Deduction of income tax at source: tax avoidance

Finance Bill – in a Public Bill Committee am 3:00 pm ar 30 Mehefin 2016.

Danfonwch hysbysiad imi am ddadleuon fel hyn

Photo of David Gauke David Gauke The Financial Secretary to the Treasury 3:00, 30 Mehefin 2016

I beg to move amendment 20, in clause 40, page 80, leave out lines 33 to 39 and insert—

““intellectual property royalty payment” means a payment referred to in section 906(2)(a) or (3)(a);”.

With this it will be convenient to discuss the following:

Government amendment 21.

Clause stand part.

Government new clause 7—Receipts from intellectual property: diverted profits tax.

Government new clause 8—Deduction of income tax at source: intellectual property.

Government new clause 9—Receipts from intellectual property: territorial scope.

Photo of David Gauke David Gauke The Financial Secretary to the Treasury

For the benefit of the Committee, I will discuss clause 40 together with new clauses 7 to 9, as they collectively implement the royalty withholding tax policy that the Government announced at Budget 2016.

Together with the new clauses, clause 40 strengthens our regime for the deduction of income tax at source from payments of royalties overseas. It introduces a rule to prevent the abuse of the UK’s tax treaties. It will prevent multinational enterprises using conduit arrangements and other schemes to exploit the provisions of tax treaties to avoid UK taxes on royalties.

New clause 8 broadens the categories of royalties from which tax must be deducted at source in the UK when they are paid abroad. Going forward, all payments considered to be royalties under internationally recognised criteria will be subject to withholding tax in the UK unless a specific exemption applies.

Mr Speaker—sorry, Mr Howarth.

I am sure that there will be lots of changes of personnel over the next few days, but I can assure the Minister that that will not be one of them.

Photo of David Gauke David Gauke The Financial Secretary to the Treasury

Thank you, Mr Howarth, although such is the fast-moving nature of British politics at the moment that who knows?

New clause 9 introduces rules to ensure that royalties paid by non-residents have a UK tax charge if they are paid in connection with a trade carried on in the UK through a permanent establishment. New clause 7 introduces consequential changes to the diverted profits tax to ensure that no advantages accrue to entities within its charge as a result of the changes I have described.

Taken together, the clauses mean that all payments of royalties from the UK will now be subject to withholding tax, unless we have explicitly given up our taxing rights under an international agreement or domestic law. The new regime will provide a robust defence against those wishing to use royalty payments to shift profits to jurisdictions where there is little, if any, taxation.

Most countries tax non-residents on royalties that arise in that country. They generally require the payer of the royalty to withhold tax from the payment and account for it to the tax authorities. The UK is no exception to this practice. The withholding requirement is subject to tax treaties, of which the UK has more than 120, and the EU interest and royalties directive. Many of those treaties provide that royalties are taxable only in the country where the royalty payment is received. The Government think that that is an appropriate treatment, as it removes tax obstacles from cross-border investment and provision of services.

However, the UK gives up its taxing rights under tax treaties only in the expectation that the royalties will be paid for the benefit of a resident of a treaty partner country. It is a frustration, and not the intention of a tax treaty, that a person resident in a third country can use a bilateral tax treaty with the UK to extract tax-free royalties from the UK, especially if no tax is paid on the receipt and no substantive activity is taking place in that third country.

It has become increasingly prevalent for multinational groups to derive large sums from the exploitation of intellectual property and cross-border royalty payments. The need to ensure that they are taxed appropriately is more important than ever. Some multinational groups have put in place arrangements under which intellectual property is held in jurisdictions where no tax is paid and no substantive activity takes place. They structure the payments of royalties to such companies in a way that takes advantage of the UK’s tax treaties with other countries, depriving the UK—the country in which the royalty arises from sales or other activity—of the right to tax. Had the royalty been paid direct to that ultimate jurisdiction, the UK would have retained its taxing rights on the basis that there was no treaty in place between the UK and that jurisdiction.

For that reason, many tax treaties in the EU interest and royalties directive contain anti-abuse provisions to prevent so-called treaty shopping and other abuses by third country residents. The OECD has recognised such abuses as a problem and, as part of its recent work to counter base erosion and profit shifting, has recommended that countries adopt regimes, either in their tax treaties or in domestic law, to counter such treaty shopping.

