Diverted Profits Tax
Diverted Profits Tax (DPT) is a tax measure designed to counteract aggressive tax avoidanceTax avoidance refers to the practice of legally structuring financial activities to minimise tax liability, reducing the amount of tax owed without violating laws. Unlike tax evasion, which is illegal and involves concealing income or misreporting, tax avoidance operates within the framework of the law. Multinational enterprises (MNEs) and individuals often engage in tax planning strategies that reduce tax liabilities... by multinational enterprisesWhat are Multinational Enterprises (MNEs)? Multinational Enterprises, commonly referred to as MNEs, are corporations that operate in multiple countries through various subsidiaries, branches, or affiliates. These entities maintain a central management structure while leveraging diverse resources, labour markets, and customer bases across borders. The fundamental aspect that distinguishes MNEs from other corporate forms is their cross-border activity, which can include... (MNEsWhat are Multinational Enterprises (MNEs)? Multinational Enterprises, commonly referred to as MNEs, are corporations that operate in multiple countries through various subsidiaries, branches, or affiliates. These entities maintain a central management structure while leveraging diverse resources, labour markets, and customer bases across borders. The fundamental aspect that distinguishes MNEs from other corporate forms is their cross-border activity, which can include...). It aims to address arrangements where profits are artificially shifted to jurisdictions with lower tax rates or where transactions lack genuine economic substanceEconomic substance is a foundational principle in taxation and business law, ensuring that transactions and corporate structures reflect genuine economic reality beyond their legal form. The concept aims to prevent tax avoidance by evaluating whether a transaction or arrangement has a real business purpose and economic effect other than merely achieving a tax benefit. It ensures that taxpayers cannot exploit.... Introduced initially by the United Kingdom in 2015, DPT is sometimes informally called the “Google Tax” due to its focus on large digital companies. However, its application extends beyond tech firms to any MNEsWhat are Multinational Enterprises (MNEs)? Multinational Enterprises, commonly referred to as MNEs, are corporations that operate in multiple countries through various subsidiaries, branches, or affiliates. These entities maintain a central management structure while leveraging diverse resources, labour markets, and customer bases across borders. The fundamental aspect that distinguishes MNEs from other corporate forms is their cross-border activity, which can include... using sophisticated structures to minimise taxable profits.
DPT generally applies in two key scenarios:
- Artificial Avoidance of Permanent Establishment (PE): This occurs when an MNEWhat are Multinational Enterprises (MNEs)? Multinational Enterprises, commonly referred to as MNEs, are corporations that operate in multiple countries through various subsidiaries, branches, or affiliates. These entities maintain a central management structure while leveraging diverse resources, labour markets, and customer bases across borders. The fundamental aspect that distinguishes MNEs from other corporate forms is their cross-border activity, which can include... avoids creating a taxable presence in a jurisdiction while maintaining substantial economic activity there.
- Profit Mismatch Arrangements: These involve transactions where the economic benefits do not align with the commercial substance, often exploiting differences in tax regimes.
Rates for DPT are typically higher than corporate taxCorporate Tax refers to the tax imposed by governments on the income or capital of corporations. Corporations, considered separate legal entities, are taxed on their profits, meaning the income generated from their operational activities, investments, and other financial undertakings. This tax is generally a key revenue source for governments, helping to fund public services, infrastructure, and other essential functions. The... rates, creating a financial disincentive for tax avoidanceTax avoidance refers to the practice of legally structuring financial activities to minimise tax liability, reducing the amount of tax owed without violating laws. Unlike tax evasion, which is illegal and involves concealing income or misreporting, tax avoidance operates within the framework of the law. Multinational enterprises (MNEs) and individuals often engage in tax planning strategies that reduce tax liabilities.... In the UK, for instance, the DPT rate is 25%, compared to the corporate taxCorporate Tax refers to the tax imposed by governments on the income or capital of corporations. Corporations, considered separate legal entities, are taxed on their profits, meaning the income generated from their operational activities, investments, and other financial undertakings. This tax is generally a key revenue source for governments, helping to fund public services, infrastructure, and other essential functions. The... rate of 19% (as of 2024).
