INTM489857 - Diverted Profits Tax: customer engagement with HMRC: detailed risk reviews – operational approach

As described at INTM489833, companies considered to be high risk for profit diversion will require more detailed risk assessment which may involve HMRC approaching the company for additional information and analysis.

Prior to deciding whether to issue a DPT preliminary notice, HMRC’s preferred approach is to engage with companies in order to gain an understanding of the global arrangements affecting the global value chain which affects the UK, either directly or indirectly.

We want to work collaboratively to obtain the information we need to establish whether there is a charge to DPT and to reach an agreed resolution of any dispute that arises.

We are encouraging companies to share information requested with us during the period prior to the potential issue of a preliminary notice. At a later date, we may wish to interview key staff/customers, make third party approaches and have sight of emails and/or other communications.

In a case where a DPT charge could be eliminated by a transfer pricing adjustment (see INTM489635, INTM489640 and INTM489645) and there is an active process involving full co-operation and disclosure towards resolving the transfer pricing issues, it would not be expected that there would be a need to issue a DPT notice, apart from for considerations around time limits.

In the context of this guidance, an active process involving full co-operation and disclosure towards resolving the transfer pricing issues includes:

  • complete transparency over the global arrangements;
  • interaction with a realistic prospect of a successful conclusion within a reasonable time frame and not just a continuation of exchanges of views and/or the provision of information and documents from the customer; and
  • genuine progression towards agreement on the appropriate quantum of the adjustment in order to settle the transfer pricing issues.

Where a company is not fully cooperating HMRC may consider a preliminary notice on the basis of the information available, even if it is likely that any DPT charge could later be eliminated by a transfer pricing adjustment.

Example of initial information request

Below is an example of the sorts of information HMRC may ask for as part of an information and document request in the context of considering a case considered high risk for DPT:

  • Copies of transfer pricing documentation, intercompany agreements, etc.
  • Identification of all legal entities that contribute to generating operating profit from sales that UK staff (for example sales and marketing staff) may contribute to and quantification of the operating profit recorded for each entity for a specified accounting period(s) as well as other factual details of the entities including:
  • (a) how they are treated for tax purposes in their respective jurisdictions;
  • (b) the number of employees for each entity.
  • Transfer pricing policy adopted for each entity.
  • Further information for more senior staff working in the UK and relevant foreign entities that earn a basic salary of greater than a specified threshold amount including:
  • Job title
  • Role performed (cross referenced to intercompany transactions they contribute to where relevant)
  • Reporting lines (who the individual reports to and their location as a minimum)
  • Basic salary
  • Economic value of bonuses, any type of share based reward and details of how staff are incentivised
  • Copies of job adverts and job descriptions for any jobs advertised by the UK company(ies) for a specified accounting period(s).
  • In order to allow us to appreciate the scale of business for different sales channels we may ask for revenue details, for example the top 10 UK customers of the group, etc.
  • Product lifecycle journeys which facilitate a detailed understanding of the involvement of all entities involved in relevant products from ‘cradle to grave’. This may include areas such as:
  • (a) Research & development
  • (b) Key milestones
  • (c) Manufacture/distribution
  • (d) Marketing and commercialisation
  • (e) Regulatory requirements
  • (f) Sales process including pricing models
  • (g) Governance roles and processes including Boards, committees and panels together with those individuals that are members.
  • Details of the group’s strategy for intellectual property/other intangibles, including arrangements in place between two foreign group entities which affect how the group’s commercial activity is carried on in the UK (for example a royalty agreement between a group IP holder and a foreign EMEA sales hub entity which books sales to UK customers).
  • Details of any internal governance documents outlining the negotiation and sales contract approval process.

The information and document request should be tailored to the specifics of the company concerned and the sector it operates in. In some cases the relevant value chain will relate to a particular line of business. In other cases there may be more than one such value chain presenting diverted profits risks.

The PDCF guidance provides details of information we require to be included in disclosure reports submitted through this facility. We expect to gather similar information as that required in such disclosure reports during the course of HMRC profit diversion investigations.

Running investigations –typical HMRC approach

Many contrived arrangements to divert profits use legal structures to shift profits away from where economic value is being added. HMRC wishes to work collaboratively with companies to understand the arrangements, and what is being done on the ground in the UK and overseas with reference to evidence.

The approach to any particular DP investigation is determined in the light of the level of risks and the nature of the issues being investigated and therefore should be determined on a case-by-case basis.

HMRC in running a DP investigation may consider carrying out the following practices where appropriate:

  • Requesting and reviewing relevant transfer pricing documentation and intercompany agreements and seeking clarification from the customer on any areas that appear unclear;
  • Holding a meeting with the customer at the outset – involving the CCM and International Tax Specialist, or DPTC, in an MSB case, appropriate senior managers and members of the tax team from HMRC and the customer – to outline the potential tax risks, agree a high level timetable for investigation, and the resources that would be required from both HMRC and the customer;
  • Encouraging cooperation and agreeing with the customer a joint action plan for carrying out work - discussing regularly progress against the plan, the reasons for any potential slippage and keeping it updated;
  • Establishing the facts before getting into detailed technical discussions. Ensuring that the key facts gathered as the investigation progresses are recorded and discussed with the customer. Any narrative provided by HMRC that summarises key facts is not intended to be agreed by the customer as a ‘Statement of Facts’ – it is HMRC’s summary of the key facts. It should not include assertions, argument or conclusions drawn from the facts;
  • Not considering just the UK economic activities in isolation but understanding them in the context of the global value chain – HMRC needs to understand the worldwide picture and the totality of the arrangements that are in place to reach a view on whether a DPT charge arises;
  • Formulating informal information requests in a format which can be converted easily into a formal request and having a dialogue with the company about the relevant information and evidence and how it can best be provided. Following that discussion HMRC expects the customer to respond thoroughly and timeously;
  • Using information powers promptly, where necessary, to obtain the evidence HMRC considers relevant. Following up failures to comply with formal information notices and considering the application of relevant penalties;
  • Promptly reviewing information and documents provided by the customer and then discussing the next steps with the customer;
  • Holding regular face-to-face meetings to ensure that the customer and HMRC understand each other’s technical analysis and arguments, the key facts on which they are based, and the key differences of view. Agreeing an agenda and where possible circulating papers in advance. HMRC and the customer should both ensure that the right people attend the meeting to discuss the agenda items;
  • Considering when appropriate the issue of protective assessments, and Notices to File on overseas entities to protect permanent establishment challenges; and
  • Considering recommending the issuance of a preliminary notice charging DPT. HMRC should explain its views and plans to the customer in this regard and give them the opportunity to respond before recommending the issuance of a preliminary notice through DP governance.