Transfer Pricing Tax Disputes - HMRC’s Profit Diversion Compliance Facility: What to do next?

HMRC’s introduction of a settlement Facility aimed at businesses with a risk of “profit diversion” confirms observations that we have made in our recent blogs. In summary, HMRC:

• Consider “profit diversion” as their number one corporate tax risk;
• Are continuing to commit significant resources to tackle this risk, with the creation of multidisciplinary teams;
• Will apply a holistic approach to its investigations i.e. considering not only Transfer Pricing (‘TP’) and Diverted Profits Tax (‘DPT’) but encompassing Permanent Establishment, Controlled Foreign Companies, Corporate Residence, royalty withholding taxes and anti-hybrids issues;
• Will no longer be satisfied with looking at the UK picture in isolation, but have a greater focus on the global value chain;
• Are adopting a more forensic, evidence-based approach to their investigations;
• Are increasingly considering whether the behaviour of the MNE can be considered as ‘careless’ or even ‘deliberate’;
• Expect that, in the majority of cases, a TP adjustment will be the solution.

Furthermore, with the introduction of the Facility, HMRC hopes to shift a significant element of the resourcing requirements associated with a typical TP / DPT investigation from HMRC onto businesses and their advisors. Self assessment already requires the business to get its TP ‘right’. However, using the Facility takes this much further and in essence asks the MNE to conduct a deeper and wide-ranging review into its own affairs and to back up its conclusions with forensic evidence.

How business should respond

Where there is a possibility, however remote, that you could become the target of HMRC’s Diverted Profits team, you should be considering what you need to do. This is particularly advisable if you:

• Considered but decided against notifying for DPT for 2015 or subsequent years and have heard nothing yet from HMRC (HMRC has been concentrating to date on those who did notify);
• Have experienced changes in your business or operating model since 2015 and haven’t revisited your DPT position, especially if there are substantial royalty payments going to low tax countries, as UK withholding tax may well now be an issue;
• Have not yet fully considered the implications of OECD BEPS changes on your operating model and TP policy.
• Have not recently updated your transfer pricing policy or documentation using contemporaneous functional analysis and supporting evidence.

If your review uncovers no areas of concern, this may provide you with sufficient comfort that no further action is required.

However, if you think that there is a possibility that you might be in line for a letter from HMRC inviting you to use the Facility, you will need to consider the best approach to pursue, including whether and how to conduct further work.

In depth analysis

This might involve the collection and review of a significant amount of documents and information, for example staff interviews, operational emails, meeting notes and contracts, and will not be limited to UK information.

This analysis could end up either as a:

• “Defence file”, where the current self assessment is believed to be the correct position and HMRC has not issued a letter, or a
• Disclosure report, where HMRC has either issued a letter or your review concludes that there are some exposures and tax may have been underpaid historically.

HMRC engagement

Where HMRC issues a ‘nudge’ letter, we think it is then almost inevitable that HMRC will start an investigation if you decide not to use the Facility.

As we have outlined in our previous blogs, when dealing with an HMRC investigation it is important to engage with it proactively and build your own team with the right skills and knowledge of all the potential tax areas that could be relevant.

Ian Woolley and Ben Proctor are Senior Managers in PwC’s Transfer Pricing Team and Tax Disputes Team respectively.