Foreign Permanent Establishments of UK Companies: anti-diversion rule: cases where safe harbour provisions not met
This applies for relevant periods beginning before 1 January 2013.
Assurance on focus of anti diversion rule
The following additional guidance addresses cases in which elements of the safe harbour test in FA11/SCH13/PARA 31 and 32 are not met. It provides additional assurance on the focus of the anti diversion rule i.e. it does not aim to catch situations where existing business is present and it can be shown there has been no significant change in that business.
Two scenarios in which we expect condition B of the motive test (CTA09/S18H) will usually be satisfied follow.
Scenario 1 - Application to existing foreign permanent establishments
Where a UK-resident company was already operating through a foreign permanent establishment for at least one year before the new legislation takes effect, it is highly unlikely that the PE will have been set up to reduce United Kingdom tax. This is because at the time of its creation the profits attributable to the PE’s activities would have been taxable in the United Kingdom, subject to relief for local taxes.
In considering whether or not such a PE achieves a reduction in United Kingdom tax by a diversion of profits within the meaning of CTA09/S18H, it is a reasonable inference that such a reduction was not one of the main reasons for a company choosing to carry on a trade through a PE. Therefore the motive test will initially be satisfied in relation to the PE.
As with any other case though, the question of whether the motive test is satisfied in relation to such a foreign PE will be a question of fact. However, as a matter of administrative practice, HMRC will, on receipt of a satisfactory clearance application accept that condition B of the motive test is satisfied in the case of a foreign PE already established one year before the legislation in CTA09/Ch 3A takes effect, provided that there has been no significant change in its business the year before commencement. Any change that results in a significant new or enhanced tax advantage for any connected company will be a significant change.
HMRC will accept that condition B is satisfied in the first relevant accounting period. It should be noted that such clearances will apply only to foreign PEs whose main business remains unchanged throughout the relevant period.
Thereafter, the main reasons for the continued existence of the foreign PE could change. The fact that the profits attributable to it were previously charged to UK tax will no longer be relevant to the reasons for it continuing to carry on business; the achievement of a reduction in tax by a diversion of profits from the UK could have become one such reason. However, we anticipate that 2012 will see significant change to the anti-diversion rule, to keep it in line with CFC Full Reform. Guidance will then be published on the application of the amended rule.
Scenario 2 - Application to a foreign PE created from business transferred from a foreign company
A United Kingdom resident company may receive business transferred to it from an overseas subsidiary or subsidiaries. Such a transfer could represent a diversion of profits as defined in CTA09/S18H if it were reasonable to suppose that the receipts of the new PE would form part of the United Kingdom company’s taxable profits if the PE did not exist.
However, the creation of the foreign PE and the transfer of activities to it might be carried out primarily for commercial reasons. For example, it might be a necessary preliminary to reducing operating costs or to facilitate the more efficient use of regulatory capital. But if one of the main reasons for the transfer is to achieve a reduction in United Kingdom tax by a diversion of profits from the United Kingdom, the test will be failed. Whether or not the motive test is satisfied is a question of fact and HMRC will wish to consider all of the circumstances surrounding the transfer of activity into the foreign PE.
Where the new foreign PE contains all or nearly all of the business previously carried on by an overseas company and there has been no significant change in the nature of the business carried on, HMRC will accept that Condition B of the motive test will be satisfied where that overseas company’s profits were not within the scope of the controlled foreign company rules either because the company was not a CFC or because it qualified for an exemption from the CFC rules.
It is possible that the anti-diversion rule may apply in respect of particular transactions, or because the availability of an exemption might be in dispute with HMRC.