The Profit Diversion Compliance Facility

HMRC has announced that it is introducing a facility for multinational enterprises (MNEs) using arrangements which might be viewed as targeted by the Diverted Profits Tax (DPT) legislation or having transfer pricing arrangements inconsistent with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations dated July 2017 (the OECD Guidelines). The new facility is designed to encourage MNEs to bring their tax affairs up to date without risk of investigation by HMRC if full and accurate disclosure is made. HMRC make the point that tackling profit diversion is a priority for the Department, which has invested in new teams of investigators and is undertaking a programme of investigations into MNEs in a variety of business sectors which could be diverting profits.

Background

Tackling diversion of profits was a major theme of the OECD’s Base Erosion and Profit Shifting (BEPS) project and has resulted in several changes to international tax rules, including an increased focus on allocation of profits to where the profit-generating business activities are located rather than based on contractual allocations of risk and legal ownership. In the UK, the DPT legislation was introduced to further deter and counteract activities that divert profits from the UK to low tax jurisdictions.

The Facility

HMRC believes there are two broad risk areas leading to profit diversion for transfer pricing:

• a misalignment between the fact pattern described in transfer pricing documentation and how it has been implemented in reality; and
• the transfer pricing analysis being inconsistent with the OECD Guidelines.

The new Facility is intended to encourage MNEs with arrangements that exhibit these features, including those falling within DPT, to review the arrangements and their transfer pricing policies, change them if appropriate and use the Facility to put forward a report with proposals to pay any additional tax, interest and, where applicable, penalties due.

PDCF also goes broader than DPT and transfer pricing and considers a range of international tax issues that are related to the arrangements, including Permanent Establishment (PE), withholding tax (WHT), company residence, controlled foreign companies (CFC), anti-hybrids and indirect tax such as VAT.

One of the advantages of the Facility is that an MNE that registers may regularise its tax affairs without investigation by HMRC with (where relevant) lower (unprompted) penalty treatment. In particular, HMRC will not charge penalties for certain careless inaccuracies in returns or failure to notify for DPT, as set out in the Facility. HMRC is setting up a dedicated team to run the Facility to provide an accelerated process with the advantage of providing certainty for the past and low risk for future activities.

HMRC will not require a technical analysis as to the application of the DPT rules and any proposals can be made on a without prejudice basis. HMRC will not regard the making of a proposal under the Facility as indicating that the MNE thinks DPT could, or should, apply. However, the Facility will not be available if HMRC has already opened enquiries into any profit diversion issues.

Where an MNE wishes to take advantage of the Facility, they will need to register and make a full and accurate disclosure of the facts through the preparation of a detailed Report for all relevant accounting periods, using reasonable endeavours to determine the correct amount of tax payable, based on the application of the arm’s length principle and pay any outstanding tax at the time of the submission. The accounting periods covered must include all those prior periods in which the disclosed arrangements operated to the extent that HMRC is within the relevant time limits to assess those periods.

The Report must be submitted within six months of registering for the Facility. HMRC will aim to respond to the proposal within three months. Once an MNE has registered for the Facility, HMRC will not investigate potential DPT or related (eg corporation tax, CFC, WHT, VAT etc.) liabilities during this period, as long as HMRC is satisfied with the Report and the analysis and conclusions are consistent with the arm’s length principle. HMRC will confirm a low risk outcome for profit diversion going forward.

If HMRC are unable to accept the proposal then HMRC will discuss their concerns with the taxpayer and seek to reach a mutual settlement.

The requirements for the report to be submitted with the proposal are very detailed and effectively require the MNE to take the position of an HMRC Inspector. Essentially, the report must include six sections:

• a description of the relevant facts referenced to the evidence from which they are derived;
• an analysis of the application of the tax law to the facts and the conclusions reached (can be disclosed on without prejudice basis);
• an analysis of the behaviours investigated and the conclusions reached on the application of penalty provisions (can be disclosed on without prejudice basis);
• the proposal being made to settle all outstanding liabilities (can be disclosed on without prejudice basis);
• a signed declaration by a senior responsible officer within the group on behalf of the entity or entities certifying that to the best of their knowledge and belief it is a full and accurate disclosure of the facts; and
• an annex listing the evidence that supports the facts referred to in the report.

Chapter 4 of the Facility provides extensive detail on each of these sections.

Comment

The Facility is being touted as something of a last chance for MNEs to regularise their DPT and TP positions before HMRC get tough on non-compliance.

HMRC clearly regard some MNEs as maintaining untenable positions and make the point that their investigations “to date have established that in a large number of cases the factual pattern outlined to HMRC at the start of an enquiry does not stand up to scrutiny once tested. That may be a result of a careless error (for example individuals within a group being unaware of what the actual facts are) but it may also be a result of a deliberate behaviour, that is a group knowingly submitting a TP methodology in a Corporation Tax Return based on a false set of facts. A common issue is “an overstatement of functions performed, assets used and risks assumed in entities taxed at lower rates, and an understatement of the functions performed, assets used and risks assumed in the UK”.

Clearly HMRC would prefer MNEs to disclose significant tax uncertainties and ensure compliance through the Facility, but whilst there is no formal deadline for the Facility, the threat now exists that HMRC will launch a concerted round of investigations into those businesses and sectors that they regard as high risk and who do not avail themselves of it.