May 30, 2019
UK issues draft regulations and guidance amending Offshore Receipts in respect of Intangible Property legislation
The United Kingdom (UK)’s Offshore Receipts in respect of Intangible Property (ORIP) rules were introduced by Finance Act 2019 (FA 2019) and came into effect on 6 April 2019 with anti-avoidance provisions effective from 29 October 2018. FA 2019 also included a power for amendments to the ORIP legislation to be made by regulation by 31 December 2019.
Under the ORIP rules, where intangible property (IP) is held in offshore companies, in a territory with which the UK does not have a full double taxation arrangement (DTA) and the IP is used directly or indirectly to enable, facilitate or promote UK sales, income derived from that IP could be subject to a UK income tax at 20% of the gross amounts. A full DTA for these purposes means a double tax treaty that contains a non-discrimination article.
Following engagement with EY and other stakeholders, the Government has now issued draft regulations which would amend the ORIP legislation, along with an explanatory memorandum and draft guidance on the ORIP rules.
The changes made in the draft regulations address a number of the issues which had been raised with HM Revenue & Customs (HMRC) during the consultations, however a number of issues and areas of uncertainty remain.
Changes proposed by the draft regulations
The draft regulations propose:
The exemption where business activities are substantially carried on in the territory has been slightly amended to ensure that an entity is not excluded due to restrictions on the meaning of ”residence,” however other relaxations to this exemption, that some may have anticipated, have not been included.
In addition to the changes in the draft regulations, the list of territories, contained in HMRC’s International Manual, that are considered to have a full DTA with the UK has been updated. This update confirms that territories that are not regarded as States are not considered to have a full DTA, even where the treaty contains a non-discrimination clause. Groups with IP in territories that may not be regarded as States – such as Hong Kong, the Isle of Man and the Channel Islands should review the position, including whether the DTA could in any event prevent an ORIP charge.
The changes made by the regulations as described above clarify the application of the ORIP rules to certain scenarios, but issues remain. Draft guidance was also released alongside the regulations which will help address some concerns but they are silent on a number of areas of uncertainty highlighted to HMRC. We plan to address these again with HMRC during discussions on the draft regulations and guidance.
Many of these areas of uncertainty relate to specific arrangements or specific entities involved in the transactions, such as disregarded limited liability companies where the investors are fully taxable.
However, the application of the targeted anti-avoidance rule (TAAR), especially in situations where taxpayers are looking to unwind their current arrangements, is a key issue that is of general importance. Broadly, the TAAR gives HMRC the power to counteract arrangements which aim to circumvent the ORIP rules. No substantive changes have been made to the TAAR in the draft regulations.
The draft guidance provides some detail of HMRC’s view on the application or non-application of the TAAR, but the legislation and the guidance are potentially difficult to relate to many common scenarios in international groups, where DEMPE (development, enhancement, maintenance, protection and exploitation) functions are typically geographically spread.
The draft guidance sets out a list of non-exhaustive factors that may indicate that the TAAR would apply on an outright disposal of IP, these include where ”The transferee does not have substantial economic operations in its jurisdiction and in particular the relevant substantive economic activity underlying the IP that has been transferred.” No detail has been given a to the meaning of ”substantial” in this context. This list of factors also includes the situation where income continues to accrete in a no- or low-tax jurisdiction, specifically where the transferor or a connected person is entitled to amounts which directly or indirectly derive from transferred rights – including amounts such as financing or other returns in connection with consideration for the transfer. Accordingly, the impact of the TAAR on transfers of IP for debt will need specific consideration.
It is noted that the draft guidance provides little commentary on the interaction between DTAs, the ORIP charge and the TAAR.
A technical consultation on the draft regulations will run for eight weeks, with responses being due by 19 July 2019. We will continue to engage with HMRC on this topic, and will make representations in response to the consultation.
It is expected that the final regulations will be made in Autumn 2019. Parts of the regulations will have retrospective effect.
In the meantime, groups which are potentially affected by ORIP should consider the draft regulations and the draft HMRC guidance in detail. In particular, groups that may have previously considered that they were outside the scope of the rules on the basis that IP is held in an entity with a full DTA (e.g., a Barbados IBC or a Hong Kong company) should consider the impact of the changes.
Some groups may have been anticipating the draft regulations would narrow the scope of the rules. Such groups will now need to consider the detail of the changes included in the draft regulations in order to determine how they are affected and whether they are indeed outside the scope of ORIP going forward.
Any groups which have already transferred IP out of a territory within the scope of the ORIP rules, or are considering doing so, will want to consider what comfort is given by the draft guidance especially in relation to the application of the TAAR.
For many, uncertainty will remain and detailed analysis will be required in determining how to respond.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (United Kingdom), London
Ernst & Young LLP (United States), UK Tax Desk, New York
Ernst & Young LLP (United States), UK Tax Desk, San Jose
Ernst & Young LLP (United States), FSO Tax Desk, New York