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The conundrum of the new profit diversion compliance facility

You will perhaps have noticed a continuing theme in our thought leadership pieces.  As the tax world gets more and more complicated, the judgement calls that tax directors and heads of tax have to make are getting tougher – with increasingly fine margins defining what is the right path to take.

In these thought leadership pieces, we hope we demonstrate that we really understand the world of senior professionals in tax – and therefore the best placed to help them in their careers!

The new Profit Diversion Compliance Facility or “PDCF” recently announced by HMRC is a very good example of the difficulties and fine judgement calls tax directors and heads of tax have to make.  

Introduced in 2015, Diverted Profits Tax or “DPT” was a new tax in its own right with a penal rate of 25% and was introduced to counteract “contrived arrangements designed to erode the UK tax base”. (HMRC guidance 2018). It can apply to UK companies and foreign companies trading in the UK.

The legislation governing the tax is very widely drawn.

Dubbed the “Google Tax”, its application has been far wider that those MNCs that found adverse publicity when accused of not paying their “Fair Share” of tax, and a number of UK plcs have been targeted. The HMRC guidance explains the investigative processes HMRC may adopt on an enquiry – they can be very extensive and intrusive! HMRC has invested significant resources to support DPT.

DPT is not a tax for the faint hearted!

DPT has its own notification requirement in that, broadly, if a company feels it is within the charge for an accounting period (this is a simplification of some very complicated law), it should notify HMRC within 3 months from the end of that accounting period.

Companies with December year ends will no doubt be considering whether to notify or not by March 31, 2019 in respect of their 2018 accounting period.

There are certain benefits in notification re penalties and the enquiry “window” after notification is reduced from 4 years to 2. However, it is also waiving a bit of a flag to HMRC – so the consequences of notification may be an enquiry. Are companies when, notifying, reducing the enquiry window or accelerating an investigation? In clear cut situations there is little choice but often these situations turn on the margins – so a fine judgement call is often required!

Some advisors advocate “protective notification” in marginal cases – in order to reduce the enquiry window. We are not convinced the legislation envisages protective notifications – but gather they are being made and have been accepted in the past by HMRC.

So, DPT already presents some judgement challenges and now there is the PDCF to consider as well.

To add further pressure on the decision as to whether to register for the new facility HMRC will now be issuing warning letters to companies who are considered high risk, “inviting” them to consider registration with the new facility.

So, what is the PDCF?

Businesses who register with the PDCF have 6 months to submit a report analysing any historic liabilities and proposals for transfer pricing arrangements going forward. HMRC guidance explains some of the risk factors that need to be considered.   

Some commentators have applauded the potential benefits of registration:

  • Greater control over the “investigation” in the preparation of the report
  • Possibly a lighter touch by HMRC and quicker resolution
  • Potential penalty reduction
  • Greater (but not necessarily complete) certainty going forward

In many ways PDCF can perhaps be seen for practical purposes as a “light” APA with historic liabilities wrapped up as well. It is wider than DPT and includes transfer pricing and indeed is aimed at situations where, say, the facts presented by a company are actually at odds with the TP methods the company thought governed their transfer pricing, or a company’s transfer pricing is just at odds with the new OECD guidelines.

There are some very fine judgement calls here in whether to register with the PDCF – over and above the existing question of notification for DPT!

We see a number of immediate scenarios that could play out:

  1. A company is considering notification – does the PDCF change the landscape? We would say no. PDCF and notification should be considered separately. If a company is within the charge to DPT it should notify – simple as that!
  2. A company is considering a “protective DPT notification” – does the PDCF change the landscape – we would say potentially yes. PDCF does give a route to greater certainty and resolution as opposed to watching the clock and waiting for the 2 year clock to wind down. And it is wider than just DPT. However, HMRC’s view is PDCF is there to clear outstanding risk areas and settle back taxes and it is not purely a protective mechanism.  The question is how it might evolve.  
  3. A company is worried about its transfer pricing position – PDCF should be seriously considered!
  4. A company receives a letter – how should it respond? We think it needs to quickly (if it hasn’t already done so) analyse its DPT and transfer pricing profile and consider next steps carefully!
  5. A company doesn’t receive a letter but some of the risk factor “boxes” are ticked when an assessment by the company is made. Again – as per 4 above, consider the position carefully – and quickly!