Paying royalties to non-residents
Extending the obligation to deduct tax at source
Currently, UK companies paying royalties to persons overseas have to deduct tax at 20% if the royalties relate to a patent or are ‘pure income profit’ (rather than part of the profits of a trade).
Under provisions included in the Finance Bill currently before Parliament, from 28 June 2016 the obligation to deduct tax is extended to any royalty, or other payment for the use of (or for the right to use) intellectual property.
The impact on companies
This has no practical effect for companies paying royalties to an overseas country where the double tax treaty with the UK provides for a nil-rate of withholding tax; under existing legislation they can apply that nil-rate without specific clearance from HMRC. Examples are the treaties with France, Germany, the Netherlands, Switzerland and the USA. In addition, payments to companies within the EU remain (for the moment) exempt from tax under existing provisions implementing the Interest and Royalties Directive if, broadly, one company owns 25% of the other or they are in 25% common ownership.
The change will, however, be significant for companies making payments to countries where the treaty provides for a reduced (but not a nil) rate, or to countries where there is no treaty. Examples of such reduced rates are Australia (5%), China (10%), India (15%) and Italy (8%). If appropriate deduction is not made, HMRC will require payment of the sum concerned, together with interest and penalties. In most cases such deduction of tax at source will be no more than an administrative inconvenience for the recipients, because credit will be available for the UK tax against their tax liability in their country of residence.
Treaty shopping provisions
The Finance Bill also includes provisions under which the obligation to deduct tax is to be determined without reference to any relevant double tax treaty if a payment is made is made to a connected person on or after 17 March 2016 under arrangements that are intended to obtain a tax advantage from a treaty contrary to its object and purpose. This is intended to counter ‘treaty shopping’ arrangements under which royalties from the UK to another country are routed via a third country.
Permanent establishments in the UK
In addition, the obligation to deduct tax is extended to payments made by a non-resident company on or after 28 June 2016 in connection with a trade carried on by it through a permanent establishment in the UK.
For further information please contact your usual advisor at Moore Stephens.