the possibility of tackling tax avoidance by other UK tax legislation. Additionally the diverted profits tax has a more extensive use as it is also aimed at arrangements and entities lacking economic substance. Another reason for the choice to propose new legislation can be found in the statement of the minister that the diverted profits tax does not result in a treaty override because the diverted
43
HC Deb 7 January 2015, vol 590, col 101 WH.
44 HC Deb 7 January 2015, vol 590, col 83 WH,
45 HMRC Diverted Profits tax: Interim Guidance, p.66-67.
46 Piccioto, The UK’s Diverted Profits Tax: An admission of Defeat or a Pre-Emptive Strike?, Tax Notes
International, January 19 2015, 239 (online).
47 Neidle, The diverted profits tax: flawed by design?, British Tax review, 2015, 2, 147-166. 48 Neidle, The diverted profits tax: flawed by design?, British Tax review, 2015, 2, 147-166,
16 profits tax is not covered by double tax treaties.49 This argument will be further dealt with in chapter 2.
2.7 Effectiveness
The diverted profits tax is a new step in the battle against tax avoidance by multinational companies. The effectiveness of the tax mainly depends on the willingness of multinational companies to contribute to paying a fairer amount of tax in the countries where their profits arise. Companies can either pay the diverted profits tax or dissolve artificial arrangements and pay UK corporation tax. It is not unthinkable however that some companies and tax advisers will explore possible ways around the diverted profits tax. The criteria set out in the diverted profits tax will be put to the test to see if they are fit to battle the tax avoidance strategies used by multinational companies. If the charges survive in court, from a UK view the diverted profits tax will be a success.
17 3 Double tax treaties
3.1 Overview
The diverted profits tax imposes a charge on profits diverted from the United Kingdom to another jurisdiction. The diverted profits might be subject to tax in that other jurisdiction as well. Bilateral double tax treaties attempt to avoid double taxation by allocating the taxing rights on certain income to the states that are party to the treaty. For companies and other tax payers it is important to know forehand if they face any tax charges and where they face these charges. Double taxation treaties contribute to the certainty of the taxpayer and the predictability of the charges that will rise. It is therefore important to know if the diverted profits tax, which is a new tax, is (or should be) covered by existing tax treaties. This is the central question in this chapter.
The UK government takes the position that the diverted profits tax is not a tax covered by its existing double tax treaties.50 Under UK law a tax payer cannot claim relieve directly on the basis of a double tax treaty. One might argue that the question whether the diverted profits tax is covered by existing tax treaties or not is not relevant because tax treaties under UK law do not apply to the diverted profits tax (see par. 3.4.1). For the scope of this thesis this question is indeed relevant.
The UK has concluded double tax treaties with over 120 countries.51 Most of these treaties are based on the OECD Model Tax Convention.52 Even though the treaties tend to share a similar structure based on the model convention, the UK tax treaties are not identical.53 This is an inevitable effect of the fact that not all treaties have been concluded at the same time and are thus based on different versions of the model convention, the fact that the OECD Model Tax Conventions leaves open some options and that the treaties are the result of extensive negotiations between the parties to that particular treaty. To be able to answer the question if the diverted profits tax is covered by existing tax conventions one could examine all existing double tax treaties. I choose to refer to the OECD model tax
50 HC 7 January 2015, vol 590, col 100 WH. 51
https://www.gov.uk/government/collections/tax-treaties.
52 OECD (2014), Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing,
Paris.
18 convention in order to answer the question if the diverted profits tax would be covered by an existing double tax treaty. Where relevant, reference will be made to a particular tax treaty. 3.2 Interpretation of tax treaties
3.2.1 Interpretation of treaties
The first step in order to determine whether or not the diverted profits tax falls within the scope of existing tax treaties is establishing the rules for interpretation of a double tax treaty. The Vienna Convention on the Law of Treaties( ‘’Vienna Convention’’) applies on all treaties and section 3 of the convention is dedicated to the interpretation of treaties. Although the Vienna Convention only applies to treaties entered into force after the Vienna Convention went in to force for those states, the Vienna Convention consists of customary international law which would have applied to the treaty independently of the convention.54 The rules of interpretation of the Vienna Convention are therefore also applied on treaties concluded after the Vienna Convention went into force and treaties between states that are not a party to the Vienna Convention.55 The relevant passages of articles 31 and 32 of the convention are as follows:
Art. 31 par. 1: A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.
