The tax treatment of royalty payments has long been a contentious matter on a number of levels. Of course the we know that the OECD BEPS project has sought to tighten up the use of royalties (amongst other things) to erode the taxable base of a particular company or country but the other element of royalty taxes is the withholding tax – the amount the paying company is required to deduct and hand over to the local tax authority as the royalty is paid.
The UK has always been rather liberal in its approach to the treatment of withholding tax on royalty payments. First of all the UK definition of ‘royalty’ as per the tax statute is drawn narrowly when compared to other jurisdictions. We know this because we spend a lot of time explaining to our clients why other countries are applying withholding taxes to things that we don’t recognise as royalties. This is now going to change and the UK definition of royalties will be expanded, most likely to be consistent with other countries views on the matter – and that means more transactions with withholding tax.
Secondly, when considering whether withholding tax should be applied one has to consider where the ‘source’ is. This is not a statutory concept but rather a case law concept defined by similar source issues in the area of interest payments. It’s been a little hazy and a little uncertain for a long time as to when a royalty has a UK source or not, and some taxpayers have argued that even though they are taking deductions for the royalty payment in a UK tax computation the royalty does not itself have a UK source. So HM Treasury are changing that – if you want a deduction then it is within the withholding tax regime. This change perhaps signals that interest source will also be tackled in due course.
Finally, if domestic withholding tax applies we need to look to the relevant tax treaties and European directives. It has been the way for a number of years that taxpayers ‘treaty shop’ that is to say if withholding looks like it is due an extra entity is added into the chain which is resident in a helpful jurisdiction with whom the UK has a favourable treaty The Treasury are introducing a targeted commercial purpose rule that allows HMRC to deny treaty benefits where the main purpose or one of the main purposes is to secure a tax advantage. Whilst this rule is not sat within a treaty itself (and so technically treaty law overrides domestic law) it is unlikely to be the case that another treaty partner takes this point in the context of the BEPS project.
So plenty of change to long standing practice, albeit understandable and perhaps a surprise it has taken so long.