Corporation tax: modification of the definition of permanent establishment

Who is likely to be affected

This change could impact foreign companies doing business in the UK. It is more likely to affect non-resident manufacturing and distribution companies that structure their operations in the UK to minimize their UK tax footprint.

General description of the measure

A non-resident company is only liable to UK corporation tax if it has a permanent establishment there.

Certain preparatory or auxiliary activities, which are normally of low value, such as the storage of the enterprise’s own products, the purchase of goods or the gathering of information for the non-resident enterprise, qualify as exempt activities and do not create a permanent establishment.

The measure ensures that foreign companies operating in the UK cannot take advantage of these exemptions by dividing their activities between different sites and related companies.

Political objective

The UK is committed to fighting tax avoidance by multinational groups. This measure denies the permanent establishment exemption when non-resident companies artificially fragment their operations to take advantage of these exemptions and avoid creating a permanent establishment.

As well as helping to preserve the corporate tax base, this measure helps to ensure a level playing field between foreign and UK companies and to combat unfair tax competition.

Context of the measure

This measure was announced in Budget 2018.

The Organization for Economic Co-operation and Development (OECD) and G20 program to tackle base erosion and profit shifting (BEPS) led to the publication in 2015 of a number of action points.

One of the recommended changes was to deny access to the exempt activity provision in tax treaties where the business activity has been artificially fragmented to avoid the creation of a permanent establishment. Accordingly, in these situations, the conditions for a permanent establishment would be met and the jurisdiction would have taxing rights over the profits of that permanent establishment.

The United Kingdom has decided to adopt this change in its tax treaties. He gave effect to this change through the BEPS multilateral instrument which was signed in June 2017 and entered into force for the UK on 1 October 2018.

HMRC must now replicate this change in UK domestic law to make the tax treaty change effective.

Detailed proposal

Effective date

The measure will apply to companies from 1 January 2019. Where a financial year straddles this date, the provision applies to the part of the company’s financial year which falls after this date.

Current law

The current definition of permanent establishment is included in Chapter 2 of Part 24 of the Corporations Tax Act (call to action) 2010. Specific activities exempt from a permanent establishment are listed in Article 1143.

Proposed revisions

A law has been introduced in the 2018-2019 finance bill to modify article 1143 call to action 2010, and thus deny the permanent establishment exemption to a non-UK resident company for such activities if they form part of a fragmented business operation, for example if:

• that company, alone or with related entities, whether foreign or UK, carry on a consistent business activity, either at the same location or at different locations in the UK
• at least one of them has a permanent establishment where additional functions are carried out
• the set of activities would create a permanent establishment if it were a single enterprise.

Summary of impacts

Impact on Treasury (£m)

This measure should have a negligible impact on the Exchequer.

Economic impact

This measure should not have significant economic impacts.

Impact on individuals, households and families

This measure has no impact on individuals since it only concerns non-resident companies.

The measure should not affect the formation, stability or breakdown of the family.

Equalities impacts

It is not expected that there will be impacts because the measure only concerns non-resident companies.

Impact on businesses, including civil society organizations

Large multinational companies will be hit when they have struck deals to erode their UK corporation tax base. There is no impact on civil society organizations.

Operational impact (£m) (HMRC or other)

The change to the definition of permanent establishment will be an additional aspect to consider in the annual risk review for HMRC’s Large Business Division, but is not expected to have a material impact on resources.

The additional tax at risk should be low, as non-exempt activities will have little added value in most cases.

Guidance issued by HMRC on permanent establishment will need to be updated.

Other impacts

Other impacts were taken into account and none were identified.

Monitoring and evaluation

The measure will be reviewed by contacting the taxpayer groups concerned.

Additional tips

If you have any questions about this change, contact Mike Hogan by phone: 03000 585 645 or email mike.hogan@hmrc.gsi.gov.uk.