Withholding tax on royalty payments

Stephen Smith, Legal Director, CMS

The 2016 Budget proposes that withholding tax will apply to most royalty payments from later this year.

Additional measures will apply to prevent avoidance of withholding taxes on royalty payments made to connected persons.

The government is  targeting multinational groups which shift profits to low tax jurisdictions to reduce the profits which are subject to UK corporation tax.

Wider range of payments

Currently, tax must be withheld from a limited range of royalty payments (e.g. some royalties payments for copyright, patents and rights in design).

It is proposed that withholding tax will apply to a wider range of royalty payments for the use of intellectual property.  For example, royalties from trade marks and brand names which are currently only subject to withholding tax if they are an “annual payment”.  Those royalties will be taxable regardless of whether they are an annual payment.

The intention is to align the UK’s rules with the OECD model tax treaty definition of royalties.

The suggestion is that withholding tax will apply to any payment of a royalty (i.e. in respect of any form of intangible property) which is not covered by a tax treaty or an EU directive.

These measures will take effect from Royal Asset to the Finance Bill 2016 which is likely to be given in July 2016.

These measures will not apply where the UK has given up its rights to tax such payments pursuant to a double tax treaty or under an EU directive.

Anti-Treaty Shopping

Anti-avoidance measures will apply where royalties paid between connected persons are being diverted via conduit arrangements through treaty jurisdictions where the main purpose is to obtain treaty benefits which were not intended.

These measures target multinational groups where IP is held in a low tax jurisdiction where no substantive activity takes place and which does not have a tax treaty with the UK.  Payments made directly from the UK to that jurisdiction would be subject to UK withholding tax, whereas payments routed through a treaty jurisdiction can be paid from the UK to the treaty jurisdiction with no UK withholding tax but are not subject to tax on receipt in the low tax jurisdiction.

These measures are modeled on a proposed OECD anti-abuse rule coming from the BEPS project which will be included in the OECD model tax convention.  HMRC says that it will follow the commentary on that convention when interpreting the UK legislation.

These measures will apply to payments made on or after 17 March 2016.

Royalties connected with a UK permanent establishment

It is intended that withholding tax will apply to royalty payments which are connected with a UK permanent establishment of an overseas company.

This will apply to payments which do not have a source in the UK.   These payments will be deemed to arise from a UK source.

This is intended to be similar to the approach adopted in the OECD model tax treaty in respect of interest, which is treated as having a UK source if the debt is connected to a permanent establishment.

It is proposed that this measure will apply to payments made from one non-UK resident to another non-UK resident.   Enforcing an obligation to withhold UK tax in those situations is likely to create some difficulties.

These changes will take effect from Royal Asset to the Finance Bill 2016.

Further comment and analysis

We are in the process of reviewing the draft legislation and technical notes which have been published today and will add more detailed commentary in due course.

Given that these measures will come into force in a few months’ time, multinationals will need to move quickly to consider the impact the extended withholding tax rules will have on their structures and commercial agreements.

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