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Consultation on measures to prevent profit fragmentation

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As announced at Autumn Budget 2017, HMRC is consulting until 8 June 2018 on measures to prevent individuals, partnerships or companies avoiding UK tax by transferring trading profits to unrelated foreign entities.

The aim is to target arrangements not caught by the transfer pricing rules or diverted profits tax. The proposals have two main strands:

  • targeted legislation requiring alienated profits meeting certain conditions to be added to UK profits; and
  • a new duty to notify HMRC of such schemes and pay tax earlier, possibly within 30 days.

This legislation would be introduced in Finance Bill 2019 to take effect from April 2019. The government intends to apply it to all arrangements in existence at the start date, whenever the arrangements were entered into.

The three conditions that would have to be met for the targeted legislation to apply are where:

  • profits are attributable to the professional or trading skills of an individual resident in the UK, whether that individual is trading as an individual or a partner, or conducting business through a company;
  • some or all of those ‘alienated profits’ end up in an entity which results in significantly less tax being paid on them than would have been paid had they arisen to the UK-resident individual (an ‘entity’ for these purposes would include a company, partnership or trust, whether or not having legal personality); and
  • the UK-resident individual, or a connected person, or someone acting together with them, is able to enjoy economic benefits from the alienated profits.

There will also be a final condition, namely, that it must be reasonable to conclude that some or all of the offshore entity’s profit is excessive, having regard to the profit-making functions it performs, with that excess being attributable instead to the connection between it and the UK-resident individual. This ‘excessive profits’ test will involve examining all of the facts around the arrangements.

The ‘significantly less tax’ test would involve a comparison with real rates of tax suffered on the alienated profits, in the region of 80% of the UK tax that would have been paid on the same profits, rather than headline rates.

HMRC expects these conditions to be met by only a relatively small number of UK businesses. The new notification requirement will be set wider than the charging conditions, to allow HMRC to examine cases where there is room for doubt over whether the new provisions apply or not.