25 October 2016
Before the 2016 Budget, royalty payments abroad were subject to a deduction of UK Income Tax at source. The UK domestic rate of withholding is 20%. Payments comprised, amongst other things, the following intellectual property (IP):
- certain copyrights (with restrictions) for the use of commercial and industrial knowhow;
- a right in design;
- royalties etc. in respect of the use of patents; and
- payments of royalties etc. that are annual payments.
Broadly, the new royalty tax regime has broadened the concept of IP. The new definition came into effect 28 June 2016 to extend the UK’s withholding tax rights to payments for the use of intangible assets such as trademarks and brand names, as well as all payments that currently fall within the current rules. This means for UK purposes, nearly all IP is regarded as being classed as a royalty. HMRC recognise that the recipient country has taxing rights over such royalty income.
HMRC has retained UK taxing rights under the 20% withholding tax regime over UK sourced payments made. This means to avoid having withhold UK Income Tax, the recipient country must rely on the relevant Treaty with the UK to reduce the withholding tax rate or to eliminate it.
The UK payer may also rely on the EU Directive; where the Directive applies to the recipient and the payer and recipient are related for the purposes of the Directive.
HMRC will scrutinise whether the royalty paid between connected parties is excessive, or where the payer and recipient are seeking to benefit from a double taxation agreement and this structure was established for tax motivated and uncommercial reasons. Where this is the case, HMRC will cancel the benefits of a Treaty claim in relation to royalty payments.
Finally, the new royalty tax regime has been extended to include UK source royalties that are paid overseas by the UK taxable branches (“PEs”) of overseas companies. The role of the UK PE might be to sell products and services in the UK, or to market these for sale by its overseas head office. Such a sale, whichever entity generates it, may give rise to the creation of a licence to use the company’s IP, which in turn gives rise to a royalty stream. This in turn gives rise to a UK source royalty which will be worked out on pro-rata or just and reasonable basis for the purposes of the new regime.