Offshore IP owners beware! More rules to tax UK-generated value could result in multiple tax charges
HMRC is apparently not satisfied with the range of tools now at its disposal to impose UK tax on the value generated from the UK using intangible property (IP) that is held offshore (including in particular transfer pricing, diverted profits tax (DPT) and withholding tax on payments made to non-UK IP owners for the use of or right to use IP). As a result, draft legislation was published in the Finance (No. 3) Bill 2018 (the Finance Bill) to extend the income tax rules to catch “offshore receipts in respect of intangible property”.
The measure was originally designed as an extension to the withholding tax regime, but following consultation has been recast as a direct income tax charge. The charge will be imposed on “UK-derived amounts” exceeding £10m that arise in any relevant tax year to persons that are not resident in a “full treaty territory” (i.e. one with which the UK has a double tax treaty containing a non-discrimination provision).
The rules are intended to catch large multinational groups holding IP in low tax jurisdictions, to the extent the income that arises in relation to that IP is referable to the sale of goods or services in the UK. They are deliberately broad, “to reflect the diverse and complex nature” of the different arrangements that are intended to be within scope, and “the importance of ensuring that the legislation is robust against tax-motivated changes to groups’ behaviour”. They also include a targeted anti-avoidance rule which applies from the date of announcement (29 October 2018) to prevent groups restructuring so that the rules do not apply.
However, as currently drafted, the rules could potentially result in multinational groups being subject to multiple layers of tax on the same arrangements.
Take a fairly common structure (depicted below) where IP is owned in a low-tax offshore jurisdiction, licensed to a manufacturer in another (non-UK) jurisdiction, and then sub-licensed to a limited risk distributor in the UK (typically on a royalty-free basis) to enable it to sell products containing the IP to UK customers. The limited risk distributor retains a percentage of the UK sales and pays the rest to the manufacturer for the goods in question. The manufacturer in turn retains a margin and pays the rest on to the IP owner by way of royalty for use of the IP.
- Subject to the exemptions:
- the amounts received by the IP owner from this supply chain are clearly the intended target of the proposed rules and would fall squarely within the definition of “UK-derived amounts”; and
- the amounts received by the manufacturer should not be caught, as they are payments for goods, not for the enjoyment or exercise of IP rights (the IP being sub-licensed by the manufacturer on a royalty-free basis).
- However, if the manufacturer in this structure were instead a sales company, which sub-licensed the IP outside the group to an unrelated manufacturer, there could easily be two layers of royalty payments in the structure that would both constitute “UK-derived amounts”. (Indeed, this is Example 7 in Annexe B to the Summary of Responses to HMRC’s consultation on the originally proposed royalty withholding tax, published on 29 October 2018.) There are no rules preventing that result, since the tax is levied on gross income rather than profit.
- There are exemptions for recipients otherwise falling within the scope of the rules if (broadly) the IP is created or developed in its territory of residence, or if the amount of tax paid locally in respect of the UK-derived amounts is at least 50% of the corresponding UK tax.
- The exemption where foreign tax is at least half of UK tax could in theory operate to remove one of the layers of income tax (perhaps at the sales company level, assuming it was not resident in a treaty jurisdiction and so outside the scope of the rules), although of course the relevant amounts would still be subject to the local tax.
- But the exemption is only available if the local tax amount is not determined under “designer tax provisions” – which are those that “appear” to HMRC (note the absence of any reasonableness requirement here) to be designed to enable persons to exercise significant control over the amount of tax which they pay in respect of UK-derived amounts. Similar concepts are used in the CFC rules to determine whether the tax exemption applies, and in that context regulations have been made specifying those provisions of certain non-UK territories that would fall within the definition of “designer rate tax provisions”. The Finance Bill does not include any regulation-making power in relation to the offshore receipts rules, so it is unlikely that similar statutory guidance will be available in this case. Although one would hope that HMRC interpret the “designer tax provisions” concept in the same way as they do for CFC purposes, on the face of the legislation HMRC have largely unfettered discretion to prevent the exemption from applying.
