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New UK diverted profits tax could apply to real estate transactions, says expert

Thursday, 05 February 2015   (0 Comments)
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Real estate transactions involving non-UK resident companies could be caught by the UK's new diverted profits tax, even though they are not the intended target of the legislation, said John Christian a tax expert at Pinsent Masons.

Christian said that from April this year the proposed new tax, as currently drafted, could apply in some circumstances where a non UK resident company, such as an offshore special purpose vehicle (SPV), has been used in a transaction involving UK land or where there is a UK presence and profits are extracted to offshore owners based in low tax jurisdictions.

A new tax called diverted profits tax (DPT) was announced in the Chancellor's autumn statement on 3 December last year and draft legislation was published for consultation on 10 December. The government said that DPT is being introduced because it is concerned that multinationals are using "contrived arrangements" to avoid paying their "fair share" of UK tax.

"Unfortunately the draft legislation is not very well drafted so it is not at all clear at present whether it will apply to real estate transactions" John Christian said.

Where a non-UK resident company is carrying on activity in the UK in connection with "supplies of goods or services" to UK customers it will be subject to DPT if it is reasonable to assume that any of the activity is designed to ensure that the foreign company is not carrying on a trade in the UK through a permanent establishment (PE) and a tax avoidance condition or a 'tax mismatch' condition is satisfied. This situation is referred to in the legislation as an "avoided PE".

Christian said "The phrase 'supplies of goods or services', as used in the draft legislation, is VAT, rather than direct tax terminology, and it is not clear in a direct tax context what it means in connection with transactions involving land. However, until clarification emerges, it should be assumed that it may be viewed purposively as referring to all supplies and therefore could apply to land supplies."

John Christian said that the avoided PE rules could be relevant to development activities. He said "development projects involving offshore owned UK property are usually structured to minimise the risk of a UK PE in respect of a property development trade. These structures should be reviewed against the proposals, in particular the avoided PE".

Small or medium-sized enterprises will not be subject to the tax and there will be an exemption where total sales revenues from all supplies of goods and services to UK customers do not exceed £10 million for a 12 month accounting period.

The tax will also apply to arrangements which "lack economic substance" involving entities with an existing UK taxable presence. This is aimed at the diversion of profits to low tax jurisdictions by way of payments, such as royalties.

Christian said "Straightforward investment structures are probably not intended to be subject to DPT" but he said that some commentators have said that "bona fide commercial arrangements could technically be argued to be caught".

John Christian said that for investment structures involving an offshore company, the main risk is that the offshore SPV has "insufficient economic substance". He said that where the local tax rate is less than 16%, a DPT charge could arise.

Christian said that "in particular, investments using a propco/opco involve a trading activity being carried on through the opco and structures should be reviewed against the 'economic substance' test".

A propco/opco structure involves one company owning all the group's land (propco), which is separate from the operating companies (opcos) which are trading and lease the premises from the propco. This enables the group to raise finance with the interest funded from the intra group income stream from the properties.

DPT will apply to diverted profits arising on or after 1 April 2015. Affected companies must notify HMRC within three months of the end of an accounting period in which "it is reasonable to assume" that diverted profits might arise. Commentators have criticised the vagueness of this notification requirement suggesting that it will lead to many unnecessary notifications. Katja Hall, CBI Deputy Director-General said "the broad scope of the rules is resulting in real concern that HMRC will not be able to cope with the quantity of notifications from companies, causing long periods of business uncertainty"

John Christian said "If the legislation is passed without significant amendment, investors and developers should review their structures and transfer pricing arrangements, and may wish to consider seeking an Advance Pricing Agreement (APA) to confirm that DPT does not apply in their circumstances."

The consultation on the draft legislation closed on 4 February. The government has said that the legislation to introduce DPT will be contained in a pre-election Finance Bill. Christian said "With the budget scheduled for 18 March and Parliament due to be dissolved on 30 March, there will be little time for the pre-election Finance Bill to be properly scrutinised."

"In our view the legislation is not designed to catch real estate transactions and should be amended so that it is clear that it does not apply. We have responded to the consultation on the draft legislation asking that the scope of the rules be narrowed." Christian said.

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