Art. 32: Recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the application of article 31, or to determine the meaning when the interpretation according to article 31:
(a) leaves the meaning ambiguous or obscure; or
(b) leads to a result which is manifestly absurd or unreasonable.
The OECD model tax convention contains the following interpretation rule for undefined terms:
Art. 3 par. 2: As regards the application of the Convention at any time by a Contracting State, any term not defined therein shall, unless the context otherwise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which the Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State.
The sources which can be used for the interpretation of a tax double tax treaty on the basis of these three articles are the treaty itself and its context, object and purpose and the laws of the contracting states.
54 Vienna Convention article 4.
55 Vogel/Rust, in Reimer & Rust (eds), Klaus Vogel on Double Taxation Conventions, 4th edn (2015), Introduction
19 3.2.2 OECD Commentary
The OECD model tax convention contains extensive interpretive commentaries to the articles of the model convention. What is the status of the OECD commentaries on the model convention in the interpretation of double tax treaties? The OECD commentaries on the model convention can provide a better understanding of the articles and can be of aid in the interpretation of the model convention.56 Its influence on double tax treaties, however, is not entirely clear. The introduction to the Model Convention states that tax authorities should follow the commentaries when applying and interpreting their double tax conventions.57 Double tax treaties do not explicitly refer to the OECD commentaries so there is no legal obligation to follow the commentaries. It is generally accepted that the OECD commentaries are an interpretation aid on the basis of articles 31 and 32 of the Vienna Convention. Uncertainty does however exist on the basis of which of these (sub) articles the application of the commentaries is based.58 Brandstetter concludes that in cases where the model convention was followed, the parties have accepted the principles and concept underlying the OECD model tax convention, this including the commentary to the extent that no reservations were made.59 The commentaries to the model convention reflect the opinions of all the members. This then raises the question what the effect of the commentaries is to double tax treaties that are based on the model convention but where one or both of the parties are not member states. The most recent commentaries or the commentaries as they read at the time of the signing of the double tax treaty. Even though the legal status of the commentaries in the interpretation of a double tax treaty may not be clear, judges of many different jurisdictions have referred to the commentaries when interpreting existing double tax treaties.60 Therefore the commentaries are a relevant source when interpreting whether the diverted profits tax will fall within the scope of existing double tax treaties. Another question is which version of the commentaries should be consulted. The commentaries to the OECD model tax convention as they read at the time of signing the treaty or the latest commentaries? The introduction to the
56 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris,
p.14.
57 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p.
7.
58 See Baker, Double Taxation Conventions, Sweet & Maxwell 2001, E-10-E17, Marres & Wattel The legal status of
the OECD commentary, European Taxation 2003, p. 225-226 and Engelen: Interpreation of Tax Treaties under International Law, IBFD 2004, chapter 10.
59
Brandstetter, ‘Taxes Covered’: A study of article 2 of the OECD model tax convention, IBFD 2011, p. 6. Similarly: Marres & Wattel: The legal status of the OECD commentary, European Taxation 2003, p. 224.
60 Baker, Double Taxation Conventions, Sweet & Maxwell 2001, E-10 contains a numeration of relevant case law
20 2014 OECD model tax convention says that existing treaties should be as far as possible be interpreted by consulting the most recent commentary. More recent commentary is not relevant when the substance of the article has changed.61 Marres and Wattel argue that only non-substantive changes to the commentary should be consulted as a supplementary means of interpretation.62Vogel/Rust state that only the edition of the commentary which was applicable at the time of the treaty’s completion can be binding.63 Since the most recent version of the OECD model tax convention will be consulted in order to answer the central question in this chapter, where relevant the most recent version of the commentaries will be consulted as well.
