What is Diverted Profits Tax?
Diverted Profits Tax (DPT) is an anti-avoidance tax that can apply to multinational enterprises (MNEs) with business activities in the UK. It counteracts arrangements that divert profits away from the UK by enabling foreign companies to avoid creating a UK permanent establishment or using transactions and entities that lack economic substance. DPT is charged at 25% on diverted profits, which is significantly higher than the current rate of corporation tax.
HMRC has already raised a number of enquiries into this relatively new tax. A substantial number of those enquiries have resulted in a DPT liability and associated penalties being assessed. HMRC believes that some MNEs have adopted cross-border pricing arrangements that bring them within the charge to DPT, but have not self-assessed or paid DPT. This would occur when, for example, the arrangements are based on an outdated fact pattern or the contribution of UK staff has been undervalued. HMRC is also concerned that, even where transfer pricing policies are appropriate, these are not always followed in practice.
The Profit Diversion Compliance Facility
In response to this underassessment, HMRC launched the Profit Diversion Compliance Facility (the Facility) in January 2019. The Facility enables MNEs to voluntarily disclose arrangements that might have brought them within the scope of DPT and calculate a settlement payment.
Since the launch of the facility HMRC has issued a number of letters to MNEs where it has identified risk factors, encouraging use of the facility to disclose arrangements where the taxpayer believes that there may be tax due under the rules or where they believe that no tax is due but the position is particularly complex or there is technical uncertainty. The letter gives the taxpayer 90 days to register and HMRC has indicated that where a letter is sent and no response is received, it is highly likely to open a formal investigation.
Voluntary disclosure under the facility allows a company to retain some control over the discussions with HMRC, and is less expensive than complying with a potential HMRC enquiry. Once a company has registered, HMRC will not open an enquiry into the DPT arrangements, Controlled Foreign Company rules or related matters during the period allowed for the completion of the review and disclosure report. This is dependent on a full and accurate disclosure, a reasonable endeavour to determine the correct liability, payment of all outstanding liabilities, and full co-operation throughout the process.
HMRC has also confirmed that where HMRC has not yet opened an investigation into profit diversion and MNEs use the facility to put forward a report with proposals to pay any additional tax, interest and, where applicable, penalties due, this will be deemed an ‘unprompted’ disclosure for tax-geared penalty calculation purposes. This a key benefit of using the facility.
Following the first few months of the Facility’s operation, HMRC has reiterated that disclosure is not treated as an admission of a DPT liability. The Facility can be used to demonstrate that a company is not subject to DPT if the position is unclear or complex. The disclosure process involves constructive and early engagement with HMRC to discuss the facts and highlight concerns before submission. The DPT liability is typically settled through adjustments to the company’s transfer pricing position, thus increasing the taxable UK profits and corporation tax liability and removing the company from the scope of DPT.
Should my company use the Facility?
Exposure to DPT is a significant risk where transfer pricing policies are out of date or do not genuinely reflect the current commercial reality. MNEs that are likely to have a DPT exposure should consider using the Facility to take advantage of an expedient process, access to specialist staff and reduced penalties. Upfront disclosure using this Facility should provide some control over a DPT review process and reduce time commitment when compared to a lengthy enquiry process.
HMRC have indicated that DPT remains an area of priority for them and, while their programme of issuing letters paused in light of the COVID-19 pandemic, this has resumed as of September 2020.
What can S&W offer?
S&W can assist with reviewing existing arrangements, deciding whether to use the Facility, and navigating the reporting and settlement processes. We can ensure that information presented to HMRC is fair and meets their requirements, considering both HMRC’s Guidance and our experience to date. Alternatively, we can assist with reviewing and updating your company’s transfer pricing policy, identifying areas of risk, and putting controls in place to minimise the exposure to DPT investigations by HMRC. S&W has experience in relation to transfer pricing and DPT enquiries and settlements and is 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. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. 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 writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.