It is relatively common these days for taxpayers with transfer pricing (TP) enquiries also to receive diverted profits tax (DPT) charging notices and thus to have a corporation tax (CT) enquiry and DPT review period running in parallel for the same period. For taxpayers in that position, the decision of the First-tier Tribunal in the recent case of Vitol Aviation UK Ltd & others v HMRC [2021] UKFTT 0353 (TC) will be of some interest.
One of the questions considered by the Tribunal was whether, where HMRC has reached a conclusion on the appropriate transfer pricing (TP) adjustment to be brought into account for CT purposes, HMRC nevertheless has reasonable grounds to refuse to issue a closure notice because of the parallel DPT process.
The Tribunal’s decision in the Vitol case to grant the taxpayers’ application and order HMRC to issue closure notices is significant because the consequence is that CT, rather than higher rate DPT, is charged on the relevant adjustment amount.
The DPT backdrop
A brief reminder of the way in which DPT and CT interact is useful to understand HMRC’s arguments in the case and the reasoning for the Tribunal’s decision.
- DPT was introduced as a “stick” to encourage the resolution of long-running TP disputes. It is imposed at a penal rate of (currently) 25% on "diverted profits" plus true-up interest (which, in effect, treats the diverted profit amount as if it had been taxed at that 25% rate from 6 months after the end of the relevant accounting period to the date of the charging notice).
- Assuming no recharacterisation of the underlying arrangements, diverted profits are typically equivalent to the TP adjustment that HMRC believes should be made for CT purposes.
- Once a DPT charging notice has been issued, the DPT must be paid. There then follows a 15 month review period during which the ambition is for the taxpayer and HMRC to try and agree on the appropriate amount of diverted profits.
- During the first 12 months of the review period, the taxpayer can amend its return to reduce the diverted profits (by making a TP adjustment).
- To the extent diverted profits are taken into account in an assessment to CT before the end of the review period, the relevant amount is then taken out of the charge to DPT and subject only to CT.
HMRC’s position
HMRC’s DPT guidance (see INTM489988) makes clear that, in HMRC’s view, diverted profits are only “taken into account in an assessment to CT before the end of the review period” at the instigation of the taxpayer through amendment of its return. Where an open CT enquiry and a DPT charging notice cover the same arrangement, the guidance explicitly states that, in the absence of a taxpayer amendment during an enquiry:
- during the first 12 months of the review period HMRC will not generally issue a full or partial closure notice in relation to the arrangement, and
- during the final 3 months of the review period HMRC would only consider issuing a full or partial closure notice “in exceptional circumstances”. (Those seem to be where the TP adjustment has been agreed with the taxpayer and the closure notice will not be appealed.)
The consequence of this position is that, if (as in Vitol) the taxpayer is not prepared to amend its return during the review period to reflect the TP adjustment HMRC consider to be appropriate, which is likely because the taxpayer disagrees with that view, the taxpayer is left paying DPT (albeit perhaps a reduced amount as compared with the charging notice, if an amending notice has been issued). The guidance goes on to note that this approach puts companies within a DPT review period in the same position whether or not there is a parallel corporation tax enquiry.
The position in HMRC’s guidance was reflected in HMRC’s arguments before the Tribunal in Vitol. HMRC argued that the power to bring profits within the scope of CT rather than DPT rests with the taxpayer and it was both counter to the purpose of the DPT legislation and outside the jurisdiction of the Tribunal for the Tribunal to determine that profits should be subject to CT rather than DPT by ruling that a closure notice should be issued in these circumstances.
The decision
The Tribunal clearly did not feel comfortable engaging with the general, policy-level points raised by HMRC regarding the interaction between CT and DPT. The legal question the Tribunal had to decide was whether HMRC had reasonable grounds for refusing to issue closure notices in this particular case, on the facts before the Tribunal, and HMRC’s arguments were accordingly considered in that light.
Three key points emerge from the Tribunal’s decision in this respect:
- It is irrelevant whether the taxpayers’ purposes in requesting the closure notices are reasonable. The legal test focuses on whether HMRC has reasonable grounds to refuse the issue of closure notices. Even if (as HMRC argued) the only reason the taxpayers had applied for closure notices was to ensure they were exposed to CT rather than DPT, that was not a relevant consideration for the Tribunal.
- The purpose of the DPT legislation is to ensure that companies pay the correct amount of CT on their profits. The Tribunal found as a fact that HMRC had already reached conclusions on the appropriate TP adjustments that would be included in the requested closure notices and those conclusions would not be altered by provision of the outstanding information that HMRC had requested from the taxpayers. In those circumstances, the purpose of the DPT legislation would be served by HMRC issuing closure notices, not refusing to issue them.
- The continuing DPT review period was not a reason to deny the issue of closure notices. HMRC had not provided any explanation as to why DPT should apply rather than CT and on the facts of this case, there was nothing to indicate either that there would be any different calculation of profits for CT and DPT purposes or that a TP adjustment taxed at CT rates would not provide an appropriate answer.
In other words, so long as HMRC has concluded on a TP adjustment and is therefore in a position to issue a closure notice, it should do so, regardless of the DPT angle or whether the taxpayer agrees with the TP adjustment.
Implications for other taxpayers
The Tribunal’s decision in Vitol is likely to be welcomed by other taxpayers with corresponding DPT review periods and open CT enquiries, especially where they continue to disagree with HMRC’s view of the appropriate TP. However, the interaction between DPT and CT is complex and this decision may not be the end of the story – it’s not yet clear whether HMRC plan to appeal.
Leaving that point aside, whether other taxpayers are able to succeed with closure notice applications will turn on the factual circumstances. Ensuring that HMRC are in a position to reach a conclusion on the appropriate TP adjustments and issue closure notices may create a further impetus for affected taxpayers to provide HMRC with requested information during the DPT review period – with the added benefit that doing so could ultimately lead to resolution.
