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Are UK staff doing the development work for your overseas Distributed Ledger Technology (DLT) company?
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In our previous article (click here), we talked about groups setting up DLT companies in jurisdictions which already have a regulatory framework, such as Gibraltar. A group which is working on applying DLT to its business will be creating intangible assets, and will therefore need to look at the tax issues which apply to such activity. There are a number of countries which have specific innovation regimes. However, one of the key factors is where the group has staff with the capability to develop these intangible assets, since transfer pricing within the group will focus on where the functions which create value are actually being undertaken. If it is not possible to move the staff to the countries offering an "innovation box", then the tax benefits will be difficult to access.
This article considers the situation where the staff within a group who will develop DLT are located in the UK, while the ownership of the technology is in the DLT company in, for example, Gibraltar.
If UK staff within the group work for the Gibraltar DLT company, then HMRC may consider that the Gibraltar company has a UK permanent establishment, to which taxable profits should be attributed. There is a further issue specific to the UK. If the Gibraltar DLT company has "avoided a taxable presence in the UK", while there is UK activity in relation to sales, then it could be subject to UK corporation tax at a higher rate of 25%, under the Diverted Profits Tax, if the group is "large".
If a UK company participates in developing the intangible assets of the Gibraltar DLT company then HMRC are likely to argue that it should be reimbursed by a share of profits, rather than on a "cost plus" basis. For a UK company which is "small or medium sized", transfer pricing does not generally apply. However, it does still apply to provisions between the UK and "non-qualifying" territories. In particular, transfer pricing would apply to work on developing DLT undertaken in the UK, where the DLT company is located in Gibraltar or Cayman, which have DLT regulatory frameworks.
For example, if a group is considering using staff of a UK company to develop the DLT software for the Gibraltar DLT company, then there are likely to be substantial UK taxable profits arising if the DLT business is profitable. It is then worth considering whether research and development (R&D) tax relief is likely to be available. There is no requirement that the UK contracting company should own the IP which it develops. In general, a UK company which is contracted to provide services to a group DLT company can claim RDEC (R&D expenditure credit), and this claim can be made even where the company is not yet making taxable profits.
For R&D relief to be available on software, the development must directly contribute to achieving an advance through the resolution of scientific or technological uncertainty, and there must be an advance in overall knowledge or capability in a field of science or technology, not just the company's own state of knowledge or capability alone. Pioneers in DLT technology may well expect to meet these conditions.
In conclusion, if the technology for a Gibraltar DLT company is being developed in the UK, then the profits attributable to the UK activity need to be considered on transfer pricing principles, even for a small or medium sized group. Equally, the potential tax benefits of R&D credits in the UK should not be overlooked; they could be particularly valuable to the group in the pre-revenue stage of its development.
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