3.2.3 Case law
There is only limited case law on the interpretation of article 2 of double tax conventions. It should immediately be noticed that case law from one jurisdiction generally has no legal power in other jurisdictions. Case law does however give an insight in the actual practice of article 2 of double tax treaties, and judges refer to legal cases from other jurisdictions in their judgements as well. Brandstetter endorses the view that the international law nature of the interpretation of treaties demands a cross border comparison of case law even though court decisions are not binding judges in other jurisdictions.64
In particular there are three cases on the taxes covered by article 2. The Irish Kinsella case65, and the Australian cases Virgin Holdings66 and Undershaft No 1 and 267. In these cases the companies where charged with capital gains tax, which the states argued were not covered by the existing double tax treaties. A fourth relevant case is Bricom Holdings68, a UK case on the question whether the UK CFC regime was covered by then existing double tax treaties. The judge did not come to answering the question whether the CFC regime constituted a ‘’similar tax’’.
61
OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p.15-16.
62 Marres & Wattel The legal status of the OECD commentary, European Taxation 2003, p. 235.
63 Vogel/Rust, in Reimer & Rust (eds), Klaus Vogel on Double Taxation Conventions, 4th edn (2015), Introduction
m.no. 105.
64 Brandstetter, ‘Taxes Covered’: A study of article 2 of the OECD model tax convention, IBFD 2011, p. 19-21. 65 Lorraine Kinsella and the Revenue Commissioners 31 July 2007 IEHC 250 10 ITLR 63 (Online) law.ato.gov.au. 66 Virgin Holdings SA v Federal Commissioner of Taxation 10 October 2008 FCA 1503 law.ato.gov.au.
67
Undershaft No 1 Ltd. v Federal Commissioner of Taxation and Undershaft No 2 Ltd. v Federal Commissioner of Taxation 3 February 2009 FCA 41. (online) law.ato.gov.au.
68 Bricom Holdings Ltd. v The Commissioners of Inland Revenue 25 July 1997, S.T.C. 1179 70 T.C. 272 BTC 471.
21 3.3 OECD model tax convention article 2: Taxes Covered
3.3.1 Article 2
Article 2 of the OECD model tax convention determines the scope to which taxes the model convention applies. The diverted profits tax will have to be covered by an existing tax treaty on the basis of one of the paragraphs of article 2 in order to determine which state is attributed taxation rights on the basis of one of the articles 6 to 22. In establishing whether the diverted profits tax is an income tax that falls under the tax treaty, paragraphs 1 and 2 seem of little help. Combined they describe a tax on income as a tax imposed on income or on elements of income. Paragraph 3 contains a listed of taxes that are covered by the convention and it is not likely that existing tax treaties will contain the diverted profits tax in this list. Paragraph 4 at last states that substantially similar or identical taxes are also covered by the double tax treaty. A more comprehensive elaboration of the paragraphs and the question whether the diverted profits tax is covered by the double tax treaty on the basis of the paragraph now follows.
3.3.2 Paragraph 1
Paragraph 1 defines the scope of application of the convention.69 The convention applies to taxes on income and capital gains imposed on behalf of the state or lower governments and irrespective of the manner in which the taxes are levied. The paragraph gives rise to questions such as; what is income? Can parties exclude certain taxes on income from being covered by the double tax treaty? And are all taxes on income covered by the conventions? It function could also be a contrario meaning that any tax which is not an income tax (or capital gains tax) will not be covered by the convention. For instance value added taxes and inheritance taxes. Because paragraph 2 further defines ‘taxes on income’, the test to see if the diverted profits tax is a tax on income will be carried out there.
3.3.3 Paragraph 2
Paragraph two gives a definition of taxes on income.70 The commentaries on paragraph 2 further elaborate on accessory charges to the tax such as increases and penalties and the
69
OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p. 77.
70 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p.
22 difference between ordinary and extraordinary taxes, both of which fall within the scope of the convention.71 The definition of an income tax given by paragraph 2 is: All taxes imposed on total income or on elements of income. The definition of an income tax as a tax on income does not brings us a lot closer to the question which taxes are income taxes. It does not give a closed definition on income.
