INTM489765 | Diverted Profits Tax: application of Diverted Profits Tax: legislation – Finance Act 2015 – core provisions: the insufficient economic substance condition – overview

The arrangements to which the legislation can apply are ones that lack economic substance and are designed to reduce tax. For example, the legislation may apply where an asset with an existing income stream is transferred by a UK company to an affiliate in a low tax territory, if no income generation activity is performed in that territory. A transaction may have been designed to secure a tax reduction despite also being designed to secure commercial objectives.

It is not intended that the DPT legislation will apply purely because a company decides to take advantage of lower tax rates offered by another territory by means of a wholesale transfer of the economic activity needed to generate the associated income.

The central consideration is whether it is reasonable to assume that the arrangements in question were designed to secure a tax reduction established by the tax mismatch outcome condition. Consistent with the interpretation of section 86(1)(e) (see INTM489655), for arrangements to be considered as designed to secure the tax reduction for the insufficient economic substance condition there will be some degree of contrivance. The arrangements will differ in some material way to those that would have been made if the opportunity to achieve the tax mismatch outcome was not a relevant consideration for any party involved at any time.

The insufficient economic substance condition is a test of design and will not automatically be met in every case where the UK is under rewarded as a result of incorrect transfer pricing of a provision or provisions. However, mispricing (and especially extreme mispricing) can be indicative of a design to secure a tax reduction. This may be especially compelling in situations where the contractual arrangements are designed to justify the mispricing, or where there is a lack of other evidence. Likewise, extensive evidence of the tax benefits of an arrangement and a lack of similar evidence of any non-tax benefits may be an indicator of contrivance. However, wider evidence of a customer’s approach to its tax obligations, while indicative of general behaviours, is not evidence of the insufficient economic substance condition being met in respect of particular arrangements.