The international community has been concerned in recent years over whether large groups of companies are paying an appropriate amount of tax, or whether they are artificially diverting profits to low tax overseas jurisdictions.
The Base Erosion Profit Shifting (BEPS) regime was the international communities’ response. It resulted in a number of recommendations which individual countries were left to implement into their own laws.
In the UK we have seen a number of new measures introduced. However, to properly comply with the new rules, it often requires detailed knowledge of the overall group position, including how other group members (both UK and overseas) treat certain items for tax purposes.
For a UK subsidiary this information is often not readily available, and we still regularly see examples where the new rules are not being fully applied. This can result in additional tax costs, interest and penalties.
We have outlined some common examples below.
Where the UK group companies have interest costs in excess of £2 million, the Corporate Income Restriction (CIR) rules can restrict tax deductions. The new rules require detailed knowledge of the tax and profits position across the group.
The new provisions are complex but, very broadly, restrict tax deductions for interest costs to 30% of the UK earnings before interest, tax, depreciation and amortization (EBITDA) as calculated for tax purposes, or if higher, a more complex calculation can be used where the UK group companies EBITDA is multiplied by the proportion that group third party debt bears to group EBITDA. There are requirements to make returns to HMRC, and it can be beneficial in some circumstances to make a return even when where there is no restriction – for example this can enable surplus capacity to be carried forward.
Hybrid mismatch rules relate to arrangements that exploit differences in the tax treatment of an entity or instrument under the tax laws of two or more countries. The rules are complex, but, broadly, catch situations where there is a connected party transaction which, for example, gives rise to a UK tax deduction but no corresponding taxable income in the recipient. Typical examples that can give rise to hybrid adjustments are partnerships which are taxed differently in different jurisdictions, and the US check the box regime which allows the US parent to treat an UK entity as transparent for tax purposes.
US parent companies often make a check-the-box election for a UK subsidiary to be treated as a branch of the US company; effectively, the UK subsidiary’s income and expenses are treated for US tax purposes as income/expenses of the US company. If the UK subsidiary then pays a management charge to the US company, it would normally give rise to a UK tax deduction. In the US parent, as the UK subsidiary is treated as transparent, there is no net income to tax. The hybrid rules can catch this type of scenario and disallow the UK tax deduction.
To pick up where a hybrid adjustment is required requires detailed knowledge of the tax treatment of income flows and entities in other jurisdictions. There are no de minimis exemptions.
Whilst the UK has had transfer pricing rules for many years, requiring connected party transactions to be on 'arm’s length' terms for tax purposes, the Organisation for Economic Cooperation and Development (OECD) has issued revised guidance on how the rules should be interpreted. In particular, rather than just looking at a transaction in isolation, and for example saying the margin in comparable with third party margins, there is a move towards looking at the entire value chain and allocating the margin proportionally to the value added. It is important to ensure that documentation to support transfer prices is kept up to date.
Where the consolidated group revenue exceeded €750 million in the previous accounting period the Country-by-Country Reporting (CbCR) rules require returns to be made of key financial information in each jurisdiction in which the group operates, enabling the tax authorities in the various jurisdiction to compare and consider whether returns in their own jurisdiction appear reasonable. It can be time consuming to pull together the necessary financial information. Whilst the main report is often made in the parent company’s jurisdiction, it is still necessary for UK groups to notify HMRC that the rules apply to make a return. The UK reporting deadline is 12 months after the year-end and the notification deadline is the end of the accounting period to which the report relates.
A UK entity, or group, is required to publish its tax strategy online, if in the previous year the UK group satisfies the below conditions:
UK turnover > £200 million, or
UK balance sheet > £2 billion
The above limits may not apply to the UK company but it may still need to publish a tax strategy if the worldwide group satisfies the global turnover threshold of more than €750 million.
The deadline for publishing the tax strategy is generally the end of their financial year.
The above limits of £200 million/£2 billion also apply for the purposes of the Senior Accounting Officer (SAO) requirements and if these are breached, the group is required to appoint an SAO who must make an annual return confirming that are appropriate tax accounting arrangements in place in their organisation.
The OECD has recently published papers on further reforms, including minimum levels of tax, and looking at paying taxes where revenues are generated rather than where a company is tax resident.
Are you complying with the recent changes?
For more information on how Crowe can help, please contact Paul Fay or your usual Crowe tax contact.