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The UK launches DPT disclosure facility

As part of its crackdown on tax avoidance, HM Revenue & Customs has introduced the profit diversion compliance facility (PDCF), forcing UK taxpayers to choose between voluntary disclosure or be investigated over their TP arrangements.

The UK revenue service suspects many multinational companies have submitted incorrect transfer pricing arrangements in their tax filings that do not reflect the economic or business reality of the company, or that are inconsistent with the OECD’s transfer pricing guidelines. Businesses will have until the end of 2019 to disclose any mis-reporting that could fall under the remit of the diverted profits tax (DPT).

HMRC will start by sending letters to hundreds of large and mid-sized companies it classifies as high risk of diverting profits since the 2016 tax returns. The tax authority believes businesses should have reviewed their tax policies ahead of their 2016 filings in light of the OECD report on Actions 8-10 published in 2015 and the introduction of the DPT on April 1 2015.

“When originally enacted, the DPT was aimed at changing taxpayers’ behaviour, transforming such activities into the regular tax regime,” said Keith Brockman, vice president of global tax at Manitowoc Foodservice.

“However, the concept of adopting this legislation purposely outside the protection of double tax treaties, coupled with the concept of pay first and discuss later, was not met with mutual satisfaction from the business community,” he continued.

The UK introduced the DPT to counter profit shifting after a slew of scandals. It was quickly dubbed the ‘Google tax’, despite the fact that the search engine company books its profits in Ireland and, according to international law, doesn’t have to pay UK tax on its advertising sales.

Under the PDFC, the UK revenue service is targeting companies that shift profits through jurisdictions like Luxembourg, the Netherlands and Ireland. This would likely include a lot of technology companies and other IP-rich businesses.

HMRC is seeking “free standing and self-explanatory” reports from taxpayers using the scheme, which should include a review of the TP arrangements and detail the extent of tax at risk, the cause of any inaccuracies and failures to notify HMRC beforehand. However, these reports will not be regarded by the tax authority as an admission that the DPT could apply.

Companies receiving a letter from HMRC will need to consider carefully whether the facility is the right way to go. The possibility of opening the books voluntarily might lead to difficult questions. Conversely, not disclosing TP practices might lead to a future investigation.

However, Brockman said it is “important to note that facts and circumstances of transactions for different taxpayers, based on OECD transfer pricing principles, [which] should be the starting point of assessing tax risk versus preliminary judgments based on incomplete facts and analyses.”

Nevertheless, Wendy Nicholls, head of TP at Grant Thornton, has suggested that taxpayers need to move quickly. Running down the clock may only be an option for certain companies.

“There is, however, a limited disclosure window, so businesses should not wait for a nudge letter to be issued,” she told TP Week. “Those who have an accounting period ending June 30 2015, will have little time to act, and should seek advice immediately.”

“One of the key advantages of making a prompt disclosure is the likely mitigation of penalties,” Nicholls said. “However, the work required will be significant, and the benefits of making a disclosure under the compliance facility remain to be seen.”

Shifting the balance

Transfer pricing is a much more subjective area than VAT or even corporate tax that suggests a wider change in the tax authority’s approach.

Heather Self, partner at Blick Rothenberg and a long-time critic of the DPT described the PDFC as “an unusual move” because “it’s the first disclosure facility aimed at corporate tax, and it relates to a subjective area, whereas earlier personal tax disclosures have related to clear errors.”

This shift in focus from individuals to large companies to make disclosures marks a step-change in British tax policy and it may just be the beginning.

“It seems to me that its main aim is for HMRC to manage their workload by getting taxpayers to do a large part of the work for them,” Self said.

“Some companies, particularly if they are confident about their TP policies and DPT disclosure, may prefer to use the formality of an enquiry rather than volunteering information at an early stage,” she added.

However, Jason Collins, partner at Pinsent Masons, expects that after the PDFC closes HMRC will launch a concerted round of investigations into those companies that it has on its list.

“If you don’t come forward under this facility you could face penalties of up to 30% of the tax HMRC considers is owed,” he said. “In some cases, HMRC has indicated that it will be looking at fraud enquiries, with penalties up to 100%, or potential criminal investigation.”

British resident companies with transactions lacking in substance are much more vulnerable to a legal challenge. This is particularly in cases where the transaction or entity in question results in a tax mismatch.

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