DPT has gained traction globally, with countries such as Australia and India implementing similar measures under different names.
Examples of Diverted Profits Tax in Practice
1. Google’s Operations in the UK
Google’s pre-2015 tax arrangements involved routing advertising revenue generated in the UK through Ireland, benefiting from its lower corporate taxCorporate Tax refers to the tax imposed by governments on the income or capital of corporations. Corporations, considered separate legal entities, are taxed on their profits, meaning the income generated from their operational activities, investments, and other financial undertakings. This tax is generally a key revenue source for governments, helping to fund public services, infrastructure, and other essential functions. The... rate. This arrangement leveraged the artificial avoidance of a PE in the UK. The UK government introduced DPT to counter such practices, ensuring that profits derived from UK activities were taxed domestically. Since DPT’s implementation, Google has agreed to pay hundreds of millions in back taxes and restructured its operations to avoid falling under DPT’s scope.
2. Australian Multinational Anti-Avoidance Law (MAAL)
Australia introduced its version of DPT in 2016 through the Multinational Anti-Avoidance Law (MAAL). One notable case involved a multinational mining company shifting profits to its Singapore trading hub, exploiting Singapore’s favourable tax rates. The Australian Taxation Office (ATO) used MAAL provisions to argue that the profits should be taxed in Australia, given the company’s substantial operational and decision-making presence there. The company was required to amend its tax filingsA Tax Return is a formal statement filed by an individual or entity that details income, expenses, and other pertinent tax information to a tax authority. Its primary purpose is to assess tax liability, determine refunds owed, or highlight outstanding taxes due. Tax returns may include information about earnings, capital gains, allowable deductions, and credits, depending on the tax regulations..., resulting in significant additional tax payments.
3. India’s Equalisation Levy
While not branded as DPT, India’s Equalisation Levy serves a similar purpose. Targeting digital businesses like Facebook and Amazon, it imposes a tax on revenues from online advertising and e-commerce services in India. In one case, an e-commerce giant claimed that its advertising revenue was not subject to Indian taxes as the operations were based offshore. The Indian tax authorities countered that the economic activity took place in India, invoking the Equalisation Levy to tax these revenues effectively.
Prominent Cases Involving Diverted Profits Tax
1. UK vs. Refinitiv and Others
The Refinitiv Ltd & Ors v HMRC case underscores the relationship between Diverted Profits Tax (DPT) and existing tax arrangements such as Advance Pricing Agreements (APAs)Advance Pricing Agreements (APAs) have emerged as a critical tool for managing transfer pricing challenges. APAs are formal agreements between a taxpayer—often a multinational enterprise (MNE)—and one or more tax authorities that pre-determine the appropriate transfer pricing methodology for specified intercompany transactions over a set period, typically up to five years, with the possibility of renewal. The primary purpose of.... Refinitiv, a multinational financial analytics firm, faced DPT charges of over £167 million for 2018, despite having an APAAdvance Pricing Agreements (APAs) have emerged as a critical tool for managing transfer pricing challenges. APAs are formal agreements between a taxpayer—often a multinational enterprise (MNE)—and one or more tax authorities that pre-determine the appropriate transfer pricing methodology for specified intercompany transactions over a set period, typically up to five years, with the possibility of renewal. The primary purpose of... with HMRC covering earlier periods. The APAAdvance Pricing Agreements (APAs) have emerged as a critical tool for managing transfer pricing challenges. APAs are formal agreements between a taxpayer—often a multinational enterprise (MNE)—and one or more tax authorities that pre-determine the appropriate transfer pricing methodology for specified intercompany transactions over a set period, typically up to five years, with the possibility of renewal. The primary purpose of... had outlined transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... methods up to 2014 but did not extend to later transactions.
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2. Chevron Australia Holdings Pty Ltd v Commissioner of Taxation
This Australian case involved Chevron’s intra-group financing arrangements designed to shift profits to a lower-tax jurisdiction. While primarily focusing on transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of..., the case underpinned Australia’s efforts to tighten DPT rules, influencing how profit-shifting strategies are scrutinised.