Widening the withholding tax net

16 June 2016

Back in 1803 Chancellor Henry Addington found an ingenious way to increase the UK’s tax revenue. He compelled the payer of income to deduct tax and pay this to the Exchequer, with only the net amount going to the recipient.

This was a revolution as it was a much easier way of collecting tax than by later assessment on the recipient through their tax returns.

Today this form of tax collection is commonplace and is referred to as ‘withholding tax’. It is a feature of most tax systems across the world and is a component of many international business arrangements.

The current chancellor has recently found another clever way to increase UK tax revenues, this time by increasing the circumstances in which withholding tax must be operated on payments for the use of intellectual property (IP).

The changes will affect many UK companies and other businesses making payments for the use of IP.

Of course, the cross-border use of IP is a key component of today’s globally connected economy, so increasing IP withholding tax should be a significant long term revenue raiser for the Government.

Current rules

UK basic rate income tax at 20 per cent must be withheld from certain payments for the use of IP.

However, the categories of payments to which UK IP withholding tax applies are currently relatively narrow, including patent and certain copyright royalties and other ‘annual payments’.

IP withholding tax is also often reduced under the UK’s tax treaty network. For example, royalty payments to US IP owners are generally taxed at 0 per cent by virtue of the UK’s treaty with the US.

Finance Bill 2016 changes

There are three proposed changes.

  • UK withholding tax will be deductible on a wider range of IP payments;
  • An anti-treaty abuse rule will be introduced; and
  • IP payments made in connection with a UK permanent establishment (PE) will now have a withholding obligation.

Wider range of IP payments

The extended categories are expected to include payments for the use of trademarks, brand names and know-how where the recipient is based outside the UK.

These changes mean that IP royalties paid in many UK inbound structures involving consumer-facing brands will be subject to withholding tax in future.

However, relief under a relevant double tax treaty may still be claimed where the person making the payment reasonably believes that the recipient is entitled to treaty benefits .

Anti-treaty shopping

Tax treaty benefits will be denied on royalty payments made to connected parties where the main purpose, or one of the main purposes, is to obtain a tax advantage by exploiting a double taxation agreement.

This measure is consistent with the outcome of the OECD/G20 BEPS project and is intended to target arrangements where IP royalty arrangements have been structured to benefit from a tax treaty in a manner contrary to its object or purpose.

UK PEs now under closer scrutiny

Rules determining whether a royalty has a UK source are also being extended to include circumstances where the royalty is connected with a UK PE.

Non-UK residents with a UK PE will now be required to withhold tax where payments for IP arise from activities which are carried out by the UK PE.

Action required

These changes will take effect when the current Finance Bill comes into force later in the year, though the anti-treaty shopping provisions apply to payments made from 17 March 2016.

All companies and other businesses currently making payments for the use of IP, or intending to do so, should review the new provisions to see how these arrangements will be affected .

If you would like to discuss these issues in more detail, please contact Dan Robertson or your usual RSM adviser.

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