1.This section sets out the third of the three rules that can give rise to a charge on taxable diverted profits. In particular, it identifies arrangements designed to avoid the existence of a UK permanent establishment.
2.Subsection (1) sets out the conditions for the section to apply in relation to a foreign (non-UK resident) company. The starting point is that the foreign company has to be carrying on a trade in all or part of the accounting period (subsection (1)(b)), and a person (“the avoided PE”) is carrying on activity in the UK in connection with that trade (subsection (1)(c)). The condition at subsection (1)(e) applies if it is reasonable to assume that the avoided PE or foreign company (or both) designed any of their activity to avoid the carrying on a trade in the UK for corporation tax purposes. Further clarification on that is provided at subsection (4). Subsection (1)(f) requires either or both of two further conditions to be met. These are explained at subsections (2) and (3). section 86 does not apply if both the avoided PE and foreign company are small or medium-sized enterprises in accordance with the definition of the term at section 114.
3.Subsection (2) sets out the requirements of “the mismatch condition”, the first of the two further conditions mentioned at subsection (1)(f), in terms of provision (“the material provision”) made or imposed as between the foreign company and another person (“A”). The use of the term “provision” here is consistent with the transfer pricing rules at Part 4 of the Taxation (International and Other Provisions) Act 2010.
4.Subsection (3) sets out “the tax avoidance condition”, the second of the two further conditions mentioned at subsection (1)(f).
5.Subsection (4) provides clarification of a reference to activity of the avoided PE or the foreign company at subsection (1)(e). It makes clear that the term includes any limitation agreed or imposed in respect of that activity.
6.Subsection (5) disapplies the section where the foreign company would not be treated as carrying on a trade in the UK through a permanent establishment in the UK as a result of section 1142 (“Agent of independent status”) or 1144 (“Alternative finance arrangements”) of CTA 2010, and subsection (5)(b) applies. The further requirement of subsection (5)(b) is that, where section 1142(1) of CTA 2010 applies, the foreign company and avoided PE are not connected within the meaning of section 1122 of CTA 2010. This further requirement does not apply if the avoided PE is regarded for the purposes of section 1142(1) of CTA 2010 as an agent of independent status by virtue of section 1145, 1146 or 1151 of CTA 2010 (in relation to brokers, investment managers and Lloyd’s agents respectively).
7.Subsection (6) extends the trading activities of the foreign company in subsection (1) to include the trading activities carried on by a partnership of which the foreign company is a member. This includes supplies made by the partnership in the course of trade, which are treated as being made by the foreign company in the course of its trade. A provision made or imposed as between the partnership and another person is to be regarded as made between the foreign company and the other person for the purposes of subsection (2)(a).
8.Subsection (7) provides a definition of “arrangements” for the purposes of the section.
9.The diverted profits tax is a new charge on diverted profits. The main objective is to counteract contrived arrangements used by large groups (typically multinational enterprises) that result in the erosion of the UK tax base.