What is Diverted Profits Tax?
Diverted Profits Tax (‘DPT’) can apply to multinational enterprises (‘MNEs’) with business activities in the UK. It counteracts both arrangements that allow foreign companies to avoid creating a UK permanent establishment and arrangements that create a tax advantage by using transactions or entities that lack economic substance.
HMRC has already raised a number of enquiries into this relatively new tax and a large number of those enquiries have resulted in a DPT liability materialising and associated penalties being raised.
HMRC believes that some MNEs have adopted cross border pricing arrangements which would bring them within the scope of DPT. For example, the arrangements could be based on an incorrect fact pattern because the business has changed over time, or the contribution of staff in the UK has been undervalued.
HMRC's Profit Diversion Compliance Facility Launched
On 10 January, HM Revenue & Customs (‘HMRC’) announced the launch of a new Profit Diversion Compliance Facility (‘the Facility’) for MNEs to voluntarily disclose information on arrangements that might take them within the scope of DPT, before HMRC initiates a compliance check. The Facility gives relevant taxpayers an opportunity to take control (for a time at least) of their own enquiry.
In exchange, and as long as registration has occurred before 31 December 2019, HMRC will treat the disclosure as ‘unprompted’ for determining penalties. HMRC will not charge penalties for inaccuracies in tax returns if the MNE has taken reasonable care and will not charge penalties for failure to notify HMRC of a DPT liability if the MNE has a reasonable excuse.
Further, once registered, HMRC will not seek to enquire into the potential DPT arrangements, Controlled Foreign Company or related matters during the period HMRC allows for the completion of the review and disclosure report (‘Report’). This is provided that a full and accurate disclosure of the facts for all relevant accounting periods is included in the Report, the MNE has used reasonable endeavours to determine the correct amount of tax payable based on the application of the arm’s length principle to its facts, paid all outstanding liabilities, and fully co-operated throughout the process.
We understand that HMRC will issue warning notices to businesses that are considered to be high risk inviting them to consider registration under the Facility. The Facility is not available to those businesses under review with respect to profit diversion.
The Facility is now open for registration and all relevant profits generated from 1 April 2015 can fall within the scope of the Facility, if the period in question is within the relevant time limits for amendment.
It should be noted that BEPS principles on mismatches will be applied by HMRC in determining appropriate risk areas to focus on during their review of the Report. These can include any mismatch between location of intangibles and associated technology teams, marketing and distribution functions and associated profits and location of senior level individuals and business activity.
The Process for Taxpayers
HMRC confirmed that DPT enquiries are usually settled by an adjustment to the group transfer pricing policy. If a MNE is confident that its transfer pricing is up to date and that it is paying the right amount of Corporation Tax, then it should not use this Facility. It is therefore recommended that, before registering with the Facility, MNEs should review and discuss their current transfer pricing arrangements with their advisors to determine whether or not registration is necessary and / or advisable.
- Registration - registering with HMRC should be done by emailing the prescribed form to HMRC and arranging a Registration Meeting to explain the plans for and timings of the Report. One UK entity can register on behalf of all UK entities involved in the disclosed arrangements. HMRC will acknowledge the registration within 14 days and will usually want to arrange the timings for the Registration Meeting at that point.
- Report – the Report will have to be submitted to HMRC within 6 months of registration, either by email or on an encrypted USB device. HMRC will aim to acknowledge the receipt of the Report within 14 days. The Report must follow the format described by HMRC in its Guidance and can be submitted by one UK entity provided the declarations at the end of the Report cover all relevant entities. HMRC is offering the option of a face to face meeting during the 6 month period to present the key points in the Report to HMRC; a ‘Pre-submission Meeting’. This will allow HMRC to identify any “showstoppers” or areas where further work or consideration might be required in the Report.
- Payment - The payment of the proposed DPT liability is to be made on or before the date the Report is submitted.
- Response - HMRC will aim to respond within 3 months.
- Post settlement - In accordance with existing Guidance at INTM483130, the only way in which a business may be able to gain certainty in relation to future years is through the formal Advance Pricing Agreement (‘APA’) process. However, where there has been no significant change in circumstances or conditions, a future return made on the basis agreed under the Facility is likely to be looked upon as presenting a low tax risk.
The content of the Report
The Report should be divided into six separate sections which include a description of the relevant facts and how the facts were obtained in relation to the DPT transactions (‘Disclosed Arrangements’); an analysis of the applicable tax law and a proposal for the calculation and settlement of the amount of tax and associated penalties due. There should also be a signed declaration by a senior responsible officer within the group using the prescribed narrative and an annex listing the evidence that supports the facts referred to in the Report.
HMRC has provided a significant amount of information on what may be included in the Report but the detail required will depend on the level of complexity of the transactions. At a minimum you should include the following three areas in the Report:
- UK P&L information - for each UK entity for the relevant period, a P&L account split between external and internal transactions, with the internal transactions split further by transfer pricing policy. This segmented P&L information should tie in to the relevant financial statements.
- Staff profiles – factual information on the number of staff members in each relevant location and the responsibilities that they have.
- Profile of non-UK entities - the profile of each overseas entity, including the operating profit profile, splitting out the different types of income and expenditure and making it clear where there are related party transactions.
On reviewing the Report, HMRC will be looking for other profit diversion risk areas, for example, company residence issues, withholding taxes, hybrid and other mismatches. It is therefore imperative that MNEs, alongside their advisors, thoroughly review the Report before submission to ensure that all relevant facts are presented correctly.
MNEs who consider it more likely than not that they have a DPT exposure could consider using this Facility to take advantage of an expedient process, access to specialist staff and reduced penalties.
The Report drafting process will certainly take up management time and incur costs. However, disclosure upfront using this Facility should provide some control over a DPT review process and could reduce time commitment when compared to a lengthy enquiry process.
What can S&W offer?
MNEs should only be using this Facility if there is a risk that their transfer pricing policies are not up to date or are not genuinely reflecting current commercial reality. As a first step S&W can therefore review existing arrangements and help the MNE decide whether to use the Facility. S&W can then help MNEs navigate the Facility and the associated reporting / payment processes and ensure that information presented to HMRC in the Report is fair and consistent with what has been requested by HMRC in both its Guidance and dialogue with S&W to date. Alternatively, the MNE should consider updating its transfer pricing documentation to minimise the exposure to DPT investigations by HMRC; S&W can also assist with this.
S&W have relevant experience in relation to transfer pricing and DPT enquiries and settlements and so are well placed to advise in this complex area.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.