On 10 January 2019, the UK tax authorities, HM Revenue & Customs (HMRC) launched a new Profit Diversion Compliance Facility (PDCF) for multinational enterprises (MNEs) using cross-border arrangements targeted by Diverted Profits Tax (DPT). DPT was introduced in April 2015 to tackle the diversion of profits from the UK to low tax jurisdictions.
The PDCF gives MNEs the opportunity to review the design and implementation of their transfer pricing policies, analyse DPT and any other tax risks and, if necessary, bring their tax position up to date by submitting a disclosure report with a proposal to pay any additional tax, interest and potentially penalties due.
HMRC has identified a list of several hundred high-risk taxpayers that it intends to investigate. Accompanying the launch of the PDCF, HMRC issued letters to some taxpayers on the list, highlighting the availability of the PDCF. Failure to respond appropriately to these letters is likely to result in an investigation.
Swiss principals, Swiss intellectual property (IP) owners and, generally, structures that result in entrepreneurial profits being allocated to Switzerland, where there is a link to UK sales or activities are among those within the scope of this new facility.
Who may register for the PDCF?
The PDCF principally is designed for MNEs with cross-border arrangements that present a risk of diverting profits from the UK. These arrangements typically involve entrepreneurial or residual profits accruing in a jurisdiction with a lower tax rate than the UK, with some link to UK sales or activity.
HMRC introduced DPT in April 2015 to target such arrangements and have increased the number of DPT and transfer pricing audits into such arrangements. The introduction of the PDCF represents another escalation in HMRC’s approach to arrangements they perceive as diverting profits out of the UK.
HMRC has set out wide-ranging risk indicators of profit diversion (summarised below). As a result, it will become hard for MNEs with a UK presence to ignore HMRC’s guidance and not review their transfer pricing policy.
How does the PDCF work, and what should be reported?
A fast-track process is guaranteed for MNEs that decide to register for the PDCF, and a taxpayer’s proposal may be accepted within three months after the submission of the disclosure report. The following diagram illustrates the process:
The disclosure report must adhere to the specific format prescribed by HMRC. The taxpayer must provide a full and complete disclosure of the relevant facts, and the report must be signed by an appropriate officer of the company. This will be a significant exercise and will need to reference supporting evidence, including a review of emails and interviews with relevant employees, customers and/or suppliers in the UK and abroad. The PDCF report should analyse any relevant tax risks including transfer pricing, DPT, permanent establishment and withholding tax and must make a proposal to settle any outstanding liabilities, including interest and penalties, where appropriate.
Guidance on the PDCF is available from the HMRC website.
What are the main benefits?
The main benefits of the PDCF for MNEs include:
- The ability to accelerate the resolution of uncertain tax issues and take control of the investigation – Although the preparation of the report requires significant effort, HMRC expects to be able to accept most proposals;
- Potential to reduce penalties – The disclosure will be treated as unprompted and, therefore, potentially will reduce penalties for inaccuracies in returns or companies’ failure to notify HMRC that the company is potentially within the scope of the DPT, provided certain conditions are fulfilled; and
- Increased certainty for future years – The acceptance of the proposal by HMRC will provide low-risk status going forward where the facts remain unchanged.
How should Swiss MNEs respond?
HMRC have compiled a list of businesses with arrangements that exhibit the risk indicators that HMRC consider present a high risk of diverted profits. In light of a generally more favourable tax regime in Switzerland, arrangements between Swiss and UK entities are likely to concern HMRC and to be listed.
HMRC are sending letters to some of the businesses on this list, asking these businesses how confident they are that DPT does not apply to them. Those businesses that receive a letter are told that if they do not register to use the DPCF within 90 days, HMRC may consider starting an investigation.
It is a matter of when not if that HMRC will ask questions for businesses that have structures or arrangements targeted by HMRC. HMRC may start asking questions before they send a letter to HMRC inviting them to register for the DPCF.
It is more important than ever for potentially impacted groups to have a clear analysis and support, at a level of factual detail perhaps greater than previously undertaken, if they consider their arrangements are outside of the scope of DPT, their arrangements are arm’s length and they have no requirement to register for the DPCF.
Furthermore, there is a requirement to notify for DPT if a business is potentially liable for DPT and the notification deadline for the year ended 31 December 2018 is 31 March 2019.
Urgent actions are therefore required. Amongst others, Swiss MNEs with arrangements with UK-related entities should not underestimate the potential risk and cost to the business of not undertaking a proper initial risk assessment and determine whether a disclosure under the PDCF may be appropriate.
If you would like to discuss more on this topic, please do reach out to one of the key contacts below.