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UK Diverted Profits Tax – disclosure facility introduced

  • United Kingdom
  • Tax planning and consultancy

08-02-2019

In January 2019, the UK tax authority HM Revenue & Customs (“HMRC”) introduced a new, pre-emptive disclosure facility that is aimed at promoting compliance for multinational groups falling within the Diverted Profits Tax (“DPT”) regime. Broadly, this scheme, the Profit Diversion Compliance Facility (“PDCF”), is designed to incentivise voluntary disclosures from large multinationals that are liable to account for DPT.

The PDCF has been introduced due to the perception of HMRC that there has been a low rate of compliance to date with the DPT. It is understood that HMRC has been analysing multinational businesses to assess those that could have potential DPT liabilities and have identified a relatively significant number of business at risk. HMRC states that it is planning a programme of investigations to target this risk group and have reportedly increasing staffing levels in its DPT investigation teams to undertake this programme. However, for obvious reasons HMRC would prefer voluntary disclosure and compliance, hence the PDCF.

With the possibility of a number of practical advantages, including reduced penalties for breaches of the DPT regime and a cessation of HMRC’s investigative powers, multinationals are being encouraged to sign up to the PDCF. However, based on guidance released by HMRC, the disclosure process is likely to be a fairly involved and substantial exercise and will require, amongst other things, robust transfer pricing and financial analyses. With this in mind, it is incumbent upon groups potentially falling within the regime to consider the disclosure process at the earliest opportunity. At the very least, this may enable groups to get ahead of a potential investigation.

This note sets out what the DPT is, who it affects, the key features of the PDCF and how taking advantage of the PDCF could be beneficial.

Diverted Profits Tax – What is it?

Since 1 April 2015, DPT has applied to multinational corporates with business activities in the UK that enter into arrangements which have the effect of diverting profits away from the UK tax regime. The objective behind the introduction of this tax was to counteract companies funnelling profits through overseas connected entities which effectively eroded the UK entity’s taxable base. In essence, the DPT is directed at ensuring that groups recognise and pay tax on profits where the underlying economic activities are carried out.

Broadly, DPT is levied at 25% of the “taxable diverted profits” (which can increase to 55% in the case of diverted profits for groups in the oil and gas sector). It should be noted that a specific exemption from the DPT exists for small and medium-sized enterprises.

DPT may apply (to accounting periods that ended on or after 1 April 2015) in the following two circumstances:

  1. A UK resident company, or the UK permanent establishment of a non UK company (a “UKPE”), enters into an arrangement with a related person (whether UK or non-UK resident) that lacks any economic substance and results in a reduction of the UK company’s or UKPE’s taxable profits; or
  2. A person (whether UK or non-UK resident) carries on an activity in the UK connected to the supply of goods, services or other property of a non-UK resident company in such a manner that it avoids creating a permanent establishment of that non-UK resident company.

Obligations to notify HMRC

There is a duty to notify HMRC if the company is potentially subject to DPT. Such a notification must be made in writing and within three months from the end of the accounting period to which the potential DPT charge might apply.

The Profit Diversion Compliance Facility

On 10 January 2019, HMRC released guidance on the PDCF, which is directed at multi-national companies who may be at risk to a DPT charge as a result of their transfer pricing arrangements.

The PDCF has been introduced to ensure that companies’ transfer pricing policies are in line with the OECD guidelines and if a company wishes to use the facility then it must adhere to stringent reporting obligations as set out in the guidance. To register for the PDCF, the company must make a disclosure of the facts for all relevant accounting periods to which it expects that DPT might apply. The key steps to making a disclosure are:

  1. The company must establish that it may have tax, interest or penalties to pay;
  2. It must register with HMRC;
  3. It must submit a report which includes a proposal to settle any tax, interest and penalties, where applicable, due; and
  4. It must make a full payment of the amounts owed under the proposal on or before the date that the report is submitted.

