Where is the UK Diverted Profits Tax and the Profit Diversion Compliance Facility now?

On 7 February 2023, the UK tax authority HM Revenue & Customs (HMRC) released its Transfer Pricing and Diverted Profits tax statistics for the 2021 – 2022 tax year. The statistics clearly demonstrate that both transfer pricing and Diverted Profits Tax (DPT) continue to yield significant income for HMRC and that these areas are likely to remain high on HMRC’s agenda. 

This blog focuses on DPT and what it means for international groups.

DPT was introduced in 2015 to target large groups which were perceived to be using contrived arrangements to divert profits outside of the UK tax net.  DPT was not only a means to recover tax revenues which had been artificially diverted away from the UK but an attempt to change the behaviour of large corporates.

How do the rules apply?

Scope

Whilst it interacts closely with transfer pricing, DPT does not form part of the corporate tax legislation and is a separate, distinct tax. 

It is charged at a rate of 25% (increasing to 31% when the rate of corporation tax increases to 25% on 1 April 2023), and applies to large companies in two scenarios:

• Where the UK subsidiary (or permanent establishment) of a group is party to arrangements with another group company and those arrangements lack economic substance and were put in place to achieve a tax benefit for the group; or
• Where an overseas party (person or company) carries on activities related to its trade in the UK in a way which has been designed to ensure that no UK taxable presence arises and there was a motive of achieving a tax benefit.

The charge does not apply in the first case if a UK subsidiary is involved and both it and the non-UK entity are not SMEs.  In the second case (avoiding a UK taxable presence), there is no charge if UK revenues do not exceed £10m or UK related expenses do not exceed £1m. 

The DPT charge

The charging provisions within the DPT legislation are complex.  In part, they consider the transfer pricing position and in part they require groups to calculate the profit that would have arisen in the UK in the alternative arrangement which would have been in place absent any tax reduction being available.

HMRC’s view is that no DPT will arise where the transfer pricing is correct or where a group agrees to make an appropriate transfer pricing adjustment.  Whilst our experience is that this is often the case, it remains that the charging provisions must be worked through in detail and the transfer pricing position fully tested before any firm conclusions can be reached as to whether a DPT charge exists.

Administration

If a company is within the scope of DPT and does not satisfy any exemptions (including that no DPT charge arises) then it is required to file a notification to HMRC within three months following the end of the accounting period in point.  If it considers that there may be a DPT liability, HMRC will then issue a preliminary notice to the company.

Where a company has filed a DPT notification with HMRC, HMRC have a period of two years from the end of the relevant accounting period to issue the preliminary notice.  Where the company has failed to file a DPT notification, this period extends to four years.

Following receipt of a preliminary notice, the company will have the opportunity to correct any factual errors in the preliminary notice prior to HMRC issuing a final charging notice which will state the DPT it considers to be due.  The DPT must then be paid in full.  There are no provisions which allow for payment of the DPT to be postponed.

Following payment, a 15-month review period will commence, during which the company can discuss the amount of DPT due with HMRC.  If the company agrees to make a transfer pricing adjustment during the review period, the DPT charge will be removed. This link between the DPT and transfer pricing legislation is important because it provides groups with the opportunity to correct the tax position through an adjustment charged at normal corporation tax rates as opposed to the penal DPT rate.

Once the review period ends, the company may formally appeal the DPT charge.  Appeals are heard by the Tax Tribunal and, if successful, it is only at this point that the company will receive a refund of the DPT which has already been paid.

The 2021-2022 statistics

Turning back to HMRC’s statistics for the tax year 2021-2022, it is clear that DPT continues to be an area which HMRC places focus on, eight years after it came into force.

Tax take

Since its introduction, the DPT net amount received by HMRC (being the DPT received from charging and supplementary notices and not subsequently repaid) exceeds £700m.  Where DPT is repaid, this will normally be because additional Corporation Tax has subsequently been paid through a transfer pricing adjustment agreed in settlement of an enquiry, therefore the impact of the DPT is even wider than its £700m tax take suggests.

£198m of this tax was received during 2021-2022.  This is the second highest yield since DPT came into force, demonstrating that HMRC’s appetite for using DPT to target profit diversion remains strong.

Notifications and HMRC notices

Over the past 8 years, more than 400 DPT notifications have been filed with HMRC by companies which believe they are involved in arrangements that may be in scope of the DPT legislation.  30 of those notifications were filed during 2021-2022.

Indicative of HMRC’s activity in this area, 49 preliminary notices were issued during 2021-2022 (in other words notices were issued to more than just those taxpayers who filed a pro-active notification) and all of those preliminary notices were subsequently issued as final charging notices.

The Profit Diversion Compliance Facility (PDCF)

In January 2019, HMRC launched the Provide Diversion Compliance Facility (PDCF).  The PDCF was designed to encourage international groups with arrangements that potentially fall within the scope of DPT to review their TP policies, make appropriate changes and put forward to HMRC a report with proposals to pay any additional tax, interest and penalties due.

The PDCF encourages open and co-operative dialogue between taxpayers and HMRC and is intended to accelerate the process for reaching agreement when compared to the traditional enquiry mechanism.  This is demonstrated by the average PDCF case lasting 16.5 months as compared to the 34 months taken to resolve the average transfer pricing enquiry.

Since its introduction, HMRC has been identifying and writing to specific groups which it believes could be in scope of the DPT rules to invite them to register for the PDCF.

In total, HMRC have written to 165 groups with 30 of those letters having been issued in 2021-2022. 23 groups registered for the PDCF during 2021-2022, with 118 having registered in total since the PDCF was introduced.  Over £516m additional tax revenue has been secured from resolution proposals.  Given its close relationship with the DPT legislation, the tax revenues generated by the PDCF can be viewed in part as relating to DPT.

Most registrants who did not reach an agreement with HMRC under the PDCF (and those who received letters inviting them to register but chose not to) are currently in the process of an HMRC enquiry.

Conclusion

DPT was introduced as a means to capture the tax from profits which have been artificially diverted away from the UK.  The penal tax rate and the cash flow disadvantage that comes from dealing with a DPT notice were intentionally designed to encourage a change in behaviour from taxpayers and to provide an incentive to international groups to be more transparent and pro-active in their dealings with HMRC.  The introduction of the PDCF four years ago reinforces this objective.

The 2022-2023 tax year statistics which HMRC released last month demonstrate that DPT and transfer pricing continue to be valuable and successful tools for HMRC.  It is clear that international groups operating to any extent in the UK need to keep compliance with these areas of tax front of mind.