In the Kinsella judgement the CGT is regarded covered under the convention on the basis of paragraph 2. It is thus possible that the diverted profits tax falls within the scope of the convention based on paragraph 2. For the diverted profits tax to fall within the scope of the convention it is irrelevant whether or not it is imposed on total income or an element of income. It is clear that the diverted profits tax is not a tax on total income. The diverted profits tax only taxes diverted profits. The diverted profits calculated on the basis of the diverted profits tax are under circumstances not ‘real’ income but only a notional amount of profits. In the Bricom Holdings case, where the relevant tax was the British CFC regime, the judge argued that merely using income or elements of income as an element to calculate a notional amount which will be taxed does not involve taxing this income itself.72 On the basis of Bricom it could be argued that the diverted profits tax is not an income tax even though the calculation of the notional amount which will be taxed is calculated with reference to (an element of) income. Almost all taxes consist of some assumptions, notional amounts or fictions. If the taxation of a notional or fictitious amount would not be covered by double tax treaties the application of tax treaties could easily be eroded by the parties. I take the view that taxes that tax a fictional income are not automatically excluded from treaty coverage.73 Even if one could argue that the diverted profits tax is not a tax on (an element of) income because a notional amount is taxed this would not rule out treaty coverage.
Given the broad definition of income under paragraphs 1 and 2 of the model convention it is not unlikely that the diverted profits tax is covered by existing tax treaties on the basis of paragraph 1 and 2. Since paragraph 4 is explicitly aimed at taxes imposed after the signature of the double tax treaties it is yet to soon to come to the conclusion that the diverted profits
71 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p.
77-78.
72
Bricom Holdings Ltd. v The Commissioners of Inland Revenue 25 July 1997, S.T.C. 1179 70 T.C. 272 BTC 471. (Online) Westlaw p5-7.
73 See Brandstetter, ‘Taxes Covered’: A study of article 2 of the OECD model tax convention, IBFD 2011, par.
23 tax is covered by existing tax treaties. Paragraph 4 is especially relevant for treaties in which article 2 only consists of paragraphs 3 and 4 of the OECD model tax convention.
3.3.4 Paragraph 3
Paragraph 3 contains an enumeration of the existing taxes to which the convention shall apply.The list is not exhaustive but serves to illustrate the preceding paragraph of the article according to the OECD Commentaries.74 The list contributes to the aim of article 2 of ensuring identification of the Contracting States’ covered taxes.75
Taxes existing at the time of concluding the treaty which qualify as a tax on income but are nonetheless omitted from the list in paragraph 3 are not automatically excluded from the application of the treaty. If a party wants to exclude a tax from the treaty this should be explicitly stated in the treaty. The non-exhaustive character of paragraph 3 combined with the broad description of the taxes covered in paragraphs 1 and 2 makes this inevitable.76 Another way to exclude an existing tax from being covered by the treaty is by excluding paragraphs 1 and 2 treaty and set up an exhaustive list containing the taxes which shall be covered.77 There is no doubt that the diverted profits tax will not be listed in existing double tax treaties drafted in either format.78 The non-exhaustive character of the list does not mean that the convention can apply to new taxes that not have been mentioned in the list because they were non-existing at the time of conclusion of the treaty. The list explicitly contains the wordings ‘’existing taxes.’’ This means that the diverted profits tax cannot fall within an existing double tax treaty on the basis of paragraph 3 in combination with the broad definition of covered taxes in paragraphs 1 and 2.
74 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p.
78.
75 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p.
77.
76 See also Brandstetter, ‘Taxes Covered’: A study of article 2 of the OECD model tax convention, IBFD 2011,
p. 5.
77 OECD, Model Tax Convention on Income and on Capital: Condensed Version 2014, OECD Publishing, Paris, p.
78. Parties will omit paragraphs 1 and 2 of the model convention. Paragraphs 3 and 4 of the model convention will take the place of paragraphs 1 and 2 in the double tax treaty.
78
Article 2 of the double tax treaty between the UK and the Netherlands is consistent with article 2 of the OECD model Convention and contains paragraph 1-4. Article 2 of the double tax treaty between the UK and the Republic of Ireland is an example of a treaty which contains an exhaustive list of the taxes covered in combination with paragraph 4 of the OECD model convention.
