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HMRC internal manual

Banking Manual

Banking surcharge: application to diverted profits tax – notional banking surcharge profits example

Example

UK Bank Co is a UK resident member of a worldwide banking group.  Its profits are subject to the banking surcharge.  A team in one of its lines of business develops a potentially highly profitable financial asset.  However rather than receive for itself the income stream that will derive from the asset, UK Bank Co enters into a complex set of contrived arrangements involving other group companies so that the financial asset, the associated income and most of the profit from it are contractually allocated to LCT Bank Co, which is subject to a much lower rate of tax.

A DPT analysis considering the potential application of FA15/S80 includes the following:

  • UK Bank Co and LCT Bank Co are wholly owned by WW Bank Co, so the participation condition is met.
  • The material provision between UK Bank Co and LCT Bank Co has been made by means of a series of transactions through which LCT Bank Co owns and receives most of the profits from the financial asset and UK Bank Co receives a fee for services provided.
  • This material provision results in an effective tax mismatch outcome for the accounting period, in relation to a reduction of income of UK Bank Co which would otherwise have been taken into account in computing its liability to a relevant tax.  (As well as corporation tax, the sum that would be chargeable under CTA10/S269DA is taken into account as if it were an amount of corporation tax).
  • This effective tax mismatch outcome is not an excepted loan relationship outcome.
  • The insufficient economic substance condition is met through either the transaction or entity based test, as:

 

  • it is reasonable to assume that at least one of the transactions to which the effective tax mismatch outcome was referable was designed to secure the tax reduction.  There was no reason to anticipate any substantial non-tax benefits referable to the transaction for UK Bank Co and LCT Bank Co taken together.

 

  • It is also reasonable to assume that the involvement of LCT Bank Co in at least one of the transactions to which the effective tax mismatch outcome was referable was designed to secure the tax reduction.  Neither of the conditions of FA15/S110(7) is met.

The conclusion is therefore that the arrangements are caught by S80.

Calculation of taxable diverted profits

In this situation the focus is on diversion of income rather than expenses of UK Bank Co and “the actual provision condition” at FA15/S82(7) will not be met.  The calculation of taxable diverted profits will be by reference to “the relevant alternative provision” under FA15/S85. The meaning of the relevant alternative provision is set out at FA15/S82(5) as:

“…the alternative provision which it is just and reasonable to assume would have been made or imposed as between the relevant company and one or more companies connected with that company, instead of the material provision, had tax (including any non-UK tax) on income not been a relevant consideration for any person at  any time”.

The designated officer concludes that it is reasonable to assume that if tax on income had not been a consideration, UK Bank Co would have held the asset itself and the intra-group transactions through which LCT Bank Co received the income would not have been entered into.  It is also reasonable to assume that UK Bank Co would have incurred some additional expenses and would not have received the fee for services provided under the contractual arrangements.

FA15/S85(4) (or FA15/S85(5)(b)) would not be applicable in the circumstances described as there is no “relevant taxable income” of a connected company to consider.  So the taxable diverted profits under FA15/S85(5)(a) would be “the notional additional amount” arising from the relevant alternative provision.  Assuming that no transfer pricing adjustment is made in relation to the material provision and included in the company’s corporation tax return before the end of the DPT review period the notional additional amount is defined by S85(6) as the amount in respect of which the company would have been chargeable to corporation tax for that period had the relevant alternative provision been made or imposed instead of the material provision.

If that resulted in the inclusion of an amount on which corporation tax had been paid then credit could be given under FA15/S100.

FA15/S79, as amended by FA (No 2) 2015, applies a 33% rate rather than the normal 25% rate to taxable diverted profits that are banking surcharge profits or notional banking surcharge profits.  The latter term is defined as the sum of:

  • profits within section FA15/S85(5)(a) or FA15/S91(5)(a), to the extent that (assuming they were profits of the company chargeable to corporation tax) they would have been banking surcharge profits, and
  • any amounts of relevant taxable income of a company (“CC”) within section FA15/S85(4)(b) or (5)(b) or FA15/S91(4)(b) or (5)(b), to the extent that (assuming those amounts were profits of CC chargeable to corporation tax) they would have been banking surcharge profits of CC.

As noted above there would be no relevant taxable income of a connected company to consider in this case, so the profits chargeable to DPT at 33% would be those within FA15/S85(5)(a) - the amount in respect of which the company would have been chargeable to corporation tax for that period had the relevant alternative provision been made or imposed instead of the material provision.