Has the UK's diverted profits tax done its job?

On 27 January 2020, HMRC published its latest statistics on diverted profits tax (DPT) and transfer pricing, covering the period up to the end of the 2018/19 tax year (see here). These make for interesting reading. While the DPT yield figures are slightly skewed by the fact that (in contrast to previous years) HMRC has chosen not to include the additional corporation tax raised from behavioural change encouraged by a DPT charge, it is striking that only £12m was raised from DPT in 2018/19. Does this mean DPT has had the desired effect of changing taxpayer behaviour and increasing the corporation tax take?

Perhaps. The additional tax revenues raised from transfer pricing enquiries in 2018/19 were down on previous years (£1,169m as compared with £1,774 in 2017/18). But DPT is not just about transfer pricing. HMRC has a lot of different tools at its disposal for tackling arrangements that divert profits away from the UK and diverted profits enquiries often encompass other challenges as well. These might include permanent establishment, residence and CFC issues. There might also be other bases for denying deductions for offshore payments made by a UK company such as purpose-based anti-avoidance rules relating to loans and in-substance profit transfers. Navigating the complex law in these areas and their interaction with each other can be a difficult task – including for those taxpayers wishing to use HMRC’s Profit Diversion Compliance Facility (PDCF) to self-assess historic additional tax liabilities resulting from profit diversion – and a transfer pricing resolution may not always be the right one.

On the topic of resolution, HMRC’s statistics show that the time taken to resolve transfer pricing enquiries continues to increase, notwithstanding a dip in 2017/18: the average age of settled enquiries in 2018/19 was 33.1 months. The complexity of diverted profits cases, coupled with HMRC’s evidence-led and consensus-based approach to resolving disputes, often means these enquiries can take a very long time to resolve. Our own experience is that, once DPT has been introduced into the mix, enquiries typically take between 9 months and 2 years to resolve, although we have worked on a number of very complex cases which have taken longer than this or have progressed into alternative dispute resolution processes, including litigation and treaty-based mutual agreement procedures (MAP). HMRC’s statistics show that the number of cases admitted to and resolved through MAP has increased markedly over the past six years and we expect that trend to continue.

HMRC's statistics also show that, in 2018/19, HMRC had 441 full time equivalent staff working on international issues involving multinational enterprises (MNEs), including those mentioned above. HMRC has stated that it is channelling its resources to bring some of the oldest cases to a full and final conclusion. However, resources will also be needed for the investigations that HMRC is starting into those businesses that have not registered to use the PDCF despite receiving “nudge” letters. There are also a number of DPT cases under civil or criminal investigation with HMRC’s Fraud Investigation Service, which will be resource-intensive.

While an increase in the people dedicated to achieving resolution of long-standing cases can only be welcomed, that of itself may not be enough where the parties are effectively deadlocked. A fresh perspective on the evidence or the issues and some creative thinking may be needed there to reach a settlement.

As to whether DPT has in fact resulted in behavioural change, it is interesting to see that the increase in VAT revenues over the 2018/19 tax year from business that have restructured their arrangements (+£2bn) is almost equivalent to the additional corporation tax brought in from the settlement of existing investigations, prompted by DPT (+£2.2bn). This suggests that some businesses at least are making operational changes in the wake of DPT enquiries, as opposed to just changing their transfer pricing arrangements – and that resolving these enquiries may be as much about putting businesses on a solid footing for the future as sorting out the past.