Further details of these stages are set out below:

1. Establishing that there may be tax, interest or penalties to pay

The PDCF guidance sets out the following non-exhaustive list of risk indicators of profit diversion:

  • General risk indicators include legal contracts between a UK company and a non-UK company which allocate key risks to the overseas company which are purported to support a “limited or reduced reward” for the UK company where control of those risks are performed by the UK company. Such legal arrangements can include: commissionaire structure; limited risk distributors toll or contract manufacturing arrangements; or contract research and development arrangements.
  • Sales, marketing and distribution risk indicators include important regional operational functions or key sales and marketing functions (i.e. key account management) being based in the UK where the profits of such entity route to an overseas company in a low tax territory that contributes minimal related functionality.
  • Supply chain risk indicators include the organisation of supply chains where non-UK companies in low tax jurisdictions become part of the supply chain and the reward to the UK company is reduced. This can also include payments by UK companies to overseas procurement or sourcing entities in low tax jurisdictions with limited functionality relative to the UK procurement function.
  • Research and development risk indicators include UK R&D functions being used for the purposes of R&D expenditure credit or patent box claims but then described as low value for transfer pricing purposes and the UK company being rewarded poorly.
  • Intangibles risk indicators include a non-UK company holding legal title to valuable intangibles and is rewarded by reference to residual profits on those assets but either: the functions of that entity are low value; a UK entity performs key functions in relation to the intangibles; headcount in the overseas entity is modest in relation to the scope of the functions driving the value or the reward is said to be due to the activities of the non-UK company which are contracted out to group operating entities based in the UK.

2. Registering with HMRC

Registration of one’s intention to disclose and sign up to the PDCF is done by filling in the registration form appended to the guidance and emailing it to HMRC.

3. Submitting the report

A report must be submitted within six months of registering a disclosure and the report can be submitted by one company on behalf of the group. The PDCF particularises the key items that will need to be provided within the report and have confirmed that it should include: the relevant facts and evidence for HMRC to consider; the application of tax law to those facts; conclusions on what penalties should be proffered; the proposal for settling all liabilities and a declaration signed by a senior officer of the company.

HMRC will require a significant amount of detailed information from companies that subscribe to the PDCF. Collating the information will likely be a substantial exercise and one that, in many cases, is likely to be particularly time and cost intensive. HMRC expects that the facts and evidence section should include, amongst other things:

  • The relevant facts and evidence gleaned not only from documentation, but also from interviewing staff, customers or supplies and from contemporaneous communications
  • Details of any arrangements that could be subject to DPT
  • Corporate group facts and context (including addresses of group companies and directors
  • The UK company’s P&L accounts analysed by reference to the current transfer pricing policy
  • •Staff profiles (including the functions of key persons and locations of employees)
  • Cost and revenue profiles of relevant non-UK companies; constitutional documentation (including board minutes) details of asset (tangible and intangible) ownership
  • UK sales reported by non-UK entities

The tax analysis should include a technical transfer pricing analysis and a comparison of the DPT-related arrangements against comparable arrangements. Full technical analysis of, amongst other things, DPT, corporate residence, withholding tax and permanent establishment is also expected.

The report should, having considered the relevant facts, law and the behaviours that have led to the underpaid tax, set out a proposal to settle all outstanding liabilities including tax, interest and, where applicable, penalties for all relevant accounting periods.

4. Penalties

Where HMRC find that there is additional tax due, the behaviours that gave rise to the error, including the timing, manner and quality of any disclosure, will be considered in determining any applicable penalties. While the standard HMRC penalty provisions will apply for failures which relate to the DPT, the PDCF offers companies the following key concessions:

  • HMRC will not open an investigation into potential DPT or other liabilities arising from the arrangements during the period that the company is preparing the report and engaging with the PDCF
  • HMRC may agree not to take any further action in respect of DPT or transfer pricing if proposed changes arising out of the PDCF are appropriate
  • “Unprompted disclosures” from companies that are not already under investigation will be subject to a lower minimum penalty than a prompted disclosure
  • The penalty for inaccuracies that are disclosed unprompted may, in certain circumstances, be reduced to nil. They may also be suspended on conditions

Other advantages

In addition to the mitigation of penalties, multinationals may be minded to take advantage of the PDCF as a tool to improve compliance and obtain greater certainty around historical DPT risk. Corporate groups may also benefit from first-mover advantage and from regularising their tax affairs in advance of a potential HMRC investigation, in the hopes of streamlining any such inquiry and managing the associated impact on the group. Accordingly, any multinational group which considers that it may fall under the DPT rules is encouraged to contact its tax advisors to discuss next steps.

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