The Brockman brief: UK diverted profits tax: The extrapolation effect

The UK's DPT, and Australia's recent draft PE legislation, prescribe tests whereby a person arrives at a decisive conclusion using a 'reasonable to assume' or 'reasonable to conclude' basis to measure tax avoidance considered improper. This inherently subjective test will lead to different conclusions being drawn by taxpayers and tax administrations.

Additionally, a main or principal purpose test is also entrenched within the UK legislation and Australia's recent proposal for PE determination. This test is evidently aimed at aggressive tax planning arrangements, notwithstanding international tax law precedents, including the arm's-length principle.

Subjective limitations for measuring a taxpayer's obligation to pay taxes in a jurisdiction seem to be the new norm, and this is expected to continue as other countries try to widen the net within which their fiscal objectives can be achieved via imprecise boundaries.

The UK's DPT is a new 'tax', not subject to the rules of domestic tax legislation and, thereby, not subject to the rights granted under its double tax treaties. This preposition, subject to legal challenge, also transforms the regular 20% tax into an escalated tax of 25% as a further deterrent to enter into the respective transactions.

The constraints, and rights, of a double tax treaty network are being creatively avoided as a new legislative trend

Australia's proposed legislation ensconces its PE rules within its general anti-abuse rule (GAAR) section (Part IVA), thereby also overriding their double tax treaties.

The constraints, and rights, of a double tax treaty network are being creatively avoided as a proactive trend for new legislation. The question "Is this fair legislation?" implants itself into the minds of many tax professionals as new rules are introduced. As a result, tax treaties - being a tenet for foreign direct investment and the application of tax doctrines - are increasingly losing their significance in the international tax arena.

The authors of the UK DPT ensured that the application of the new 'tax' would be encased within its GAAR definition. Accordingly, it widened its tax avoidance definition within its GAAR legislation to include the avoidance or reduction of a charge to DPT as a GAAR enforceable mechanism.

Australia decided to place its PE legislation directly within its section of the income tax legislation governed by GAAR, so the new rule will be their tool to combat international profit shifting, while purposely avoiding limitations of the double tax treaty network.

It is likely that other countries will purposely draft new provisions that use GAAR as a primary, or secondary, mechanism to attract tax. Global inconsistency and the hybrid application of GAAR in domestic law and/or treaty provisions will proliferate if this trend continues.

The loss of double tax treaty relief, as well as a concerted resistance to global arbitration guidelines, will result in additional double taxation.

New legislation is not accompanied by parallel efforts to reduce the implications of double taxation. As a result, additional complexity, costs and significant tax burdens of multinationals (and tax administrations) will increase exponentially with every new law introduced.

The UK's DPT and Australia's recent Budget proposals are noticeably silent in addressing the arm's-length principle. This principle has a long history in the OECD guidelines, and will continue to be prominent in its new guidelines.

Application of the arm's-length principle is subject to continual erosion as countries unilaterally enact new laws in advance of the OECD's base erosion and profit shifting (BEPS) guidelines without automatic recourse for alignment.

In this way, international tax law is becoming subject to additional personal discretion, uncertainty, complexity and lack of consistency around the world; the very things multilateral efforts such as the G20/OECD BEPS project sought to avoid, reduce or stamp out. The UK's DPT has reinforced those conclusions at the expense of the OECD's idealistic goal of providing guidelines that form a base from which international tax principles and global consistency would be realised.

Keith Brockman is global tax director at Mars. He is also a lecturer, frequent speaker and the author of the Strategizing Multinational Tax Risks blog. In his regular ITR column he provides a practical analysis of some of the more challenging recent developments for corporate taxpayers, looking at how in-house professionals can mitigate new risks and identify effective solutions in an evolving environment.