An Unnecessary Diversion

Matthew Wentworth-May

Why the Diverted Profits Tax is both a mistake and ripe for judicial review

Last December the Government announced the introduction of a new tax, called the Diverted Profits Tax (“DPT”), “to counter the use of aggressive tax planning techniques used by multinational enterprises to divert profits from the UK.” Rushed through before the election, the DPT is now law, and will charge to tax at 25% (higher than the main corporation tax rate of 20%) the profits of multinational businesses that fall within its scope.

Our view is that, in the face of a deluge of hostile media coverage over international tax avoidance arrangements, the Government has overreacted. The DPT is too broad in its scope, catching as it does genuine commercial arrangements, and imposing a costly compliance burden on those multinational businesses who the UK should be trying to attract to do business in the UK to bolster this country’s economic growth.

The DPT was introduced despite the efforts of the Organisation for Economic Co-operation and Development (“OECD”) to co-ordinate an international response to this type of tax avoidance (the Base Erosion and Profit Shifting (or “BEPS”) project).

Unsurprisingly, the OECD is concerned about the UK’s DPT. It fears that such unilateral action by individual governments, instead of coordinated international action, will instigate the introduction of retaliatory taxes by other countries, giving rise to a real risk of double taxation and the kind of uncertainty that damages, rather than promotes, beneficial international trade.

We are already seeing the prospect of such retaliation, with both Australia considering its own DPT (although for now it has sensibly decided to wait for the OECD to finish its work) and Italy actively reviewing its position, with the real possibility of new withholding taxes being introduced on businesses, including British businesses, doing business in Italy.

There is a strong argument that the DPT, broadly drafted as it is, breaches the UK’s obligations under the double tax treaties it has entered into with other nations. Significantly, there is also a strong argument that the DPT breaches EU law, and so is susceptible to a judicial review challenge. Any such challenge would need to be brought soon (within 3 months of Royal Assent of the Finance Act, and so by 25 June), but should stand a good chance of success.

An attraction of bringing a judicial review would be the potential to force the Government to rethink going it alone, and instead to use its influence to shape the international effort being pursued by the OECD with a view to achieving a coordinated and sensible response to genuine international tax avoidance. It might also serve to deter other jurisdictions from taking unilateral action.

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