By Liz Hughes, Grant Thornton UK LLP
Yesterday, the UK’s HM Revenue and Customs (HMRC) published their 2017/18 ‘Transfer Pricing and Diverted Profits Tax’ statistics.
The data makes for interesting reading in part because it is now clear that the diverted profits tax (DPT) is having an effect on the behaviour of multinational businesses.
At the same time, the statistics show that it is taking longer to resolve enquiries and close advance pricing agreements (APAs), a concerning trend given that tax authorities are likely to increase the number of multinational firm tax audits they carry out in the future.
The statistics reveal that HMRC secured cumulatively £6.5bn of additional tax from transfer pricing enquiries in the years 2012/13 to 2017/18.
The year-on-year picture shows that there was a large increase in tax receipts from transfer pricing challenges between 2015/16 (£853m) and 2016/17 (£1.618bn) but that same rate of increase has not been seen between 2016/17 and 2017/18 when the receipts remained broadly similar at £1.682bn.
There has also been a steady increase in the average age of open transfer pricing enquiries over the period, with the average age in 2012/13 being 18.6 months and, by 2017/18, that figure rising to 30.4 months.
Now that the first country-by-country reports are submitted and being considered by tax authorities around the world, it is reasonable to assume that the additional (and maybe new) information about the tax affairs of large groups will lead to more transfer pricing enquiries.
That may have several effects. For example, more enquiries could lead to an increased tax yield in future years and could also drive up the demand for APAs and mutual agreement procedures to minimise the risk of double taxation from transfer pricing enquiries.
Diverted Profits Tax
DPT is designed to deter large groups from trying to minimise their tax liabilities through the use of contrived tax arrangements. The deterrent is a 25% tax rate (compared with the usual 19%), on the avoided taxable income.
The newly released statistics reveal that in 2017/18, the DPT tax yield was £388m, an increase of nearly 40% on the previous year. However, not all of the DPT yield was actually DPT tax. Of the tax yield, £169m was additional corporation tax that arose because businesses had restructured their transfer pricing arrangements such that DPT did not apply.
The statistics also reveal that HMRC received 220 notifications by groups that consider that they potentially fall within the scope of the DPT rules.
Notifications were up by around 50% on the previous year; however, the same group may make several notifications – potentially one for each entity affected by the planning. It would be interesting to know how many separate groups are represented by the 220 notifications.
So, what do the new DPT statistics tell us?
To start with, we can see that businesses have started thinking about DPT and how it could apply to their operations.
The yield of £169m is also interesting. If groups are changing their transfer pricing arrangements then DPT may ultimately achieve the objective of making itself a ‘defunct tax’. If every taxpayer changed its pricing arrangements to minimise the risk of DPT, then arguably DPT would be completely fulfilling its purpose as a deterrent to contrived tax arrangements.
However, as more taxpayers change their transfer pricing policies (presumably at the expense of an overseas counter-party) there is also an increasing risk that the UK’s treaty partners will disagree with the group’s change in policy and seek to pursue a different outcome under the mutual agreement procedures permitted by the relevant tax treaty.
What may have started as a focus on the UK tax take, may end up with an increasing number of disputes with other tax authorities.
Advance pricing agreements
To minimise the risk of lengthy disputes and to get certainty over complex transfer pricing issues, taxpayers may seek to agree an APA with one or more tax authorities.
Conceptually, an APA is appealing to many businesses but the small number of applications accepted into the UK APA programme (16 applications were made in 2017/18 and of those 6 applications were turned down by HMRC) and the length of time to complete an APA (in 2017/18 the average time to reach agreement was 37.1 months), discourages many taxpayers from applying for an APA.
However, the statistics also note that the number of staff dealing with international tax risks including transfer pricing has increased and, as at 30 April 2018, there was 365 full-time equivalent staff focused on international tax risks, transfer pricing, and DPT.
These people are not necessarily dealing with APAs but an increasing pool of expertise in HMRC can only help taxpayers and the tax authority better understand complex industry issues.
Thin capitalisation agreements
A subset of APAs are represented by advance thin capitalisation agreements (ATCAs) – effectively APAs between the taxpayer and HMRC in respect of the application of the transfer pricing to financing.
In 2017/18 there were 79 ATCAs agreed during the year, compared with 124 in the previous year and 366 agreements were in force during the year compared with the 479 in the previous year.
The lower number of ATCAs in the year could be because they are taking much longer to agree (in fact the average time to reach agreement in 17/18 was 17.5 months compared with 14.9 months in the previous) year but could also reflect a fall in the number of applications.
This is not surprising given that the UK’s new corporate interest restriction came into effect on 1 April 2017, reducing the amount of allowable interest expense in a number of groups below that which could have been allowed under the terms of an ATCA.
It seems clear from these statistics that issues raised by the DPT rules are being addressed through changes to a group’s transfer pricing arrangements.
A key takeaway is that the importance of designing and implementing a robust and defensible transfer pricing policy is now more important that it has ever been if a business is to minimise the risk of DPT being charged.