UK: UK Diverted Profits Tax Update

Last Updated: 12 August 2015
Article by David Kent

Summary of events since my last blog:

  • DPT has come into effect (1 April 2015) .
  • DPT is a 25%  tax surcharge, and is here to stay.  By an amendment, prior to the Finance Act  being passed, it has been allowed that UK corporation tax (CT) and some other taxes may be allowed as deductions from the amount of DPT calculated as due. 
  • HMRC (the UK's tax authority) has drafted in from other of its  departments over 40 of its  international transfer pricing experts to raise the new tax.
  • Amazon (its EU HQ is based in Luxembourg) has announced that it is now recording revenues in each of its subsidiaries rather than in Luxembourg.
  • UK corporation tax is at a record low of 20%. It will reduce again to 19% in 2018 and then again to 18% in 2020.
  • A new UK Patent Box regime is awaited. The existing 10% regime is operational for election  until 30 June 2016, lasting until 30 June 2021.

In what follows I have not gone into huge detail on DPT.  That is for the experts, including my colleagues in our tax team, other tax advisers and the accountants.   DPT is extremely complicated so I have included  some of the provisions which most affect companies. These I have included in Italics. DPT is charged on a fictional profit proposed by HMRC.

Here is my take on the most ground breaking tax legislation I can remember. This blog does contain some crystal ball gazing.

It has been argued that DPT is in breach of EU law, and maybe puts the UK in breach of tax treaty obligations. These arguments do not assist a company that is in the position of trying to ascertain whether or not it falls within the ambit of the rules. Any challenge will take some years.  There has been no public challenge to DPT so far as I can see.  So in reality it's time for some honest appraisal of each group's tax structures now. The  basis for a DPT charge is very wide indeed and all multinational operations with either (i) UK sales over, or close to £10m, or (ii) close to 1m in expenses, or (iii) having a group company in a low tax jurisdiction, need to consider DPT as a matter of urgency.

Having just come back from a US West Coast trip I have been conscious of a lack of knowledge within companies with offices on the West Coast of the wide scope and ambit of DPT.  Whether HMRC uses the width of the scope and ambit of its new power to tax remains to be seen, but I expect they will.

Now for some of the heavy part (in italics in case you don't have time to read all this blog).

DPT applies in two distinct cases.

1. where a foreign company structures its affairs to avoid a UK taxable presence (an "avoided PE"); or

2. where a company which is taxable in the UK creates a tax advantage by involving entities or transactions with a lack of economic substance (the "insufficient economic substance condition")

Where there is an avoided PE or the insufficient economic substance condition applies, and "the financial benefit of the tax reduction is significant relative to the non-tax benefits of the material provision" the company "must notify an officer of Revenue and Customs to that effect."

Notification is only not required when:

  • the company and its group are still small enough to be SMEs (see my previous blogs)
  • the tax reduction is not "significant"
  • it is reasonable for the company to conclude that no charge to DPT will arise for the current period. (The main reason for this would be that the company reasonably concludes that HMRC is content with its transfer pricing methodology).
  • before the end of the notification period, HMRC have confirmed that the company does not have to notify, because it has provided sufficient information to inform HMRC's decision about whether or not to issue a preliminary notice and HMRC have examined that information
  • notification has been made for the immediately preceding accounting period and it is reasonable for the company to conclude that there has been no change in the relevant circumstances
  • notification has not been made for the immediately preceding accounting period (on the grounds HMRC has been provided with sufficient information) and it is reasonable for the company to conclude that there has been no change in the relevant circumstances
  • it is reasonable for the company to conclude that no charge to DPT will arise for the current period. (The main reason for this would be that the company reasonably concludes that HMRC is content with its transfer pricing methodology).
  • before the end of the notification period, HMRC have confirmed that the company does not have to notify, because it has provided sufficient information to inform HMRC's decision about whether or not to issue a preliminary notice and HMRC have examined that information " notification has been made for the immediately preceding accounting period and it is reasonable for the company to conclude that there has been no change in the relevant circumstances " notification has not been made for the immediately preceding accounting period (on the grounds HMRC has been provided with sufficient information) and it is reasonable for the company to conclude that there has been no change in the relevant circumstances

To conclude, unless a company has an advance pricing agreement in force with HMRC post April1 2015, (which is very unlikely) or HMRC have said that the company does not need one and have indicated that they are content with its current transfer pricing methodology, then the company may need to notify.

Notification must be made within 3 months of the end of the accounting period to which it relates. If HMRC decide that a company may be chargeable to DPT a "preliminary notice" will be issued to the company. If the company notified (in time), the preliminary notice may not be issued more than 24 months after the end of the accounting period. If the company did not notify, then a preliminary notice may be issued to the company within 4 years after the end of the accounting period to which the charge relates. For companies where the accounting period ends on or before 31 March 2016 the notification period has been extended to 6 months ie for an accounting period ending 30 April 2015 the notification period is extended to 30 October 2015.

