The new UK “Profit Diversion Compliance Facility”: what MNEs need to know

By Liz Hughes, Grant Thornton UK LLP  

The UK’s new “Profit Diversion Compliance Facility,” issued on 10 January, makes it clear that HM Revenue and Customs (HMRC) believes that some multinational businesses have failed to assess properly whether the UK’s diverted profit tax legislation impacts their structures.

We understand that HMRC expects both large groups and mid-market businesses (those with a turnover around £50m– £1bn) to use the facility.

The new facility is designed to encourage groups with arrangements that might fall within the scope of the diverted profits tax to review both the design and implementation of their transfer pricing policies, amend them if necessary, and then use the facility to submit a report with proposals to pay any additional tax, interest, and potentially any penalties due.

Groups will need to register for the facility and submit a report by 31 December. The key advantage to the taxpayer of using the facility is the penalties are likely to be lower than those applied if HMRC starts an enquiry and finds that diverted profits tax should have operated. However, a significant amount of work is required to prepare a compliant report for submission through the facility. The facility is not intended to be a clearance facility for those businesses that do not consider diverted profits tax applies to them but still want confirmation of that fact from HMRC.

UK Profit Diversion Compliance Facility – benefits to the taxpayer

According to HMRC, the benefits to the taxpayer of using this facility are:

• It will enable MNEs to bring their tax affairs up to date openly, efficiently, and without investigation by HMRC if full and accurate disclosure is made.
• It will give the business certainty for the past and to be flagged as ‘low risk’ in respect of profit diversion in the future.
• It provides an accelerated process, with HMRC aiming to respond to the proposal within three months of submission of the report.
• It allows the group to manage its internal processes around what evidence to gather, who is interviewed, what benchmarking comparables are used (if any) and how the analysis is presented.
• It gives ‘unprompted’ penalty treatment if HMRC has not already started an investigation into profit diversion by the time the taxpayer registers to use the facility (which closes on 31 December).

Who is affected?

The new UK profit diversion compliance facility is aimed at groups using, or which have used, arrangements that reduce UK taxable profits by under-rewarding UK activity and over-rewarding activity based in an overseas entity where its profits are taxed at lower rates or not taxed at all.

Taxpayers are expected to prepare a detailed report covering all prior accounting periods affected by the arrangements to the extent that HMRC is within the relevant time limits to enquire into those accounting periods. This includes those years that can be the subject of discovery assessments.

Some background about the diverted profits tax

The diverted profits tax came into effect in relation to diverted profits arising on or after 1 April 2015. Its primary aim is to ensure that profits taxed in the UK fully reflect the economic activity occurring in the UK.

The diverted profits tax applies in two situations, namely, to:

• UK companies (or UK permanent establishments of foreign companies) that use entities or transactions that lack economic substance to exploit tax mismatches.
• Persons carrying on activities in the UK in connection with supplies by foreign companies which are designed to ensure that the foreign company is not trading in the UK through a permanent establishment thus securing a tax advantage or tax mismatch.

The diverted profits tax is charged at a higher rate than the normal rate of corporation tax to act as a disincentive for groups to enter into tax driven arrangements. The diverted profits tax is mitigated by having in place appropriate transfer pricing policies applied to the actual ‘on-the-ground’ business activities and not seeking to artificially avoid a permanent establishment in the UK. The UK profits reported for corporation tax purposes will then correctly reflect the economic substance of the activity that is undertaken both in the UK and with the UK. This will ensure that the correct profits are subject to corporation tax and in the vast majority of cases will eliminate the need for a diverted profits tax charge to be raised as there are no diverted profits to charge to the diverted profits tax.

The new UK profit diversion compliance facility sets out a number of risk indicators for profit diversion and, whilst not intended to be an exhaustive list, it helps taxpayers understand better what HMRC considers to be potentially within the scope of planning subject to the diverted profits tax.

The UK Profit Diversion Compliance Facility — what needs to be reported?

A report made under the UK Profits Diversion Compliance Facility needs to cover the following matters:

• 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 (which can be disclosed on a without prejudice basis).
• An analysis of the behaviours investigated and the conclusions reached on the application of penalty provisions (which can be disclosed on a without prejudice basis).
• A proposal to settle all outstanding liabilities (which can be disclosed on a 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.
• An annex listing the evidence that supports the facts referred to in the report.

Final take-aways

The UK Profit Diversion Compliance Facility allows businesses to approach HMRC and take the opportunity to bring their UK tax affairs up to date.  However, the work required to comply with the facility is substantial and complex.

Businesses should consider whether and how diverted profits tax applies to their operations. If it is reasonable to conclude, based on the risk indicators HMRC has published, that the diverted profits is likely to apply, then groups should consider the costs and benefits of using the new UK Profit Diversion Compliance Facility.

The diverted profits tax and transfer pricing are complex areas of the UK’s tax code and expert advice should always be sought on the application and implementation of these rules.

–Liz Hughes, a partner with Grant Thornton UK LLP, advises on all aspects of transfer pricing with a focus on the pricing of debt and the financial services sector and can be reached at [email protected] or +44(0)207 728 3214.