Profit fragmentation

By Chris Sparkes, Tax partner

New rules aimed at preventing profits escaping the UK tax net were introduced from April
2019 and have far reaching consequences for any person or business with overseas
transactions.

The new regime tackles tax avoidance involving the fragmentation of UK business profits and the diversion of these profits to overseas entities by ensuring that the profits diverted offshore are fully taxed within the UK. If the new regime applies, then the only defence is to apply OECD transfer pricing rules to show that arm’s length prices were used. This could be very onerous in practice and effectively extends the reach of the transfer pricing regime to SMEs for the first time.

HMRC says that the type of arrangements that will be affected by the new rules would typically involve a UK business either diverting business receipts to an offshore entity when the entity does not have the commercial substance to earn those profits, or, where higher fees are paid to an offshore entity than is justified by the work done by that entity.
The rules will then bite where a individual who is related to the UK resident party could enjoy the benefit of the value transferred.

An exemption applies in cases where the overseas party pays at least 80% of the tax that the UK resident party would have paid on the profits, or if the arrangements have not been entered into with tax avoidance being one of the main motives. However, the 80% test will be complex to apply in practice as calculation of the overseas tax must take account of overseas reliefs and deductions so you cannot simply compare headline tax rates. It is also notoriously difficult to prove what the motives behind a transaction were and therefore reliance on the motive test may not be straightforward.

The new rules are deliberately very widely drafted and provide another weapon in HMRC’s ever expanding arsenal which they can use to challenge arrangements that they
perceive as abusive. As such, they may catch many existing structures as the regime applies to the profits diverted from April 2019 rather than structures put in place from this date. Existing structures should be reviewed to determine their compliance with the new regime and if you would like to talk to us about implications it may have for you and your business please contact Chris Sparkes, chrissparkes@lubbockfine.co.uk.

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