24 3.3.5 Paragraph 4
A new tax in addition to, or in place of, existing taxes will also be covered by an existing double tax treaty if it is identical or substantial similar to those existing taxes. The new tax will have to be a tax on income or capital gains, otherwise it is excluded by paragraph 1. Whether or not the new tax is an income tax must be tested to the definition given in paragraph 2 see 3.3.3. If paragraph 3 consists of a non-exhaustive list of existing taxes covered by the treaty the obvious starting point is to compare the diverted profits tax to these taxes. Given the non-exhaustive character of the list the diverted profits tax may also be similar to other existing taxes which are covered by the convention (or not explicitly excluded) but not listed, which can also result in the diverted profits tax being covered.
The existing taxes to which the diverted profits tax should be compared are not limited to those listed in paragraph 3. Lang states that even though paragraph 4 seems to refer to the taxes listed in paragraph 3, this does not mean that a new tax may fall under the treaty only if a similar tax was already levied. Even if a tax is not similar to the taxes listed in paragraph 3, a tax might fall within the scope of the treaty.79 In Kinsella the judge carries out an exercise derived from Klaus Vogel’s Double Taxation Conventions.80The new tax should be considered with reference to all types of taxes historically developed within the state. The Judge notes that the CGT and the CT and Income tax are part of the same legislation (1997 act). The CGT is computed in a different way than the other taxes in the 1997 act but the judge sees substantial similarities. Logical reasons can justify the legislator’s choice to tax capital gains in a different way than (other) (corporate) income.
If we do want to compare the diverted profits tax to one of the taxes generally listed in paragraph 3 of double tax treaties, the most obvious tax to compare to the diverted profits tax is Corporation Tax.81 The diverted profits tax is a tax on diverted profits of companies and a Corporation tax generally taxes the income of corporations. Persons income taxes and capital gains taxes are far less similar to the diverted profits tax. The first taxes persons while the
79 Lang, “Taxes Covered” – What is a “Tax” according to Article 2 of the OECD Model?, Tax Treaty Monitor
(2005) (IBFD online) p.221.
80 Lorraine Kinsella and the Revenue Commissioners 31 July 2007 IEHC 250 10 ITLR 63 (Online) law.ato.gov.au p.
8-9.
81 The list in the OECD model convention is obviously blank because it is up to the parties to a double tax
convention to list the existing taxes they ought covered by the treaty. The UK generally lists the income tax, corporation tax, petroleum revenue tax and capital gains tax.
25 diverted profits tax taxes corporations and the latter taxes the capital gains where the diverted profits tax taxes diverted profits.
The diverted profits tax aim is to impose a charge on profits relating to UK revenue that, as a result of artificial arrangements, have been diverted from constituting a UK tax base for corporation tax. Had the artificial arrangements not been in place, the same profits (or at least the profits relating to the revenue) would have been charged with corporation tax in the UK. It can thus be said that a corporation tax and the diverted profits tax share a common tax base. Also, the company confronted with a charge to diverted profits tax has the option to include the profits in a corporation tax assessment.82 A very substantial element of a tax is its tax base. Because the diverted profits tax’s tax base can also be taxed with corporation tax there is a substantial similarity. In Virgin Holdings the Judge argues that if the tax to which the new tax is being compared to, depending on circumstances and time taxes the same object (in that case capital gains), the more readily will a conclusion of substantial similarity be reached.83
There are of course differences between the diverted profits tax and a corporation tax. A difference between the diverted profits tax and the UK corporation tax is the way of imposing a charge (self-assessment v. a charging notice). Other differences are the penalties and the possibilities to challenge a charge. These procedural differences should not withhold the conclusion that taxes are substantially similar. Paragraph 1 explicitly states that taxes on income should be covered by the convention irrespective of the manner in which they are levied.84 Another difference between the corporation tax and the diverted profits tax are the tax rates (20% and 25% respectively). In my opinion tax rates are irrelevant because of three reasons. First, a tax which is covered by the double tax treaty can apply different tax rates in the case of progressive taxes. Second, the tax rate of a tax that is covered by the double tax treaty can change, in which case the similarity of a new tax would depend on the modifications of an existing tax. Third, different tax rates would not be such a substantial difference that speaking of a substantial similarity is ruled out.
Another difference between the diverted profits taxes and corporation tax is that where corporation tax generally applies to most corporations, the diverted profits tax only applies to
82
Finance Act 2015, s 83(3).
