14 Jun 2016

Diverted Profits Tax – deadline approaches

The extended notification period for Diverted Profits Tax (DPT) for the first affected accounting periods (those ending on or before 31 March 2016) permits notification up to 6 months after the end of the period instead of the normal 3 month deadline. For further background, see below.

Diverted Profits Tax key points:

  • Notification deadline is looming
  • Assessing whether to notify is not straightforward
  • Not notifying may lead to greater uncertainty, and potentially penalties
  • For oil and gas sector companies we understand that HMRC is primarily focusing on payments to captive insurance companies.

CW-Energy-3

Detail

Background 

The Diverted Profits Tax (DPT) rules were introduced in Finance Act 2015 as a key part of the Government’s response to criticisms that corporate taxpayers were not bearing a proper share of the tax burden. It is thought that the scheme has been given a high priority within HMRC, with a dedicated resource (the ‘Task Force’) and an expectation that DPT will change behaviours.

The HMRC forecast was that the introduction of DPT would bring in £270m in 2016/17, which at rates of 25% and 55% represents over £1 billion of ‘diverted profits’. Some of this expected increase may however come from income subject to normal CT rates as a result of groups revising their commercial arrangements.

The initial focus was on the ‘Avoided PE’ arrangements, where sales to UK customers were arranged without creating a taxable permanent establishment in the UK, notwithstanding the presence of ‘sales’ personnel and/or large warehouses. This is not thought to have much, if any, application to the upstream sector.

However, the other “Lack of Economic Substance” test may apply as a result of the difference in tax rates between ring fence and non-ring fence activities.

For ring fence trades, where deductions are claimed in respect of services provided by an affiliate, the potential liability to DPT comes where there is insufficient economic substance to the provision and the parties meet the particular participation test used in the transfer pricing rules. This test goes beyond a straightforward control test.

The taxable diverted profits are then established by identifying transfer pricing adjustments not already assessed, and potentially on top of that any profits chargeable to UK CT that would have arisen if the arrangements in place were not tax motivated.

In other words, the taxable diverted profits rely on judgements around market prices and what the situation would have been absent any tax considerations.

Notification 

In the absence of a notification HMRC have an extended period of time in which to issue a preliminary notice, the precursor to any charging notice, in relation to particular arrangements; whereas the normal time limit is 24 months after the end of the accounting period, where no notification has been made the time limit runs to 4 years after the end of the accounting period.

When it is unclear whether notification is required companies should be aware that not notifying will extend the period of uncertainty for a company.

Assessing whether to notify or not is complicated by the fact that for both types of potential charge companies effectively need to notify if there is uncertainty over whether some of the tests are “failed”. The tests in question are set out in the rules and are broadly those that require most judgement to be applied.

However, no notification is required where it is reasonable for a company to conclude that no charge to DPT arises, ignoring the possibility of transfer pricing adjustments that could, if made, eliminate the DPT charge.

Where a DPT liability is established after a failure to notify there are provisions for a tax geared penalty, calculated by reference to the potential lost revenue, whether it is a domestic or offshore ‘matter’ and the circumstances surrounding the failure.

Areas of risk

HMRC has undertaken discussions with some groups on particular issues and more generally has indicated areas of concern to the oil and gas industry. Payments to captive insurance companies are one key area of concern to HMRC but, as recognised in the HMRC guidance notes, the application of the rules to payments to captive insurance companies requires an interpretation of the particular facts which can give different results in terms of DPT exposure.

Of course, whilst HMRC’s current focus for the oil industry would appear to be captive insurance arrangements, there may be other areas where the DPT rules need to be considered, for example payments to overseas affiliates for services.

Any payments across the ring fence will meet the tax mismatch condition embedded in the DPT provisions as one of the triggers, so the potential application of the DPT rules requires analysis of the other elements, many of which are open to interpretation. Whilst the correct transfer pricing, coupled with an absence of any design to avoid UK chargeable income or boost ring fence deductions should offer protection from a DPT charge, some judgement is required in assessing any risk.

CW Energy can assist in making the decisions about notification and assessing the risks; please get in touch if you wish to discuss DPT with us.


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