Introduction: When do these rules apply?
The Profit Fragmentation legislation is applicable to value transferred as a result of a material provision on or after 1st April 2019 (for corporation tax) or 6th April 2019 (for income tax). The rules apply to amounts arising from arrangements whenever those arrangements were put in place.
This measure tackles tax avoidance arrangements that involve the fragmentation of UK business profits whereby some or all of those profits are said to arise in the hands of an offshore entity in a jurisdiction where there is significantly lower tax than in the UK.
Example 1 –No Residual UK Business
The Profit Fragmentation legislation will not apply to transfers of value that have taken place in periods before the legislation was introduced, nor to arrangements where profits are not attributable to a business whose profits are taxable in the UK. We assume for the purposes of this example that other existing legislation does not apply.
In 2016 Company A, a UK resident research and development company, (“A Ltd”) created a new type of high-tech micro-chip used in mobile phones. The technology was ahead of its time on creation and the company did not anticipate that it would need any technological maintenance for at least 4 years.
In 2018 the patent for the micro-chip was transferred to Company B (“B Ltd”). B Ltd is another group company, based in the British Virgin Islands (BVI), which holds all of the group’s patents and exploits them all over the world. This transfer took place on arm’s length terms: B Ltd paid a significant sum to A Ltd. in return for the patent
B Ltd. has a workforce based in the BVI responsible for exploiting the group’s patents to customers. During the accounting period ending 31 December 2019 B Ltd. generated income of $1m from its customers relating to the patent.
The Profit Fragmentation legislation will not apply to the transfer of the patent in 2016 because the transfer took place in advance of the legislation applying. Furthermore, it will not apply to the income generated by B Ltd during the APE 31 December 2019 as this income is not properly attributable to the UK business.
Example 2 – Basic Post-Commencement Transfer
This example shows when the Profit Fragmentation legislation will apply to certain transfers occurring after 1 April 2019 (or 6 April 2019 for income tax purposes) in relation to transfers that have taken place before that date. As with other examples in this guidance, it is likely that accounting principles, other legislation or case law would ensure the appropriate amount of profits are charged to UK tax: the following example illustrates how Profit Fragmentation rules would apply if that were not the case.
The facts for this example are the same as those as set out in Example 1, but we are now considering the accounting period ended 31 December 2020.
In January 2020 it becomes apparent that the micro-chips will need updating to ensure the technology remains current. B Ltd. does not have the necessary expertise to update them, so A Ltd. updates the technology for B Ltd. but does not receive any remuneration for doing this. The service of updating the technology by A Ltd without receiving any remuneration results in a transfer of value to B Ltd.
The Profit Fragmentation legislation could apply to this transfer of value at the time this occurs (in this example this is during the accounting period ended 31 December 2020) provided the arrangements are Profit Fragmentation Arrangements and the exception conditions don’t apply.