Domestic UK law imposes a 20% royalty withholding tax on limited types of payment and on specific categories of intellectual property. This year's Finance Bill expands the scope of intellectual property royalties that are subject to UK royalty withholding tax. UK businesses should review their intellectual property licensing agreements to determine the impact of these changes and may need to make tax treaty claims to reduce or eliminate withholding where applicable.
Currently, UK withholding tax applies to UK-sourced royalties that are paid to non-UK residents and which are for copyright (but not film or video recording copyright), for design rights, for public lending rights in respect of books and for patents. Payments for intellectual property that are 'annual payments' are also subject to withholding. Case law defines annual payments as sums which are 'pure income profit' for the recipient; this typically means that the receipts by businesses which incur expenses in generating income from intellectual property will not be pure income profit and so not annual payments. Payments to creative professionals for work created in the ordinary course of their business are typically treated as
payments for services and so do not attract any withholding tax.
The practical effect of the current rules is that there is a wide range of payments for the use of intellectual property to which no UK withholding tax applies, regardless of any double tax treaties or the EU Interest and Royalties Directive. In particular, it is uncommon for UK withholding tax to apply to payments for trademarks and know-how.
Royalty withholding post Finance Bill
This year's Finance Bill proposes to change all this. The key change will be to widen the scope of royalty withholding tax so that it applies to royalties paid in respect of 'relevant intellectual property', regardless of whether the royalties are annual payments or not. Relevant intellectual property will be defined to cover most types of recognised intellectual property right, including copyright, design rights, patents, trademarks and know-how (among others). Further changes will bring within the scope of withholding tax royalty payments made between non-UK residents in respect of intellectual property that is used by a UK permanent establishment. These changes are expected to have effect from Royal Assent to the Finance Bill, which typically occurs in late July but may be delayed this year until early September in light of the June Parliamentary recess to permit Brexit referendum campaigning.
In practice this will mean that royalties for trademarks and know-how come within the scope of UK royalty withholding tax for the first time, as such royalties currently do not attract a withholding unless they constitute a pure income profit of the recipient (which is unusual). It is hoped that the current exemption for film and video recording copyright will be preserved. Of course in many cases relief could be available under the EU Interest and Royalties Directive or an applicable double tax treaty, subject to the administrative burden of completing any necessary procedural formalities.
Finance Bill anti-treaty shopping
This year's Finance Bill also seeks to limit the benefit of UK tax treaties in respect of royalties. Essentially, treaty relief in respect of royalties paid between connected persons will not be available where "it is reasonable to conclude that the main purpose or one of the main purposes of the arrangements was to obtain a tax advantage by virtue of any provisions of a double taxation arrangement and obtaining that tax advantage is contrary to the object and purpose of those provisions". This change has effect from 17 March 2016 and echoes the OECD BEPS proposal for an anti-abuse test to be included in treaty limitation of benefits provisions.
UK businesses should review current intellectual property licensing agreements that involve payments to non-UK residents where currently they have no obligation to withhold UK tax. The aim will be to determine which party bears the economic cost of any withholding tax under the terms of the agreement. UK businesses may find that agreements require them to 'gross-up' foreign licensors for withholding tax, leaving UK businesses with an additional cost. In appropriate cases it may be possible to reduce or even eliminate that cost under the EU Interest and Royalties Directive or a double tax treaty, subject to any necessary procedural formalities. UK businesses should consider the prospects of treaty relief claims as a matter of urgency.
When negotiating who should bear any UK withholding tax cost in new intellectual property licence agreements, UK businesses should keep in mind the increased scope and significance of the UK's royalty withholding tax rules. It will become more important to ensure that
licence agreements include provisions requiring the parties to co-operate in making treaty relief claims (where possible) to reduce or eliminate any UK royalty withholding tax that might otherwise arise. Finally, intra-group licence agreements which rely upon a double tax treaty to reduce or eliminate UK royalty withholding tax should be reviewed to ensure that the treaty benefits will be preserved regardless of the new anti-treaty shopping rule.