Budget 2014 – Corporation tax changes to prevent companies artificially transferring profits within the group to avoid paying tax

It was announced in the Autumn Statement that Finance Act 2014 would introduce legislation (effective from 5 December 2013) to counteract tax avoidance schemes that use derivative contracts such as total return swaps linked to company profits. Broadly, these schemes worked by paying all, or a significant proportion, of the profits of a UK company under a total return swap to an offshore company in the same group. The offshore company was often resident in a tax haven.  Any payments made under the total return swap by the UK company were claimed as allowable deductions in calculating the taxable profits of the UK company, so that the overall profits of the UK company were significantly reduced.

The anti-avoidance legislation will be widened to encompass any other financial instruments or mechanisms that have the same economic effect of transferring profits to another group company, where these arrangements have been entered into with a tax-avoidance motive. This wider anti-avoidance legislation will apply to all payments made on or after 19 March 2014 and where the legislation is applied, the company in which the deemed advantage has been obtained will have the profits added back for corporation tax purposes.  There will be no adjustment to the profits of the company to which the profits are diverted. There is therefore the potential for the diverted profits to be double taxed.

As well as publishing the draft legislation, HMRC have issued a guidance note on what they mean by ‘profits’ for these purposes and the circumstances which they consider fall within the new legislation.  The guidance note helpfully indicates that payments for services linked to profits, reinsurance arrangements and franchise arrangement should not normally fall within the provisions, unless they have been entered into for tax avoidance purposes. However, where a company is entitled to receive a compensation payment which is calculated as a percentage of profit and it arranges for this to be paid to a different company for tax avoidance reasons, this will be caught. They have also indicated that where excessive interest is charged on an intragroup loan, this could be challenged under the new legislation, as well as existing legislation such as transfer pricing or unallowable purpose.

This measure applies purely to transfer of profits between companies.  This new anti-avoidance legislation goes beyond the previous targeted anti-avoidance legislation, to encompass all mechanisms under which profits of a corporate group are diverted for tax avoidance purposes.