Transfer pricing tax disputes – Facts and behaviours

HMRC has made tackling the diversion of profits from the UK their number one corporate tax priority and continue to increase the resources allocated to this area of risk.

As noted in our previous article, where HMRC believes there may be a significant tax risk, they will pursue a holistic approach so that all potential international tax issues are considered during the course of an enquiry. At the end of the day, however, the resolution is very likely to be revolve around the transfer pricing.

From a transfer pricing perspective, HMRC will no longer be satisfied with looking at the UK picture in isolation, but is insisting that the UK outcome must be viewed in the context of the global value chain. Increasingly HMRC will be receiving data from Country by Country Reports and will be incorporating this in its risk reviews, looking in particular at stateless income and ratios that are out of line, i.e. indicating where there may be insufficient substance to support an allocation of profits.

In addition, in recent conversations with HMRC’s Diverted Profits team they have made it clear that they are surprised to be seeing a number of cases where the transfer pricing policies, and the reports that support them, do not always match the facts on the ground. They have a concern that in some cases the facts and assumptions that have been used as the base of a transfer pricing report have not been adequately tested and verified by the business.

This has two consequences. Firstly, HMRC is now adopting a forensic, investigative approach to evidence the underlying assumptions upon which the TP policies and documentation have relied. Secondly, there is an increasing focus on what HMRC refer to as ‘behaviours’. HMRC is increasingly likely to argue that discrepancies should be deemed at least ‘careless’, which allows for the application of penalties. And in some cases, HMRC has actively investigated whether such discrepancies were ‘deliberate’ (akin to fraudulent) and liable to much larger monetary penalties ( up to 100% of the tax lost) as well as reputational impacts through measures such as ‘naming and shaming’ and personal liability for the Senior Accounting Officer. Ultimately and in the more extreme cases, this could lead to HMRC employing its Corporate Criminal Offence legislation.

Businesses now find themselves challenged by HMRC with very extensive requests for documents and information, usually including very sizeable email reviews and interviews with operational employees, in order to defend their existing TP position. Interviews with 15 or more employees are not uncommon. HMRC often ask, informally at least, for documents and information that is not within the power and possession of the taxpayer and are challenging with greater frequency than previously seen any defense relying on power and possession arguments. HMRC is also known to be asking for permission to speak to third-party customers to verify what a business has told HMRC.

Another feature of the new enquiry is the increasing use of information requests to other tax authorities under the UK’s tax treaties or through multilateral instruments such as the OECD’s Convention on Mutual Administrative Assistance.

So how best to navigate this daunting new landscape? We have found that the key is not to underestimate the challenge presented, but to engage with it pro-actively and by employing a multidisciplinary approach. We see the main elements of such an approach as:

1. Transfer pricing – TP is the core technical issue and, in our experience, usually the key to an agreed resolution. Taxpayers know their business and how it works, and are best placed to make suggestions to HMRC as to the most efficient way in which HMRC can obtain the necessary level of understanding of the arrangements in scope.
2. Tax Disputes – Knowledge of HMRC’s governance procedures and powers such as opening enquiries, filing requirements, information powers, discovery assessments, and penalties is essential. These enquiries now also routinely involve review and presentation of large amounts of documentary and other evidence, in particular emails.
3. Legal –A cooperative approach is still the best and most efficient way to progress an enquiry, especially as the overwhelming majority of enquiries will end by reaching an agreed settlement with HMRC. However, DPT is anti-avoidance legislation with many and varied contentious legal points, and with the strict time limits applicable to DPT, the need to be prepared for the prospect of litigation can become a reality much sooner than has been the case in historic TP enquiries. It is therefore important to have an appropriate level of legal oversight and advice.
4. Other technical specialists – As these enquiries can be extremely wide-ranging and HMRC has not hesitated to deploy alternative technical avenues to address perceived tax risk, other specialists may need to be on call to deal with aspects ranging from company residence to CFCs.

To find out more about our approach please contact Ian Woolley or Ben Proctor, Senior Managers in PwC’s Transfer Pricing Team and Tax Disputes team respectively. Both Ben and Ian are former HMRC tax inspectors.