Diverted profits tax: ready or not?

Publication June 2017


Introduction

It is now two years since diverted profits tax (DPT) was introduced. Up to now, there has been uneven engagement by both taxpayers and HMRC. This is changing. HMRC have started to issue protective payment notices.

What is behind HMRC issuing DPT notices is that, where a taxpayer has notified that it is potentially within the scope of DPT, HMRC have two years from the end of the relevant accounting period to issue a DPT notice. If no notice is received within this period, HMRC will be unable to impose DPT for that period. So for groups with a September year end, the deadline for HMRC to issue a DPT notice in respect of the first period potentially subject to DPT is September 30, 2017. For December year end groups, the deadline is December 31, 2017.

Companies which receive a DPT notice will be required to pay within 30 days. No appeal is possible for 12 months. So it may be necessary to fund the DPT payment for a number of years.

It is expected that groups with ongoing transfer pricing disputes are particularly at risk of receiving DPT notices. By serving a notice, HMRC are entitled to receive payment of the tax upfront and charge the tax at a higher rate. This imposes considerable pressure on taxpayers to settle such disputes prior to the DPT deadline. Equally taxpayers have to be prepared to fund the tax due. Briefing June 2017

DPT timetable

The timetable is as follows

  • Companies that consider they may be within the charge to DPT are required to notify HMRC of the fact. That notification is required within three months of the end of their accounting period (SIX months for accounting periods ending on or before March 31, 2016).
  • Following notification, HMRC have two years from the end of the relevant accounting period to issue a preliminary notice.
  • The company then has 30 days to respond to the preliminary notice.
  • HMRC then has a further 30 days to issue a charging notice specifying the DPT payable.
  • The company has 30 days to pay the DPT.
  • No appeal is permitted for 12 months from the date on which the DPT was due.
  • Any appeal must be made between the date falling (i) 12 months after the DPT was due; and (ii) 12 months and 30 days from the date the DPT was due.

Impact of timetable

Taxpayers (particularly where they have made a DPT notification) should be prepared for the possibility of receiving a DPT notice. In particular, a taxpayer should

  • Assess the risk of receiving a notice.
  • Consider the impact of receiving a notice on any existing transfer pricing dispute.
  • Take advice on the strength of its DPT position.
  • Decide whether to proactively engage with HMRC regarding DPT.
  • Have open communication between tax department and senior management in respect of the DPT risk.
  • Be prepared to fund the DPT cost.
  • Consider the necessity of making any public announcement.
  • Seek advice on the accounting implications of paying DPT.

The basic rules of Diverted profits tax: a reminder

When imposed?

Avoided permanent establishments

DPT seeks to bring within the charge to tax the profits of non-UK resident companies doing business in the UK but which avoid the charge to UK tax by the manipulation of the rules relating to permanent establishments (an avoided permanent establishment). For the tax to apply, the arrangements must either have tax avoidance as one of their main purposes or result in an ‘effective tax mismatch’. One of the open questions is when is tax avoidance one of the main purposes. This is a notoriously difficult test to apply in practice. The test of an effective tax mismatch is the same as that for the connected party arrangements and is explained in the following paragraph.

Connected party arrangements – ‘super transfer pricing’

The DPT rules include powers to adjust the taxable profits of companies where there is an effective tax mismatch as a result of arrangements put in place between connected parties.

This occurs where, as a result of provisions made between connected parties, there is either a reduction of income or an increase in the expenses of a party taxable in the UK without a corresponding increase in the tax liabilities, in the UK or overseas, of the other party to the arrangements. There is a safe harbour exemption if the provision results in an increase of tax paid in the UK or elsewhere of at least 80 per cent of the reduction in the UK taxpayer’s liability to tax. In broad terms, the transfer of profits to a jurisdiction with a tax rate of 15 per cent or less would fall outside this safe harbour. If the DPT is to apply, it must also be the case that: either the financial benefit of the tax reduction outweighs any other financial benefit of the transaction; or the contribution of economic value (in terms of the functions performed by the staff of a party to the transactions) is less than the financial benefit of the reduction in tax.

Quantum of DPT

DPT is charged at a rate of 25 per cent which is much higher than the rate of conventional corporation tax.

Where the effective tax mismatch provision applies, the profits of a UK taxable company, branch or an avoided permanent establishment are to be calculated on the basis of the provisions which would have been made between the parties had they not been seeking to achieve a tax mismatch outcome.

In appropriate cases HMRC can apply a presumption that expenses should be reduced by 30 per cent in estimating taxable diverted profits.

Recharacterisation of transactions

There are already powers to adjust taxable profits as a result of non-arm’s length transactions between connected parties under the UK transfer pricing rules. A major change under DPT is that HMRC can assess tax by reference to a recharacterised transaction. As a general rule, transfer pricing adjustments are based on a re-pricing of the transaction the parties have undertaken and not on the basis of a re‑characterisation of the transaction.

Payment on demand

HMRC can assess tax on the basis of a provisional adjustment and require that tax to be paid before any appeal is made. This will mark a significant shift in the balance of power between taxpayer and HMRC. Transfer pricing disputes often take many years to resolve. Under DTP, having paid under an estimated assessment, the onus will be on the taxpayer to seek resolution.

No appeal for 12 months

When HMRC issues a preliminary notice (indicating that it believes DPT to be due), the taxpayer has a limited ability to make representations before the tax becomes due (for example, if the preliminary notice contains an arithmetical error).

Even once the tax has been paid, a taxpayer cannot appeal the assessment until the 12 months after the DPT fell due. This means that taxpayers will need to fund the potential DPT liability whilst the matter is being resolved with HMRC. Early consideration should be given to the likelihood of a successful appeal as this will determine the accounting impact of a taxpayer being required to pay DPT.

Conclusion

The introduction of DPT marked a significant shift in HMRC’s taxing powers, and we are now just starting to see HMRC moving towards enforcement in this area. Given the timetable for paying DPT, those taxpayers who have made DPT notifications should be making plans to deal with a DPT notice.

The amounts of DPT payable could be substantial. Public announcements (for example to the relevant stock exchange) may also be required in respect of the DPT charge.

The nature of DPT will put pressure on companies to settle any transfer pricing enquiry which falls within the scope of DPT – given the differential in rates and the ability of HMRC to impose DPT on a recharacterised transaction. Advice will need to be sought as to the likelihood of successfully challenging the DPT due – as this will impact upon the decision whether to settle and what a company is required to show in its accounts in respect of the DPT charge.


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