UK Asset Managers: Act Now on Transfer Pricing and Anti-Avoidance Tax Legislation
This is a summary of an article written by Michael for the Hedge Fund Law Report.
The transfer-pricing policies adopted by multinationals has been an area subject to increased scrutiny for a number of years. However, U.K.-based investment managers are subject to additional layers of regulation that pose a significantly greater risk, not only at a corporate level but also at an investor and personal level. Since April 2015, U.K.-based asset managers have been within the scope of the Diverted Profits Tax (DPT) and the Disguised Investment Management Fee (DIMF) regimes, two pieces of anti-avoidance legislation that pose their own unique set of challenges but also have themes common to transfer pricing.
In October 2015, the final recommendations of the OECD/G20 Base Erosion and Profit Shifting (BEPS) project were released. Starting in April 2016, the U.K. has begun adopting a number of these recommendations into legislation.
Additionally, investment managers in the U.K. managing an offshore trading fund typically need to adhere to the conditions of the investment manager exemption (IME), a longstanding piece of tax legislation designed for the asset management industry that prevents the fund from being taxed in the U.K. One of the conditions of the IME is that the U.K. investment manager receives customary remuneration – which requires investment managers to apply the OECD transfer pricing guidelines.
Diverted Profits Tax
Known in the media as the “Google Tax”, DPT legislation is intended to prevent the diversion of profits by multinational groups using contrived arrangements that either lack economic substance or avoid creating a U.K. permanent establishment. Effective since April 2015, the Google Tax imposes a 25% charge on “diverted profits.”
Taxpayers within the scope of the DPT regime are required to notify HMRC within three months of the end of the accounting period, requiring businesses to exercise considerable judgement whether to make a notification to HMRC or not. This is brought into sharp focus when the tax-geared penalties for failure to notify are considered, along with the fact that HMRC – not the taxpayer – calculates the DPT charge.
Disguised Investment Management Fee
The DIMF is a specific piece of anti-avoidance legislation and part of a package of legislative changes the sole focus of which is U.K.-based investment managers. In common with transfer pricing and DPT, DIMF focuses on how and where fees arise.
A DIMF charge requires an individual to provide investment management services directly or indirectly to a collective investment scheme or certain managed accounts. The legislation operates by re-characterizing untaxed income (essentially anything not taxed as trading or employment income in the U.K.) arising to an individual as U.K. trading income, subjecting it to income tax and national insurance contribution. One of the key differentiators is that the DIMF legislation applies at an individual level rather than at a corporate level.
The regime has been in force since April 2015, and it has targeted management fees and other amounts not linked to the profitability of the fund. From April 2016, it will be extended to performance fees and carried interest.
Both transfer pricing and DPT have small and medium sized enterprise (SME) exemptions, but DIMF does not have an equivalent protection. Nor for that matter does the IME. To arrive at the correct tested figures for SME exemption the turnover and balance sheet tests, a thorough analysis of the group structure is required. Definitions of “linked” and “partner enterprises” could inadvertently lead to fund structures falling within the definition of the group, thus removing the potential to rely on the exemption.
The requirement to exercise judgement is also common to both the DPT and DIMF regimes. Whilst transfer pricing has mandatory requirements with regard to maintaining appropriate documentation, for DPT and DIMF the path to evidence this judgement is not as clear.
Underpinning all three regimes is the entirely reasonable proposition that activities undertaken in the U.K. are to be taxed in the U.K. However DPT and DIMF both can focus on the commercial decisions taken by taxpayers which, until now, HMRC would quite rightly struggle to influence.
Action to Be Taken
The first step should be to get up to speed with the legislation to determine how it could apply and whether any of the exemptions or other exclusions are available. For transfer pricing, existing policies should be reviewed to determine if they are sustainable and whether the current structure is still fit for purpose. For DPT, it is important to determine the applicable HMRC notification date and make the critical decision whether to make a notification or not, documenting it accordingly. For DIMF, asset managers should seek to identify potential issues particularly with regard to remuneration structures and fee flows.
A plan of action should be developed at both the corporate level and with the individuals impacted, as consultation may be vital for achieving a consensus. Where the legislation has a material impact and is inadequately covered in the guidance, taxpayers may consider approaching HMRC to confirm the position.