83 Virgin Holdings SA v Federal Commissioner of Taxation 10 October 2008 FCA 1503 law.ato.gov.au. p 56. 84 Commentaries elaborate: ‘’The method of levying is equally immaterial: by direct assessment or by deduction at
26 a limited group of corporation as a result of the exemptions for SME’s and companies with limited UK related revenue and expenses. It should be noted that other taxes also contain provisions which only apply to certain persons or companies under certain circumstances. The relatively limited scope of the diverted profits tax as a result of the possible tax subjects and the limited tax object; diverted profits, is not such a substantial difference compared to other taxes that any substantial similarity is ruled out.
I would say that the diverted profits tax is a substantially similar tax to the corporation tax, since there is a substantially similarity in the tax base and the taxable persons. The differences between the diverted profits tax and a corporation tax are not such that a substantial similarity between the two is ruled out. Corporation tax is generally a tax covered by taxation treaties, either explicitly listed in paragraph 3 or otherwise on the basis of paragraphs 1 and 2 because it is without doubt a tax on income. The Diverted profits tax is therefore covered by existing double tax treaties on the basis of paragraph 4.
3.3.6 Conclusion
Article 2 of double tax treaties based on the OECD model tax convention regulates to which taxes the double tax treaty applies. Paragraph 4 aims to bring a tax imposed after the signing of the treaty under the application of the treaty if the tax is substantially similar to an existing tax that is already covered by the treaty. The diverted profits tax is substantially similar to corporation tax and should thus be covered by double tax treaties on the basis of article 2. This does not mean that the diverted profits tax would not survive a challenge to double tax treaties. There are further implications which will be discussed in the following paragraph.
3.4 Further implications for an appeal to double tax treaties. 3.4.1 UK Law
Under UK law, tax treaties do not have direct effect. The limitation on direct effect of double tax treaties under UK law is not a problem inherent to the diverted profits tax. Other taxes might likewise be not effectively covered by double tax treaties. Neidle elaborates on this aspect of the diverted profits tax and its relationship to double tax treaties.85 The lack of
27 direct effect means that a tax payer can only claim the benefits of the double tax treaty if the effects have been incorporated in domestic law. TIOPA 2010 section 6 gives effect to double tax treaties regarding limited UK taxes. The Corporation tax is one of the taxes covered; the diverted profits tax is not. Even if the diverted profits tax falls within the scope of existing UK tax treaties a UK resident can thus not claim the benefits regarding diverted profits tax. A non-UK resident might be able to directly claim the benefits of the tax treaty but will have to rely on outcome of a mutual agreement procedure between his state of residence and the UK. It is unlikely that the UK will agree with allowing benefits regarding diverted profits tax to non-UK residents in a mutual agreement procedure with the other state.
3.4.2 Treaty override
Not granting the tax treaty benefits with an appeal to TIOPA 2010, while the diverted profits tax is covered by double taxation treaties can be regarded as treaty override. A treaty override cannot generally be justified with an appeal to combatting treaty abuse.86 A treaty override does not provide a ground to challenge the legislation to the taxpayer. It is up to the other State that is party to the double tax treaty act against the treaty override.87 It is at this point to soon to establish a treaty override by the UK regarding the diverted profits tax. Other than a general justification of treaty override based on combating tax avoidance, this nature of the legislation might entail that the UK rightfully denies treaty access in the way that no treaty benefits should be granted. In that case there would not be a treaty override.
3.4.3 OECD commentary
In the parliamentary debate on the diverted profits tax held on 7 January 2015 questions were asked about the compatibility with the diverted profits tax and existing UK tax treaties.88 The minister responded to these questions by referring to the limited scope of UK tax treaties under national law (see par. 3.4.1), and the OECD commentaries.89 According to the minister, states can deny treaty benefits where arrangements have a main purpose of securing more favourable tax treatment in circumstances contrary to the object and purpose of that treaty.
86 Vogel/Rust, in Reimer & Rust (eds), Klaus Vogel on Double Taxation Conventions, 4th edn (2015), Introduction
m.no. 156-156.
87 Vienna Convention Article 60.
88 HC Deb 7 January 2015, vol 590, col 82 WH. 89 HC Deb 7 January 2015, vol 590, col 100 WH.
