When is an amnesty not an amnesty? When the carrot is the (possible) absence of stick.
HMRC announced today the introduction of their new Profits Diversion Compliance Facility (PDCF). This is a way for multinationals to take the initiative and explain their legal and operational structures before HMRC launch their next wave of full-scale “transfer pricing” investigations into corporates. The PDCF will be particularly relevant to groups with long established transfer pricing models which HMRC now believe need updating, and will allow groups to retain greater control of the process.
We believe HMRC is serious about launching that next wave of investigations. It may well start in early 2020.
Full-scale HMRC investigations are intrusive. HMRC is also confident that when they launch investigations they will recover significant tax. This is based on what they see as recent high-profile successes. There is also a real prospect that a corporate subject to one of those investigations will suffer penalties. So 2019 is a window of opportunity.
Four points of background are critical
First, HMRC’s guidance on the PDCF states that the authority may send letters to companies identified as having indicators of profits diversion (see below on data analytics), suggesting that they consider using the facility. Penalties are more likely to apply where companies receive such letters but have not registered to use the facility.
Second, HMRC is no longer accepting transfer pricing arrangements that have been widely accepted by tax authorities in the past. This even includes arrangements that HMRC previously accepted itself in Advance Pricing Agreements, or after lengthy investigations. It also includes arrangements that many transfer pricing advisors in the US (and elsewhere) still believe are technically robust, a rather puzzling picture explained by fundamental differences of interpretation and law across the two sides of the pond.
Third, in 2015 HMRC introduced a new tax (the “Diverted Profits Tax” or DPT) specifically aimed at transfer pricing arrangements or models that it considered lack proper economic justification. Until now its focus in applying the tax appears to have been on the largest and most high-profile groups (largely tech giants). With those investigations nearing conclusion, HMRC is actively looking to cast its net more widely, to tackle other groups it believes are still avoiding their obligations to pay the right amount of tax.
Fourth, technology firms with valuable IP that have adopted “old-style” transfer pricing models are particularly at risk. HMRC has created new teams and extra staff to handle the workload, and has indicated that it has used data analytics to identify companies that it sees as posing the greatest risk to the UK Exchequer. Both large and mid-sized companies are potentially affected.
The new facility will require a review of past years (typically back to 2015) as well as current years, and will likely give some comfort for future years. Although the PDCF focuses largely on transfer pricing and diverted profits tax, HMRC’s guidance makes it clear that taxpayers using it will also need to consider corporate residence, permanent establishment, withholding tax, controlled foreign companies, and hybrid and mismatch rules.
With the threat of penalties hanging over groups that ignore the facility, but who are subsequently found to fall short of what HMRC expects, the new facility applies an approach HMRC has used to great effect in relation to high net-worth individuals: it effectively looks to turn the approach to normal corporate tax investigations on its head. It asks the taxpayer to do work that HMRC investigators would otherwise do themselves, produce a detailed report, and then make a proposal for additional tax to be paid. This will be a significant task, but may well still be the lesser of two evils, at least for some groups. As indicated, it:
- will allow groups to retain control,
- should be significantly less intrusive than a full-scale investigation,
- should allow groups to avoid penalties, and
- may well provide some level of assurance about future tax positions.