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Diverted profits tax driving up HMRC tax challenges, expert says

More challenges over diverted profits tax (DPT) appear to be driving up the amount of tax HM Revenue and Customs (HMRC) suspects large companies operating in the UK of underpaying, an expert has said.26 Oct 2017

The amount that HMRC believes may have been underpaid by large companies through the use of transfer pricing arrangements increased by 51% last year to £5.8 billion, up from £3.8bn in 2015/16, according to figures obtained by Pinsent Masons, the law firm behind Out-Law.com. The increase corresponds with an increase in enforcement activity around DPT, which was introduced in April 2015.

"The tax affairs of the UK's largest businesses are a top priority for HMRC, particularly the use of cross-border structures including the possible manipulation of pricing methods," said tax expert Ian Hyde of Pinsent Masons, the law firm behind Out-Law.com.

"DPT is being applied much more widely than was anticipated when the rules were first introduced. In some cases, HMRC is using DPT to get a second bite of the cherry in respect of existing structures. Businesses may have thought they had cleared the tax position by obtaining an advanced pricing agreement (APA) on the transfer pricing issues, but now that DPT is available that may not be the case," he said.

HMRC has also been investing in more transfer pricing specialists, particularly in the run-up to the introduction of DPT, Hyde said. This "is clearly reflected in the figures", he said.

Businesses often enter into advanced pricing agreements (APAs) with HMRC, which determine the appropriate transfer pricing method that the business should use for a set period of time. However, any transaction not explicitly included in an APA that was entered into before DPT came into force could still be challenged by HMRC under the new rules.

DPT was introduced to counter the use of "aggressive tax planning techniques used by multinational enterprises to divert profits from the UK", according to HMRC's own guidance on the tax. It is charged at a rate of 25%, as opposed to the corporation tax rate of 19%, and has its own regime within the 2015 Finance Act entirely separate from corporation tax self-assessment.

The tax is charged on arrangements that either exploit the permanent establishment rules, or which use entities that lack economic substance. An example would be where a foreign company takes tax out of a UK subsidiary through a large, tax deductible payment to an associated entity in a low-tax jurisdiction.

HMRC normally has two years from the end of the relevant accounting period to issue a DPT notice, which means we are likely to see a "flurry" of notices issued over the next few months in relation to 2015 DPT liability to companies with 31 December year ends, Hyde said. In order to charge DPT, HMRC must first issue a preliminary notice, which gives the company a very limited opportunity to make representations against a DPT charging notice. Once the charging notice is issued, the tax demanded has to be paid in full and usually cannot be appealed for another 12 months while HMRC reviews the notice.

Many DPT disputes end up as transfer pricing disputes, as transfer pricing relates to the pricing of a transaction when two companies which are part of the same multinational group trade with each other. Setting an appropriate transfer price is a difficult exercise in complex transactions, so disputes are common. Transfer pricing now accounts for 23% of the £25bn large business tax under consideration by HMRC, up from 17% of the £21.8bn under consideration at the end of the previous tax year, according to Pinsent Masons.

Figures released last month showed that transfer pricing enquiries are now taking longer to settle, with enquiries settled in 2016/17 taking an average of 28.8 months to settle compared to 27.6 months the previous year. Typically, around half of the tax under consideration by HMRC is actually due once full investigations have been completed in every case.

"An increase in transfer pricing investigations by HMRC is likely to lead to an increase in international tax disputes for multinationals," said tax expert Ian Hyde. "Transfer pricing disputes are complex, and are notorious for often taking a very long time to resolve."