Royalty withholding tax
- A further aspect here is the potential overlap with the new(ish) rules for withholding from payments of royalties, or other payments for the use of or right to use intellectual property, to owners of that intellectual property situated outside the UK that are subject to income tax or corporation tax (section 906 ITA 2007, as amended by FA 2016). If a payment falls within those rules, the person by or through whom the payment is made must withhold from it on account of UK income tax. If UK-derived amounts also represent payments within the scope of the royalty withholding rules, overlapping amounts could in theory be within the scope of both a direct income tax charge and withholding on account of income tax.
- There are no express provisions in the draft legislation addressing the interaction or priority between these different sets of rules to make it clear that the amounts in question should only be subjected to a single dose of income tax. However, that should be the effect of section 848 ITA 2007 read with section 59B TMA 1970 – any amounts withheld from a payment under Part 15 ITA 2007, including pursuant to the royalty withholding tax rules, are treated as income tax paid by the recipient and, to that extent of the recipient’s income tax liability, no further payment obligation arises. (That would also be consistent with the indication given in the Summary of Responses to the earlier consultation that double taxation relief would be available where the same income had already been subjected to UK income tax.)
- In the scenario above it may be fairly straightforward to conclude that the royalties paid by the manufacturer to the IP owner are in principle subject to both royalty withholding tax and income tax under the offshore receipts rules, with the result that the withholding would effectively discharge the IP owner’s income tax liability under the offshore receipts regime. That may not always be the case though, because “UK-derived amounts” could potentially catch more than just the kinds of payments that are subject to royalty withholding tax. It is therefore possible that amounts received by an IP owner could be only partially subject to royalty withholding tax, leaving the recipient with liability for a top-up payment.
- Then of course there is DPT to consider. Broadly speaking, whether DPT under section 80 FA 2015 applies is likely to come down to whether the UK limited risk distributor is regarded as sufficiently remunerated for its activities. If not, or if HMRC consider that (it is reasonable to assume that) the arrangements would have been structured differently absent tax, some of the UK-derived amounts that would under the new proposals be subject to income tax in the hands of the IP owner could also be brought into the UK tax net via a DPT charge on the limited risk distributor.
- While the Finance Bill includes provisions making it clear that a taxpayer is not to be subjected to both DPT and corporation tax in respect of the same profits, this presents a slightly different variation of double taxation involving two different taxpayers within the same group (in circumstances where the UK limited risk distributor is likely to be a “relevant person” from whom the income tax levied on the non-UK resident can be collected in the event of non-payment).
- If the manufacturer (as a “foreign company”) sold goods into the UK directly in the course of its trade, DPT under section 86 FA 2015 would be in point if an avoided PE carried on activity in the UK in connection with those sales. In that scenario, the “diverted profits” of the manufacturer would include the royalties that the manufacturer paid to the IP owner in connection with its trade, to the extent those payments are not subject to royalty withholding tax.
- The Finance Bill does not include any carve-out from a section 86 DPT charge for royalties paid to an offshore IP owner that are otherwise subject to income tax in its hands, by virtue of the new offshore receipts rules. Again, therefore, a double dose of tax could be imposed on the same amounts: DPT on the manufacturer and income tax on the IP owner.
Digital services tax
- While the proposed digital services tax is still being consulted on, its clear focus is on revenues facilitated by UK users – which could include payments for the use of IP rights, particularly in the case of subscription fees for the use of online marketplaces. In a group context, this may end up adding yet another layer of potential tax on essentially the same revenues.
The danger of introducing revenue-based taxes alongside those calculated by reference to profits is that multiple layers of tax may potentially be imposed by reference to the same amounts. To avoid this here, it will be necessary to give due consideration to the way in which the proposed new income tax charge interacts with other parts of the tax code. We can only hope that the issues with the current proposals will be addressed prior to enactment, and that this third attempt to ensure that the UK tax net catches value generated from the UK by IP held offshore will be the last.