Not all of the UK’s tax treaties contain anti-abuse provisions that frustrate treaty shopping arrangements and other abuses. The Government have therefore introduced a targeted domestic anti-abuse rule based on the rule recommended by the OECD and aimed at royalty payments between related parties that seek to take advantage of the UK’s tax treaties. The rule took effect for royalties paid on or after 17 March 2016. As part of this approach to tackling tax avoidance, new clause 8 will bring the definition of royalties on which non-residents are required to withhold tax into line with the OECD definition of royalties used in tax treaties. At present, payments for the right to use trade names and trademarks are subject to UK withholding tax only if they are annual payments. New clause 8 will ensure that all such payments will be subject to withholding tax.

The third part of the Government’s reform, which goes hand in hand with the anti-abuse element introduced by clause 40, is to change what is meant by royalties arising in the UK—that is, to define whether they come from a source in the UK. At present, there is no statutory definition of what constitutes a UK source for royalties. As a result, it is not clear that all royalty payments connected to a permanent establishment that a non-resident has in the UK have a UK source. New clause 9 will introduce a new rule to ensure that all royalties have a UK source where the payment is connected with activities taking place through a permanent establishment that the payer has in the UK. Royalties paid by a non-resident to another non-resident that are connected to a UK permanent establishment of the payer will now be taxable in the UK, and the non-resident payer will be expected to withhold tax and account for it to Her Majesty’s Revenue and Customs.

However, where there is a tax treaty between the UK and the country of residence of the beneficial owner, that treaty will govern the taxation of the payment. Where that treaty follows the OECD model and the anti-abuse rule does not apply, the taxation rights will continue to belong exclusively to that other country. New clause 7 is being introduced to ensure equal treatment between cases where a non-resident company maintains an actual permanent establishment in the UK, and cases where a person has contrived to avoid a taxable presence in the UK in circumstances that bring them within the diverted profits tax.

The changes made by the clauses are fairly simple. Clause 40 inserts a rule that denies the benefit of a tax treaty in the face of abuse. New clauses 8 and 9 extend the definition and territorial scope of royalty payments within the charge to tax in the UK. Finally, new clause 7 amends the diverted profits tax to ensure that entities within the scope of that tax are subject to the changes being made. The changes bring the UK into line with accepted international practice in respect of the taxation of royalty income arising in a state. The benefits of tax treaties and the interest and royalties directive will remain available, except where taxpayers have entered into transactions internationally recognised as abusive.

Before I conclude, I will speak briefly to amendments 20 and 21, also tabled by the Government. The amendments are being introduced to ensure that royalty payments subject to the anti-abuse rule include those payments brought within the scope of withholding tax by new clause 8. Together, the proposed new clauses will protect the UK from arrangements that seek to avoid UK tax through the use of royalty payments.

I hope that my explanation helps the Committee to understand the issues set out both on the odd-numbered pages and on the even-numbered pages.

Amendment 20 agreed to.

Amendment made: 21, in clause 40, page 81, line 12, at end insert—

‘(3) In relation to payments made (under any such arrangements) on or after 17 March 2016 and on or before the day on which this Act is passed, section 917A of ITA 2007 as

““intellectual property royalty payment” means—

(a) a payment of a royalty or other sum in respect of the use of a patent,

(b) a payment specified in section 906(1)(a) (as originally enacted), or

(c) a payment which is a “qualifying annual payment” for the purposes of Chapter 6 by virtue of section 899(3)(a)(ii) (royalties etc from intellectual property);”.

(4) In relation to payments made (under any such arrangements) on or after 28 June 2016 and on or before the day on which this Act is passed, section 917A of ITA 2007 as inserted by subsection (1) has effect as if “intellectual property royalty payment” also included (so far as it would not otherwise do so) any payments referred to in section 906(2)(a) or (3)(a) of ITA 2007 as substituted by section (deduction of income tax at source: intellectual property).’—

Clause 40, as amended, ordered to stand part of the Bill.

Clause 45