HMRC raise the stakes on diverted profits investigations

HMRC have published their latest annual Transfer Pricing (TP) and Diverted Profits Tax (DPT) statistics which cover the year ended 31 March 2024 (FY23-24).

The statistics show HMRC continue to be very active on transfer pricing initiatives with the headline TP yield number increasing to £1.79 billion (up from £1.64 billion in FY22-23), the second highest yield reported over the past six years. There are no signs that this yield is going to tail off; the Large Business annual report shows £13.8 billion tax under consideration for ‘International’ at 31 March 2024, so there is still a significant pipeline.

The most eye-catching statistic was the figure of £4.5 billion reported as the total tax under consideration at the end of March 2024 in relation to 74 ongoing HMRC diverted profits reviews (including cases where taxpayers have registered under the Profit Diversion Compliance Facility).

This figure stood at £2.6 billion from 90 reviews at 31 March 2023 and £2.4 billion from around 100 reviews at 31 March 2022. So there has been a dramatic increase of some £1.9 billion, despite a decline in the number of ongoing reviews. There are a number of factors which could be driving this such as remeasurement of the tax under consideration on existing reviews including from additional years coming into scope, as well as the opening of new reviews.

HMRC adopt a resource to risk approach so the amounts of tax at stake in these cases make it likely that they are soaking up a significant amount of HMRC’s resources. That should create more impetus around the resolution of these cases and HMRC note they have been taking actions to improve international compliance work, including internal measures on acceleration and effectiveness. Alternative Dispute Resolution (ADR) has been under-utilised in transfer pricing disputes to date whereas overall application numbers have shown double digit growth. ADR would seem to offer a potential solution to accelerate some of the more difficult cases where there are entrenched positions or a need to draw a line under protracted information gathering efforts. The statistics on ADR tell us that the main challenge is access, but once you are accepted into ADR the results indicate it is a highly effective tool with issue resolution in over 80 percent of cases.

The differentiation in HMRC’s statistics between TP enquiries, reviews into arrangements to divert profits and cases where DPT notices are being issued is unclear. For example, in FY23-24 DPT charging notices were issued to less than five customer groups (six in 2022/23) despite the 74 open reviews mentioned. This may point to DPT being a tool that it is increasingly not necessary for HMRC to formally use in many of their investigations where it potentially could be – paving the way for the proposed reforms to the DPT legislation for which draft legislative clauses are expected in spring 2025.

The number of HMRC staff working on international tax issues has been hovering just below 400 full-time equivalent staff (FTE) for the last three years, but has fallen slightly over this period from 398 to 395, having stood at 431 in FY20-21. This resource is not exclusively dedicated to transfer pricing, but it forms a significant element of the work performed and is bringing in a yield of over £4.5 million per FTE.

Whilst we expect HMRC to look to increase the number of international specialists, with the new Labour Government reportedly increasing HMRC funding, in the short term HMRC will have to manage their resources carefully as TP enquiries are very resource intensive.

Given those circumstances it is understandable that HMRC have put increased emphasis on upstream compliance initiatives which are aimed at increasing voluntary compliance with HMRC’s interpretation of TP rules. In September 2024, HMRC published new guidelines for TP compliance. These are extensive practical guidelines aimed at helping steer taxpayers and advisors towards lower risk approaches in designing, implementing and documenting TP policies. These may not be mandatory, but are likely to have a significant bearing on how HMRC assess taxpayer behaviours for inaccuracy related penalties and how they assess taxpayer and advisor behaviours for discovery purposes.

We expect to see HMRC issue further guidance, in relation to TP risk areas and tax compliance standards more generally, and to look for ways they can measure the behavioural impact of these upstream initiatives. A good example of this is the disclosure channel included within the Guideline for Compliance itself.

In practice HMRC will need a mix of upstream initiatives along with healthy levels of new enquiries downstream if they want to improve voluntary compliance.

If we had one ask for HMRC to improve their annual statistics, it would be to include the number of new enquiries opened.

The statistics show that the PDCF is viewed by HMRC as ‘very successful’ with an average time taken of 21 months from the registration meeting and £830 million of revenue generated by HMRC since its introduction in January 2019. This time take statistic compares favourably to the 33.1 months average age for settled enquiries although is up from the 20 months reported for FY22/23 and 16.5 months reported for FY21/22, likely a result of a tail of older cases that have been more challenging to resolve and fewer new registrants.