The company has 30 days from the issue of a preliminary notice to send written representations. Only certain (essentially factual) representations may be considered by HMRC at this stage. Absent representations in respect of arithmetical errors, representations in relation to transfer pricing and profit attribution are to be considered during the "review period", not at the representation stage

HMRC has 30 days immediately following the end of the period for representations to issue a charging notice (or inform the company that a charging notice will not be issued)

The charging notice creates a formal liability to pay the DPT within 30 days of the date that the notice is issued. Payment of DPT "may not be postponed on any grounds". Payment of DPT is ignored in its entirety for the purpose of calculating income, profits or losses. No appeal against a charging notice may be made until after the end of the review period (which can last 2 months).

During the review period, HMRC must review the charging notice. The review period begins immediately after the 30 day period during which the DPT included in the charging notice must be paid and ends 12 months later.

Where a company has paid CT or a non-UK tax that corresponds to CT on profits that are also subject to a DPT charge, a credit for those taxes can be allowed against the DPT liability of that company, "where and to the extent that it is just and reasonable to allow such a credit". No credit will be given for taxes paid after the end of the review period.

So, DPT is a punitive tax, payable upfront, with no immediate right of appeal, and the cash flow consequences could be significant for some.

Any previous tax structuring or tax planning on UK taxation prior to 1 April 2015, even including HMRC  negotiated and approved transfer pricing arrangements (APAs), will  most likely bring the group within the scope of DPT unless they are exempted as above.  DPT is a completely different approach and wipes out  whatever arrangements had been approved by HMRC previously .

My "crystal ball " approach in discussions with  clients goes like this;

HMRC is allowed to assume that groups are within the scope of DPT. For any major group the assumption by HMRC will  almost certainly be that tax efficient structuring took place to avoid paying full corporate taxation in the UK.  As the vast majority of  companies did engage in tax planning of some sort or another they will all be within the ambit of DPT, with very few exceptions.  I know because I helped set up many hundreds of companies in Ireland ,The Netherlands and Luxembourg, to name but a few of the low tax jurisdictions.  This was at a time  when it was the correct approach to create maximum shareholder value.  A suspicion by HMRC  of low tax jurisdiction involvement, will be backed up by the facts as most Group's publish their locations around the globe on their websites.

The charging notice regime remains the key driver forcing groups to engage with HMRC.  It is a clever device but it could be unfair for groups which haven't indulged in tax planning.    

In my view approaching HMRC prior to the issue by HMRC of a charging notice is now essential and companies should be concentrating on this. This translates into opening a dialogue before the end of the current accounting period to which each company draws its yearly accounts.  A charging notice is not what a group  wants to receive!  As with, say, value added tax, payment of the tax may not be deferred until the charge to tax has been taken to appeal. But, in contrast to VAT, there is no 'hardship' exception to this rule.

I hear HMRC are receiving over 300 new calls a day on DPT.  Why?

Because well advised groups are contacting the Revenue now to commence a dialogue about if and  how DPT will affect them. Those discussions will be open where there has been disclosure to HMRC about their global tax structuring. The discussions may involve either reaching agreement with HMRC that such structuring is "acceptable", or that changes need to be made to ensure this.  As part of that dialogue groups subject to the tax will eventually  have to disclose to HMRC their entire global tax planning structures anyway, following which they will need to negotiate a solution involving the making of  increased profits  in the UK on a third party style buy/sell.

There has been some discussion on whether stripped risk distribution structures will be acceptable. We shall have to see how these turn out.

Please see the HMRC guidance notes for the notification templates

As a conclusion my quick tips  are;

  • The DPT legislation is here to stay and within a year or two all companies and groups, and their advisors worldwide, will know about it and should be rectifying their structures. Within that time period use of low tax structure will become minimal where sales in the UK are important.
  • Just because a group knows it isn't liable to DPT doesn't save them from a charging notice. They need to go to their lawyers and accountants now and discuss DPT and their situation in detail and disclose it to HMRC.
  • A call to HMRC may stop or at least delay the charging notice.  Most UK, US and global groups are liable for DPT. Please don't delay. Delay results in a charging notice.
  • The best tax planning for a new group coming to do business in the UK  remains running the structure on a cost plus basis initially.  That means providing  sales and support  to UK/global customers from the UK entity until expenses are due to hit £1million or sales £10 million in a year. Then the group should change to  running a buy /sell  and third party style support functions. Companies should notify HMRC of their plans to avoid receipt of a charging notice.
  • For these new entrants to the  UK market beware of  including a  low tax jurisdiction company in the structure. These include Ireland, The Netherlands, Luxembourg, and Switzerland. ( I listed many more key low tax  jurisdictions in my previous blogs).  If a company in a low tax jurisdiction is included, the group MUST co-locate its major activities in the low tax company  in order to defeat DPT (see HMRC's example in the Guidance notes previously published in my blogs).  Then the group  should  operate the UK entity on a third party buy/sell. This structure will automatically be within the ambit of DPT and so the group should  approach  HMRC for its blessing  in order to avoid  receiving a charging notice.

A seismic change has occurred! To misquote the proverb, the best time to consider DPT and engage with HMRC was when you set up in business. The second best time is now. HMRC is watching you.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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