In our fourth part in a series of Insights looking at key international tax issues for multinational entities (MNEs) in the Tech, Media & Communications sector, we explore anti-avoidance measures used and being introduced by Tax Authorities to limit tax avoidance by MNEs which have a particular focus on IP rich companies, such as the UK's offshore receipts in respect of intangible property and profit fragmentation.
To read the other parts in the series, please click on the following links:
- Part One looks at recent and forthcoming VAT changes
- Part Two looks at tax incentives
- Part Three looks at the debate around profit attribution for tax purposes to digital business
- Part Five looks at the practical issues that arise from the evolving international tax landscape
Tax avoidance rules
Following BEPS, the EU adopted a number of binding anti-avoidance rules in its Anti-Tax Avoidance Directive (ATAD) and a further directive relating to hybrid structures known as ATAD 2. These rules have the effect of imposing minimum standards in the EU for various anti-avoidance rules, including controlled foreign company rules and debt interest limitation rules and introducing a general anti-avoidance rule in the EU.
The anti-hybrid rules in ATAD 2 are also designed to prevent structures seeking a double tax deduction for the same expense or a tax deduction with no taxable inclusion of the same income, through the use of hybrid entities (for example, an entity that is treated as a company in one jurisdiction and a partnership in another) or hybrid instruments (treated as debt in one jurisdiction and equity in the other).
These changes have further restricted the ability of IP-rich multinationals to obtain tax advantages by holding and licensing IP rights.
As the UK already had relatively sophisticated anti-avoidance rules, the impact of ATAD has mainly been to tighten up its anti-hybrid rules. However, separately to the BEPS and ATAD processes, the UK introduced a diverted profits tax (DPT) which is similar in target to the US BEAT and was introduced to counter MNEs diverting profits from the UK to overseas entities lacking substance or avoiding a PE in the UK and thereby reducing their UK corporation tax liability. DPT applies at a rate of 25% (which is higher than the current UK corporation tax rate of 19%). DPT does not apply to small or medium-sized enterprises and has de minimis thresholds so is often not applicable to our smaller clients.
The Netherlands also has specific rules integrated in its corporate income tax system to target similar cases to those at which the DPT is aimed. These rules generally apply to ensure that income of overseas entities in low tax jurisdictions (which levy tax at a statutory rate of less than 9%) is subject to Dutch corporate income tax (for example as a consequence of Dutch controlled foreign company rules that attribute such income of overseas entities to the Dutch taxpayer controlling this entity). There are various specific rules incorporated in the Dutch corporate income tax system with various exclusions.
Offshore receipts in respect of intangible property (ORIP) is another rule that the UK has introduced. It applies from 1 April 2019 where at any time in a tax year a person who is, effectively, resident in a tax haven has earnings derived from Intellectual Property rights where the exercise of those rights facilitates directly or indirectly UK sales.
ORIP is a 20% tax on these sales and can be enforced against group companies in the UK. There is a £10 million de minimis such that if UK sales of the group are less than this the rules do not apply. Although there are various exclusions to the ORIP rules, they can apply harshly – we have seen examples where despite the income ultimately being taxed in the UK in any event, ORIP can apply in addition to UK tax.
Conditional withholding tax
The Netherlands introduced from 1 January 2021, a conditional withholding tax on interest and royalty payments made to related entities in low tax jurisdictions or jurisdictions included on the EU list of non-cooperative jurisdictions, in each case as listed on a Dutch ministerial decree. The withholding tax also applies in "abusive situations", where two cumulative tests are met. These tests require detailed analysis of the interest/royalty payments made to entities lacking substance within the tax structure as well as an analysis of hypothetical interest/royalty payments made to a chain of entities within the tax structure. Having operational business substance at the right level of the entities within the tax structure, prevents most of the Dutch analysis for abusive situations and provides a more robust tax structure. The rate of the tax is equal to the highest Dutch corporate income tax rate in the concerning year, namely 21.7% (2021 rate).
Another new set of UK rules which applies from 1 April 2019 counters arrangements under which profits are moved outside the UK and are taxed at less than 80% of the UK rate. This involves there being a transfer of value and the main purpose (or one of the main purposes) of the arrangements being to secure a tax advantage. Unlike transfer pricing rules, there is no exemption for small and medium-sized enterprises.
Various rules, both tax and non-tax have been introduced to increase transparency on tax matters. As well as country-by-country reporting (as mentioned in Part Three), there has been the introduction of FATCA in the US. This has been followed by the "common reporting standard" which has been developed by the OECD, under which payments between financial institutions have to be reported and the information exchanged between tax authorities.
The EU has also issued a blacklist of non-cooperating countries. Being on that list can give rise to increased audit risks and also impact local tax rules as they apply to that jurisdiction such as controlled foreign company rules, non-deductibility of payments to that country or, as we have seen above in respect of the Netherlands, withholding tax obligations.
Another initiative is to report in advance certain tax schemes. We have had this in the UK for a while under "DOTAS" rules. An EU equivalent, called DAC6, has been introduced across the EU (and, in part, in the UK), which significantly widens the rules where there are cross border activities. Notably where transfer pricing rules apply to "hard to value intangibles", DAC6 in the EU can have the effect of having to notify the structure to the local tax authorities irrespective of whether there is a tax avoidance motive. For more information on DAC6 please see our Insight here.
On 3 July 2020 the OECD published a model set of rules for reporting by digital platforms involved in the sharing and gig economy which it is expected jurisdictions will implement in due course. Under these rules digital platforms would be required to collect information on the income realised by those offering accommodation, transport and personal services through platforms and to report the information to tax authorities.
Osborne Clarke comment
Given the rise in reach of MNEs in the TMC sector it is important to know when arrangements in which your business is involved are within the scope of reporting to tax authorities. We can help you understand how your business operations fit into the tax landscape and ensure that your business maximises its potential growth.