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How much can you save if you register for the Profit Diversion Compliance Facility before you’re “nudged”?

How much can you save if you register for the Profit Diversion Compliance Facility before you’re “nudged”?

We’ve recently published three articles on HMRC’s use of “nudge” letters in various contexts. HMRC are expected to issue another batch of nudge letters in the Autumn in relation to Profit Diversion, and in this article we consider the potential cash benefits of registering for the Profit Diversion Compliance Facility (“PDCF”) before such a letter is received.

HMRC’s approach here is very similar to that we’ve outlined in our previous articles; they have used their ability to collect significant amounts of information to produce a list of taxpayers who they consider may not have paid the full amount of tax due. Then, rather than opening an enquiry, they issue a nudge letter suggesting that the taxpayer considers carefully what tax they owe and discloses it to HMRC. The nudge letter doesn’t specify what their information is, and the strategy is not to tell the taxpayer, with the aim of eliciting disclosures of other matters HMRC is unaware of.

The PDCF is similar to other disclosure facilities, in that it puts the onus on the taxpayer to calculate the tax, interest and penalties due. A taxpayer is required to register and then has to make the full disclosure on a fixed timetable. For the PDCF, a taxpayer who registers before they are “nudged” will be charged lower penalties, on the basis of “unprompted disclosure”. We’ve set out below why penalties are possible in this context, and what the PDCF means for penalties.

This article covers;

• When HMRC will charge a penalty for a transfer pricing adjustment
• How many years they might seek a penalty for
• The penalty reduction available when a group registers for the PDCF before HMRC open an enquiry
• Why registering before 31st December 2019 can also save a Diverted Profits Tax penalty
• Why penalties can apply to a group which has taken transfer pricing advice from appropriate professionals

Registering before you are nudged reduces penalties, which can save costs and reputational damage.

How can HMRC charge a penalty for a transfer pricing adjustment?

Tax directors might be thinking that transfer pricing is a technical area where a range of outcomes is possible, so a transfer pricing adjustment is a difference of technical opinion not subject to a penalty. They may also be expecting to rely on the professional advice they took to prevent penalties being charged.

This is not HMRC’s view. The guidance that they’ve issued for the PDCF refers to situations where the transfer pricing position in the returns is not backed up by the facts on the ground. It is not uncommon for careful arrangements for significant people functions to be in low-tax jurisdictions to have lapsed as people drift over time back to offices in the UK.

More importantly, when HMRC refer in their guidance to transfer pricing policies which are not “BEPS-compliant”, they have very specific examples in mind of arrangements which were introduced before 2015 putting contractual risk and entrepreneurial reward into low-tax jurisdictions, which isn’t supported by substance. The key point is that an arrangement which was common in the past is in HMRC’s view incorrect now and vulnerable to penalties.

HMRC say specifically in their guidance that it is careless to submit a corporation tax return after 31st December 2016 without reviewing the BEPS action report published in October 2015 and amending the return if necessary. A penalty can be charged for careless behaviour.

HMRC say in their guidance (we’ve inserted the italics);

“Having taken advice on a transfer pricing position is not enough, by itself, to show that you took reasonable care to submit an accurate return. You will need to show, amongst other things, that you have asked for appropriate advice, have given your advisors accurate and complete information, have checked the advice in light of the facts and implemented the advice given.”

In our experience, regular reviews to confirm and demonstrate that TP policies and practices have been implemented correctly are not standard practice; it appears HMRC see this as one of the key triggers for a PDCF disclosure.

We discuss below the taxpayer’s obligation to determine whether the group has been careless.

How much does registering save in penalties for a transfer pricing adjustment?

A group with a 31st December year end which has not checked whether its transfer pricing is BEPS compliant has two potentially careless returns, for 2016 and 2017. So, supposing that the corporation tax profits are understated by £1m in each year, HMRC will be looking for penalties for corporation tax on £2m.

If they find this in an enquiry after issuing a nudge letter, then the minimum penalty rate is 15%, because this is “prompted disclosure”. If the group registered and disclosed this, the minimum penalty is nil.  Registering could save around £60,000 in penalties on our example figures (3% of the tax). Registering could prevent a penalty being charged, and hence avoid the reputational damage of being penalised for tax inaccuracies.

How far back will HMRC look if they have shown that behaviour has been careless?

A group which registers has to put forward a report showing all of the tax, interest and penalties which are due. In particular, a group which registers has to determine whether or not its behaviour has been careless, in order to determine whether penalties are due.

If the recent returns have been careless, then it will be necessary to consider whether earlier returns, submitted before the BEPS report, have also been careless. This is because if a careless return has been made, HMRC have longer time limits to open an enquiry. For the example of a company with a 31st December year end, the returns for 2013, 2014 and 2015 are in scope if carelessness applies.

It may be that the transfer pricing arrangements were in line with the view of transfer pricing at that time, (before the BEPS action report) and not careless. However, the point about whether the transfer pricing position taken agrees with the facts on the ground is still important. If the reality of the group’s activities isn’t in accordance with the position taken on returns, then assessments can be made and penalties charged.

Thus, penalties might apply for up to 5 accounting periods, and the reduction for registering and qualifying for unprompted disclosure treatments could be even more significant.

Penalties and your CFO

If HMRC charge penalties for carelessness, and the company is within the Senior Accounting Officer regime, then this exposes the Senior Accounting Officer, usually the CFO, to personal penalties.

In their PDCF guidance, HMRC say

“Where a business makes a full and accurate disclosure through the facility and then fully co-operates, an admission of careless behaviour by the business in connection with the disclosure made will not, of itself, be used by HMRC as a reason to consider a possible related past SAO main duty failure or inaccurate submission of a SAO certificate.”

Penalties for failure to notify potential chargeability to Diverted Profits Tax

There is a wide obligation to notify HMRC of a potential liability to Diverted Profits Tax, and a group which can show it has no liability is still required to notify.

The HMRC guidance says that provided a group registers before 31st December 2019, and that its failure was not deliberate, the penalty will be reduced to nil. If a group doesn’t register, and is subsequently found to have failed to notify, then the minimum penalty is 20% of the potential lost revenue.

How do we establish whether the risks mean we should register?

A group needs expert transfer pricing advice, and it also needs advice from experts in the classification of behaviour as careless or not in terms of HMRC’s powers.

The team at Trident has very extensive experience of making voluntary disclosures over many years, a critical part of which is to assess the question of whether there has been careless behaviour. Please contact us if you would like to discuss your approach to the PDCF.