Is it time for a review of your transfer pricing arrangements? The potential impact of the HMRC Profit Diversion Compliance Facility

The UK tax authority, HMRC, recently announced the introduction of a new Profit Diversion Compliance Facility, which is aimed at tackling the avoidance of tax by diverting profits outside the UK without proper economic justification. The facility represents a step-change in how HMRC intends to tackle transfer pricing and diverted profits tax cases going forward.

PE funds with portfolio companies that have "old style" transfer pricing models should consider carefully whether to take advantage of the HMRC facility. Based upon our experience, having a detailed transfer pricing report will not necessarily be seen by HMRC as demonstrating or proving that what it sees as "high risk" transfer pricing is correct. And in the past few years, HMRC has challenged and secured significant adjustments in numerous cases, even where taxpayers had extensive transfer pricing documentation.

HMRC is likely to launch intrusive investigations into international groups that do not take advantage of the facility where it considers them high risk. HMRC has already used data analytics to identify several hundred such companies, and has created new teams and added staff to handle cases.

How the facility works

  • Taxpayers register with HMRC their intention to use the facility and then have six months to file a detailed report, including a proposal to settle any tax, interest and penalties due (which must be paid when the report is filed)
  • Taxpayers using the facility in the manner expected by HMRC will be treated as having made an unprompted disclosure, resulting in lower applicable minimum penalty rates, and potentially no penalties where the taxpayer registers by 31 December 2019
  • If HMRC accepts the taxpayer's proposals, the relevant accounting periods are closed, and HMRC is likely to consider future tax returns as low risk, provided that facts do not change materially
  • Otherwise, if HMRC does not agree with the proposals, the report prepared by the taxpayer (in the manner HMRC expects) is likely to provide the basis for a "quick and efficient" resolution

Implications for Private Equity

  • portfolio companies with head-quarters in the US could be particularly vulnerable: US transfer pricing rules, case-law and practice are different in important respects from that in the United Kingdom
  • portfolio companies with hubs in low tax jurisdictions (e.g. Ireland, Switzerland or Luxembourg) are also likely to be vulnerable
  • risks are increased for international groups where:
    • there is a substantial UK presence
    • the UK is a regional headquarters
    • there is significant revenue from the UK market
    • valuable intellectual property is exploited in the UK
    • the business has high margins
  • scrutiny of transfer pricing will increase in diligence on exit and when acquiring new businesses
  • the transfer pricing exercise on any restructuring will become more critical
  • PE funds with offshore structures could also be directly impacted by the increased HMRC focus on transfer pricing

How can we help?

Our UK tax and transfer pricing team has directly relevant experience. It has negotiated recent settlements with great success, has years of experience in the area, and includes a former senior HMRC officer who played a key technical and practical role in developing HMRC's current approach to transfer pricing. They would be delighted to discuss this and explain the benefits (and possible downsides).

Please contact us if you want to discuss what the Profit Diversion Compliance Facility means for you.

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