INTM610210 - Profit Fragmentation Adjustments: Hierarchy of Legislation

The Profit Fragmentation legislation is intended to reinforce existing tax legislation and not override existing rules where they already apply effectively. It only applies where other legislation does not fully counteract the tax advantages arising from the arrangements.

If other provisions have already applied to fully counteract the tax advantage then no further adjustments are required. If the tax advantage is partially counteracted by the application of an alternative provision then adjustments should be made to counteract any remaining tax advantage.

This is with the exception of two pieces of legislation both of which are explored further below:

  • The Diverted Profits Tax (DPT)
  • The General Anti-Abuse Rule (GAAR)

Example 21 – Other Legislation Applying First

A UK Company, the resident party, makes arrangements with a Bermudian company that meet all the conditions to be Profit Fragmentation Arrangements. The Bermudian company is owned by the same parent company as the UK Company.

The UK Company makes a cash payment of £100,000 to the Bermudian company, however, the services the Bermudian company actually provide to the UK Company are only worth £10,000, this is the price that would be paid between independent parties acting at arm’s length.

The company makes transfer pricing adjustments to reduce the deduction claimed to £10,000 meaning there is no tax advantage gained from the arrangements.

As the tax advantage has been fully counteracted by the transfer pricing adjustment it would not be just and reasonable to make further adjustments under the Profit Fragmentation legislation so not further adjustments should be made.

Diverted Profits Tax

DPT is a separate tax from income or corporation tax. If the Profit Fragmentation legislation leads to adjustments which bring any amount into charge, that amount will not be taxable diverted profits for the purposes of DPT. This is because S83(3), S84(2)(c), and S85(6)(b)(iii) FA 2015, remove any amount taken into account in an assessment to corporation tax from being considered diverted profits.

More information can be found in the DPT guidance.

General Anti-Abuse Rule

The GAAR is designed to counteract the tax advantage which abusive arrangements would otherwise (that is, in the absence of the GAAR) achieve. This means that it will usually be necessary to determine whether the arrangements would achieve their tax avoidance purpose under the rest of the tax code (that is, the non-GAAR tax rules), before considering whether the arrangements are ’abusive’ within the meaning of the GAAR.

This will apply to the Profit Fragmentation legislation as it does to the rest of the tax code. The application of the Profit Fragmentation legislation will not preclude HMRC’s ability to apply the GAAR where arrangements are considered abusive.

In practice HMRC expect to argue GAAR where it is appropriate to do so, at the same time as arguing other technical challenges that may be available as alternatives – such as the Profit Fragmentation rules.

More information can be found in the GAAR guidance.