Despite the apparent success of the PDCF we have seen HMRC use PDCF nudge letters more sparingly over the last two years, with the focus largely on taxpayers whose affairs are handled by the Wealthy and Mid-Sized Business Compliance Directorate. This may reflect the fact that taxpayers whose affairs are handled by Large Business will have a Customer Compliance Manager (CCM) and undergo a Business Risk Review process that can enable HMRC to obtain information outside of a formal enquiry and then decide if an enquiry is necessary.

Given that many of the 19 PDCF nudge letters issued in FY23-24 were issued in January 2024, with registration deadlines falling after 31 March 2024, we don’t view the registration rate decrease in 2023/24 that might be read into the statistics as significant (we know from direct experience that some registrations occurred in April 2024). More targeted HMRC nudge letters are expected shortly, again less than 90 days from the end of the tax year.

It is now more than six years since the PDCF was launched and a good time for HMRC to consider their future plans for the facility. As announced in the Corporate Tax Roadmap published alongside the Autumn Budget last year, the Government is weighing up whether to expand the scope of the UK TP rules to include some medium-sized enterprises that are currently exempt from applying the rules, as well as introducing a requirement for multinationals to report additional information on cross-border related party transactions to HMRC. If introduced, these new requirements may support maintaining the PDCF as it offers a more efficient alternative to an enquiry from HMRC’s perspective, and the data obtained from the reporting requirements may aid HMRC’s risk assessment procedures.

The 2023/24 statistics show that the numbers of APAs settled have returned to more typical levels with the 27 APAs agreed during the year representing the highest since 2018/19. The increased interest of businesses in applying for new APAs continues despite the long-time take reported in the statistics (and this timeline still, of course, compares favourably with the average duration of a TP enquiry followed by a MAP).

In our experience most applicants recognise that, as well as reflecting the complexities involved, the APA average time take relates to historical cases and challenges like COVID-19, HMRC agreeing their first APAs with the likes of China and an increased interest in multilateral APAs. A positive way of viewing the time-take is that HMRC will generally stay the course and see cases through to an agreement that provides certainty and once you have an APA a subsequent renewal is typically a quicker process.

The APA landscape is changing as more countries establish programs and existing programs become more mature. The new OECD statistical reporting for APAs will hopefully have a similar effect to the MAP statistics and translate to lower time take statistics in the medium term but it would unrealistic to expect the average time take for pre-existing applications to come down (time take for new applications may be closer to the 30 months target mentioned in HMRC’s APA Statement of Practice but this would not be visible in the statistics short term).

HMRC are successfully reducing their inventory of TP and profit attribution Mutual Agreement Procedure (MAP) cases – this was the third year in a row that HMRC resolved more MAP cases than they admitted. HMRC highlight that their statistics for the 2023 calendar year (as reported to the OECD) compare favourably to the global average per the OECD statistics with, for example, double taxation fully eliminated in 90 percent of these cases and the average time taken of 25 months outperforming the global average of 32 months. Fewer MAP cases were resolved in FY23-24 compared to the previous two years, but this was consistent with a smaller number of newly admitted MAP cases. The reduction in new cases was surprising although we do find that MAP is not always well understood by taxpayers and this can mean it can be discounted too quickly.

HMRC’s Advance Thin Capitalisation Agreement (ATCA) programme has been in decline since the Corporate Interest Restriction (CIR) rules came into effect. However, there were 10 ATCAs agreed in FY23-24 which was double the number agreed in the previous year and the average time taken of 37 months was a marked improvement on the last few years. We still see taxpayers requesting ATCAs on new funding transactions, but this has become the exception rather than the norm. Bilateral and multilateral approaches to funding issues are increasingly important as we are now in a higher interest rate environment. One route that taxpayers could explore is using the International Compliance Assurance Programme (ICAP) to manage TP risks for common financing issues like cash pooling and short-term working capital funding arrangements.

The statistics demonstrate HMRC remain focused on transfer pricing related compliance risks and businesses can respond to this by:

• Undertaking a review of your transfer pricing policies and how they are being implemented within the business to assess your audit readiness. We have risk assessment tools and methodologies that can help you do this efficiently and gain fresh insights into TP risk areas and how to manage them;
• Considering whether APAs or other programs like ICAP could be used to address identified areas of uncertainty; and
• Ensuring UK TP documentation for key cross-border transactions meets HMRC’s expectations as set out in the Guidelines for Compliance as well as the new mandatory UK TP documentation requirements.

Overall, the transparency from the annual HMRC statistics and ongoing efforts to expand TP related guidance are very useful in helping businesses better understand HMRC’s approach and compliance expectations and know what to expect in this high profile and key area. We will be discussing this further in our next quarterly TP Controversy Round Table on 5 March 2025. If you are interested in attending this event, please contact the authors.

For further information please contact:

• Phil Roper
• Nicholas Stevart