Following the autumn 2017 Budget announcement, the UK Government has launched a consultation looking at extending the circumstances in which royalties and other types of payments made to non-UK residents have a liability to UK income tax. The consultation is particularly significant as it could herald the first major shift away from the UK’s traditional ‘source’ based system of taxation and could signal the start of a whole new approach to taxation for a global, digital world.
The proposal is aimed at preventing tax avoidance, particularly the types of high profile international arrangements that have caused certain tech giants to be the subject of great media scrutiny. However, the scope of the new rules will not be sector specific: all businesses operating in the Life Sciences sector, for whom royalty taxation is clearly an issue, will, therefore, need to understand the impact that any changes might have.
The proposed rules will target payments made to a connected party in low or no tax jurisdictions. However, as with the implementation of most other anti-avoidance measures, the rules will inevitably cause uncertainty in relation to genuinely commercial transactions (particularly as the consultation notes that the Government is considering whether there are any circumstances in which the rules should apply to payments between unrelated parties).
The consultation follows rules introduced in 2016 that both extended the type of payments and the range of underlying intellectual property (IP) to which royalty withholding tax could be applied. The 2016 changes also made clear that a royalty payment made by a non-UK resident company’s UK branch or other ‘permanent establishment’ (PE) would attract UK withholding tax. However, those changes did nothing to alter the traditional UK direct tax model under which a company is not subject to UK direct taxation in respect of sales to UK customers unless it is UK tax resident or has a PE in the UK.
The current proposals would impose a UK withholding tax obligation where the entity making the royalty payment has no presence in the UK but simply makes sales to UK customers. To illustrate with a practical example, the withholding tax obligation would apply where an online business resident outside the UK (Seller Co) uses IP owned by its connected group company based in a low tax jurisdiction (IP Co) and Seller Co makes online sales (using the underlying group IP) to UK customers. Under the current proposal, Seller Co would be liable to tax on those sales to UK customers unless IP Co’s country of residence has a double tax treaty with the UK which has an appropriate non-discrimination clause. Essentially, what constitutes ‘taxable UK source income’ is being significantly extended to cover (in certain circumstances) payments that allow businesses to exploit IP rights in the UK.
There are a number of difficulties with the proposal, not least the collection and enforcement mechanism and the practicalities of working out what proportion of total UK sales are derived from the exploitation of the IP owned in the low tax jurisdiction. The consultation is looking in detail at these issues but one suggestion on enforcement and collection is that any related party of Seller Co would be jointly and severally liable to pay the tax.
The consultation closes on 23 February 2018. The Government aims to introduce legislation in the Finance Bill 2018-19 with the intention that changes will have effect from April 2019. This is a very interesting development and, when read in light of the Government’s position paper on Corporate Tax and the Digital Economy (and OECD publications on the same topic), is a strong indication of the fundamental changes to traditional tax concepts that are on the horizon.