On May 10, Diageo, a FTSE 100 alcoholic beverage company, reported that it will have to pay a Diverted Profit Tax charge of £107 million in relation to a period of just 15 months. This evidences the approach HMRC is taking in inquiries where it does not agree with the transfer pricing structures and historic arrangements employed by multinationals. The Diverted Profit Tax is a broad reaching and contentious legislation enacted in April 2015, which all multinationals operating in the UK should be closely assessing…
Diverted Profit Tax
Initially, the Diverted Profit Tax legislation came about after public pressure to tax multinationals which actively avoid paying tax in the UK. High profile stories on Amazon, Apple, and Starbucks introduced terms like ‘transfer pricing’ and ‘tax avoidance’ to the general public and created a public backlash. The UK Government decided not to wait for the conclusions of the OECD Base Erosion and Profit Shifting project, and acted unilaterally.
The Diverted Profit Tax legislation was announced in the 2014 Autumn Statement and enacted by the Finance Act 2015. Quickly labelled ‘Google tax’, the legislation was designed to discourage large companies diverting profits out of the UK to avoid tax. It would apply a 25% tax charge on any profits ‘diverted’ from the UK. However, the actual scope of the legislation went far beyond the targeting of only large global multinationals, and came with several surprises, such as a requirement for a taxpayer to notify HMRC as well as a requirement to pay the tax before the position is agreed between HMRC and the taxpayer.
The effects of the Diverted Profit Tax were quick to surface. Amazon decided to move from a centralised sales hub in Luxembourg to booking sales in the jurisdictions the goods are sold. Google was quick to report increased profits in the UK. However, with this announcement from Diageo two years later, we can start seeing the true reach of the new legislation.
Why is the Diageo announcement significant?
Diageo has noted that it does not agree with the HMRC assessment and does not believe that it falls within the scope of the new Diverted Profits Tax regime. Nonetheless it will have to pay the charge before it can challenge the position of HMRC.
There are several highlights here. Firstly, the timing of the payment. Secondly, the arrangement which was challenged. Thirdly, the circumstances in which the Diverted Profit Tax was charged.
First of all, the procedure of the Diverted Profit Tax charge is noted in the legislation itself. Effectively, this legislation is based on a ‘pay first, argue later’ principle. First the taxpayer has to notify that it falls under the legislation (unless it wants to risk penalties). The HMRC has then a window to issue a preliminary notice. This is what happened in the Diageo case. After the issue of preliminary notice, it is likely that a charging notice will follow in less than 60 days. After a charging notice is issued a taxpayer has 30 days to pay the charge. Then there’s still a year for HMRC to review the preliminary amount, before the taxpayer can challenge it.
Secondly, in respect to the arrangement in question, it was reported that this is likely related to the profits that have been moved between the UK and the Netherlands, where Diageo employs 220 people. If this is true, it shows that the arrangement had real substance. The Netherlands, although it has some preferential regimes, is not considered to be a tax haven. It is likely that Diageo, as a listed multinational, would have also discussed the arrangement with the tax authorities of both jurisdictions and likely even got a binding ruling on it. Despite of all these factors a Diverted Profit Tax charge still came.
Lastly, Diageo also noted that it had been discussing its transfer pricing position and related issues with HMRC. This evidences that HMRC is likely to pressure companies into settling in transfer pricing disputes by introducing a Diverted Profit Tax charge. This is a worrying sign for any multinational which has operations in the UK. The legislation is loosely worded and can potentially apply to a wide range of situations. This allows HMRC to use Diverted Profit Tax in a number of cases where the taxpayer is not willing to accept HMRC’s position.
It is evident that the Diverted Profit Tax is extending the HMRC’s powers on certain transfer pricing disputes. Multinationals should look closely at any arrangements in effect after 1 April 2015 and new structures to be put in place should be reviewed from a Diverted Profit Tax position. The arrangements similar to the ones listed below should attract special attention:
- Paying royalties, license fees, and management fees from the UK;
- LRD or commissionaire structures;
- R&D activities in the UK;
- Sales support activities in the UK;
- Sales into the UK from a foreign entity;
- Profit split arrangements involving UK entities;
- Use of low tax regimes (taxing less than 80% UK tax rate) within the value chain of the multinational;
- Sale of IP anywhere in the group;
- Involvement of low substance entities anywhere in the group; and
- Any arrangements involving reduction of UK corporation tax as one of the main drivers.
The application of the Diverted Profit Tax legislation is complex and subjective. In order to improve the chances of defending against the Diverted Profit Tax challenge, it is important to assess and document the notification obligations in respect of the arrangements which could be potentially caught. Compliance to the Diverted Profit Tax legislation is largely driven by a robust audit trail, which potentially can discourage HMRC to challenge the arrangement.
How can we help?
Quantera Global can assist you by:
- Performing a high-level assessment on the structure to assess if it is at risk of being caught under the Diverted Profit Tax legislation;
- Performing a Diverted Profit Analysis and support your organisation in documenting the audit trail to evidence compliance with the legislation;
- Helping you to understand the Diverted Profit Tax notification requirements and providing advice on making the ‘notify or not’ decision;
- Preparing the notification submission and assist throughout the notification process;
- Estimating the Diverted Profit Tax exposure; and
- Defending the structure in the negotiations with HMRC.
About Quantera Global
Quantera Global is one of the world’s leading independent transfer pricing advisory firms, providing specialist and integrated transfer pricing services to multinationals of all sizes across the globe. We provide specialist transfer pricing consulting services throughout Europe, as well as in the Asia Pacific region and the Americas.
If you have any questions on the above, please contact firstname.lastname@example.org, or contact your trusted Quantera Global advisor. We are always happy to assist you.