Transfer pricing tax disputes - HMRC’s response to Profit Diversion

With the resolution of some major transfer pricing enquiries by HMRC since the introduction of Diverted Profits Tax, together with the introduction of further far-reaching legislation in the recent Budget, it’s a good time to look the changing landscape for transfer pricing disputes in the UK and what might come next. In this series of articles we will share experience gained on how best to prepare for, and successfully navigate a way through, the new type of TP enquiry in the UK.

Although something of a generalisation, it would be fair to say that in common with many, if not most tax authorities, the HMRC’s emphasis has been on the UK operations and establishing the right reward. Now, empowered by the BEPS agenda and the analysis performed by the EU in State Aid cases, the HMRC’s emphasis is much more on the UK businesses’ role in the wider value chain.

The key event shaping a new TP landscape in the UK was the government’s decision to introduce DPT in April 2015. The primary intention of DPT is not to raise tax revenue per se, but to make multinational businesses review their TP arrangements. DPT has proved successful in this respect in helping to secure significant TP adjustments in a number of high risk cases.

But DPT is only one aspect of HMRC’s growing investigative arm that is focused on what they refer to as “profit diversion” by MNEs. HMRC will now consider in one enquiry process all the tax risks that are related to “arrangements” that they believe to be inconsistent with the aims of the OECD BEPS project. HMRC is devoting more resources to deal with the increasing number of these complex and wide-ranging investigations, and has recently created new multidisciplinary teams in both its Large Business and Mid-Size Divisions. These teams are made up of inspectors from across HMRC’s Customer Compliance Group who cover Company Residence, PE, TP, DPT, WHT, Controlled Foreign Companies, the Hybrid and mismatch rules and VAT risks, and also includes HMRC’s Fraud Investigation Service.

As well as increasing its resourcing, HMRC has introduced additional legislation since 2015 to deal with the technical issues arising from profit diversion. The recent Finance Bill introduced a number of amendments to DPT, in the main to close loopholes and to ensure the legislation is working as intended by Parliament. The Budget also saw the introduction of the new tax on ‘offshore receipts in respect of Intellectual Property’. In short, this legislation introduces an income tax charge in the UK when a person resident in a country without a full tax treaty receives income derived from UK sales. In some respects, this legislation also shows HMRC’s willingness to anticipate and go beyond BEPS in pursuing “diverted profits”.

Despite this variety of challenges, and the increase in scope and HMRC resourcing, TP remains at the heart of these enquiries. HMRC still expects that the majority of profit diversion cases will be resolved through a TP solution, together with any necessary changes to group structures that HMRC sees as creating artificial diversion of profits from the UK.

In summary, the landscape of TP enquiries in the UK has changed beyond recognition in the last couple of years and there is no sign of HMRC pulling back from this invigorated approach any time soon. PwC’s approach in helping businesses prepare for, or navigate their way through, an enquiry on profit diversion will be set out in our next article.

Ian Woolley and Ben Proctor are Senior Managers in PwC’s Transfer Pricing Team and Tax Disputes Team respectively. Both Ben and Ian are former HMRC tax inspectors.