What is BEPS? What is Diverted Profits Tax? Will either of these affect me or my SME clients?

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This is a freeview 'At a glance' guide to BEPS and Diverted Profits Tax.

At a glance

What is BEPS?

BEPS stands for 'Base Erosion and Profit Shifting'.

  • BEPS is an issue for all tax authorities. It results from tax planning deliberately set up to exploit gaps and inconsistencies in tax rules of different countries and jurisdictions so that shifted profits and income either 'disappear' or are taxed at low rates.
  • The G20 countries and the OECD (Organisation for Economic Cooperation and Development) have been working on a BEPS project.

On 7 June 2017, 68 countries and jurisdictions signed a Multilateral Instrument (MLI) in order to implement the treaty-based recommendations of the BEPS process. Some eight more countries are expected to sign later on. This will update some 1,100 bi-lateral treaties and includes measures to prevent treaty abuse, changes to the definition of Permanent Establishment (PE), changes to the residence tie-break for companies, mutual agreement procedures and mandatory binding arbitration. The new measures will apply once participants adapt their treaties and ratify the MLI.

The MLI came into force in the UK on 1 October 2018. It began to have effect for UK tax treaties from:

  • 1 January 2019 for taxes withheld at source
  • 1 April 2019 for Corporation Tax
  • 6 April 2019 for Income Tax and Capital Gains Tax

The date on which individual UK tax treaties are modified by the MLI depends on the date our treaty partners deposit their own instruments of ratification, acceptance or approval.

The original BEPS Framework consisted of 15 Actions:

  1. Address the tax challenges of the digital economy.  
  2. Neutralise the effects of hybrid mismatch arrangements.
  3. Strengthen controlled foreign companies rules.  
  4. Limit base erosion via interest deductions and other financial payments.  
  5. Counter harmful tax practices more effectively, taking into account transparency and substance.
  6. Prevent treaty abuse.
  7. Prevent the artificial avoidance of permanent establishment status.
    (8 through 10 are grouped together as the Transfer Pricing (TP) Actions)
  8. TP relating to intangibles and Cost Contributio Arrangements
  9. TP relating to returns on capital-rich group companies.
  10. Recharacterisation of transactions and use of TP methods in tax-abusive situations.
  11. Establish methodologies to collect and analyse data on BEPS and the actions to address it.
  12. Require taxpayers to disclose their aggressive tax planning arrangements.
  13. Re-examine transfer pricing documentation.
  14. Make dispute resolution mechanisms more effective.
  15. Develop a multilateral instrument. 

The OECD's BEPS project has developed into the Pillar 1 and 2 projects:

  • Pillar 1 aims to redefine tax allocation rules ensuring an element of the residual profit of a multinational company (MNC) is taxed in the countries where the revenue is sourced.
  • Pillar 2 aims to ensure that there is a global minimum tax rate. Historically, in 2021, over 130 countries signed up to a minimum tax rate of 15%.

Pillar 2 is made up of two key measures:

  • The Undertaxed Profits Rule (UTPR) which allows for an additional tax charge where an MNC's effective global tax rate is less than 15%.
  • The Income Inclusion Rule (IIR) allows the jurisdiction of the MNC's ultimate parent company to use a top-up tax where foreign subsidiaries have not paid that minimum level of tax.

Countries may also adopt a Domestic Minimum Tax (DMT). This tax would operate instead of the other two measures, were they not to be implemented. It allows a top-up tax to be imposed in the country in which the undertaxed profits are generated.

What's new?

Finance Bill 2023-24/ Finance (No 2) Act 2023

  • As part of the UK's commitment to the OECD's Pillar 2, the Finance Bill 2023-24 will provide for the Undertaxed Profits Rule (UTPR) to have effect no earlier than for accounting periods beginning on 31 December 2024.
  • The UK's adoption of the Multi-national Top-Up Tax (Income Inclusion Rule) and the Domestic Minimum Tax will take effect for accounting periods beginning on or after 31 December 2023 and was enacted in the Finance (No 2) Act 2023.
  • In October 2023, the OECD published a new multilateral convention on reallocating taxing rights to market jurisdictions, improving tax certainty, and removing digital service taxes. It also brings a finalisation of Pillar 2 closer.

Will it affect me or my clients?

It is unlikely to affect typical UK-based Small and Medium-Sized Enterprises (SMEs) or their owners as they are probably too small.

  • The measures are primarily aimed at large multinational companies and have been designed to minimise the impact on SMEs.  Taxpayers categorised as Wealthy or Mid-sized by HMRC should also be aware of the changes even if it does not currently impact them.
  • Companies who considered themselves to be a SME, but are part of a larger multi-national group should check the group size as they may inadvertently be included in te rules.

Reporting under BEPS

The BEPS initiative introduced a requirement to submit annual country-by-country reports setting out information relating to global activities, transfer pricing strategies and the level of income and taxes paid in each location. It is limited to groups with consolidated turnover in excess of €750 million.

The UK has now introduced mandatory TP documentation requirements in line with these requirements as part of Finance (No 2) Act 2023.