Policy paper

Profit fragmentation

Published 6 July 2018

Who is likely to be affected

Individuals who carry on a trade or profession within the charge to UK taxation, as a sole trader, in partnership, or through a company (in the last case it is likely that the company will be closely held). This will only apply where arrangements are in place such that value is transferred from a UK trader to an offshore entity.

General description of the measure

From April 2019, this targeted legislation aims to prevent UK traders and professionals from avoiding UK tax by arranging for their UK-taxable business profits to accrue to entities resident in territories where significantly lower tax is paid than in the UK. The counteraction will be effected by adding those profits to the profits of the UK trade.

This measure will also introduce a duty to notify HMRC of relevant arrangements meeting certain criteria.

Policy objective

The aim of the measure will be to ensure that the amount of profit that should be taxable in the UK is fully taxed in the UK.

Background to the measure

This measure was announced at Autumn Budget 2017. A consultation document was published on 10 April 2018. The consultation closed on 8 June 2018.

The draft legislation and a response document were published on 6 July 2018. This will be followed by a period of technical consultation before the legislation is introduced in Finance Bill 2018-19.

Detailed proposal

Operative date

The measure will have effect from 1 April 2019 onwards for Corporation Tax and 6 April 2019 for Income Tax and Class 4 National Insurance contributions, and will apply to all profits diverted on or after that date.

Current law

Current law is contained in Part 2 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA) and Part 3 of the Corporation Tax Act 2009 (CTA 2009). These contain the main charging provisions for the taxation of profits of a trade.

Section 6 of ITTOIA deals with the territorial scope of Income Tax. Profits of a trade arising to a UK resident are chargeable to UK tax wherever the trade is carried on. Profits of a trade of dealing in or developing UK land arising to a non-UK resident are chargeable to UK tax wherever the trade is carried on. Profits of a trade arising to a non-UK resident are chargeable to UK tax only if they arise:

• from a trade carried on wholly in the UK
• in the case of a trade carried on partly in the UK and partly elsewhere, from the part of the trade carried on in the UK

Section 5 of CTA 2009 deals with the territorial scope of Corporation Tax. A UK resident company is chargeable to Corporation Tax on all its profits wherever arising. A non-UK resident company is within the charge to Corporation Tax only if:

• it carries on a trade of dealing in or developing UK land
• it carries on a trade in the UK through a permanent establishment in the UK

A non-UK resident company which carries on a trade in the UK through a permanent establishment in the UK is chargeable to Corporation Tax on its profits that are chargeable profits as defined in section 19 of CTA 2009 (profits attributable to its permanent establishment in the UK).

Legislation in Part 13 of the Income Tax Act 2007 (Transfer of assets abroad) charges Income Tax on a person who makes a relevant transfer where certain further conditions apply. This legislation may apply to some of the arrangements or to some parts of the arrangements that will be affected by this measure.

Proposed revisions

Targeted Legislation

Legislation will be introduced in Finance Bill 2018-19 which will consider whether certain conditions are present as follows:

• there must be a transfer of value from the UK trader to an offshore entity - this could be a diversion of income to the offshore entity, or payment of expenses to the offshore entity
• the effect of the arrangement must be that a significantly lower level of tax is paid on the profits than would be the case if they were correctly taxed in the UK in accordance with the current law
• the proprietor of the business, whether a sole trader or partner in an unincorporated business, or as director and/or shareholder of a company must be able to enjoy the profits that have been diverted
• the UK person must have arranged for the profits to be diverted to the offshore entity
• the diversion or payments mentioned in the first condition are not commensurate with the work undertaken by the offshore entity

Where these conditions are present the arrangement is to be counteracted by bringing the profits back into UK tax by attributing the correct amount of profits to the UK-taxable source.  

Notification of Arrangements

A person will be required to notify HMRC on their tax return if the first 4 conditions set out above apply to their arrangements but they have not made the necessary adjustments to profits in accordance with the legislation. Notification will be required on or before the time that the relevant person is required to submit their tax return for the relevant period.

Summary of impacts

Exchequer impact (£m)

2017 to 2018	2018 to 2019	2019 to 2020	2020 to 2021	2021 to 2022	2022 to 2023

The final costing will be subject to scrutiny by the Office for Budget Responsibility and will be set out at Budget 2018.

Economic impact

This measure is not expected to have any significant macroeconomic impacts.

Impact on individuals, households and families

This measure is likely to affect approximately 10,000 wealthy individuals many of whom will need to consider notification but may not face counteraction under these new rules.

This measure has no impact on individuals and households as it only affects sole traders, partnerships and companies who are in business.

The measure is not expected to impact on family formation, stability or breakdown.

Equalities impacts

It is not anticipated that there will be any particular impacts on groups sharing protected characteristics.

Impact on business including civil society organisations

This measure is expected to have a negligible impact on businesses and civil society organisations who are undertaking normal commercial transactions, who will need to familiarise themselves with the changes and may, in some circumstances, need to notify HMRC. The measure is focussed on the businesses that are avoiding tax by arranging for their UK business profits to accrue to entities resident in territories where no tax, or only a low rate of tax, is paid.

Operational impact (£m) (HMRC or other)

There are anticipated to be both IT and operational impacts from this proposal for HMRC. These have yet to be determined.

Other impacts

Other impacts have been considered and none have been identified.

Monitoring and evaluation

The measure will be monitored through information collected from tax returns and receipts.

Further advice

If you have any questions about this change, please contact Chris Stewart by telephone: 03000 519402 or email: profitfragmentation.mailbox@hmrc.gsi.gov.uk.