HMRC says it is targeting US businesses for £4.6bn in underpaid tax – up 35% in the past year alone

• Increase in disputed tax reflects HMRC’s focus on businesses diverting profits overseas

HMRC says it is targeting US-based multinational businesses  for £4.6bn* in underpaid tax last year, up 35% from £3.4bn in the previous year, says Pinsent Masons, the international law firm.

Some US-based multinational businesses have come under media scrutiny in the UK over the low levels of corporation tax paid in  comparison with their global profits

Pinsent Masons says multinational businesses are being targeted by HMRC’s investigations into diverting profits overseas.

This growing scrutiny on the diversion of profits by HMRC comes after recommendations made by the OECD in 2015 as part of its  programme for reducing international tax avoidance by corporates – its Base Erosion & Profit Shifting project. HMRC introduced the Diverted Profits Tax in 2015 as a way to combat the diversion of profits.

The Diverted Profits Tax (DPT) is designed to deter activities that divert profits away from the UK so that they are not subject to corporation tax. DPT is paid at 25%, compared to corporation tax at 19%. This higher rate is intended to be an incentive to groups to adjust their transfer pricing, as paying more corporation tax can eliminate a DPT liability.

Transfer pricing refers to the necessary charges made between different parts of a multinational business for goods, services or intangible assets, including intellectual property. The UK rules require transactions between connected parties to be priced as if they were on arm's length terms so that businesses cannot shift profits to low or no tax jurisdictions.

DPT raised £388 million in 2017-18 – more than the £360 million forecasted when the tax was introduced.

Pinsent Masons says multinational technology groups have been a focus for HMRC’s diverted profits initiatives. This is because digital business models enable the company to generate revenues in places where it has little physical presence and therefore, under current international tax rules established in a pre-digital era, a limited tax liability. 

However, Pinsent Masons adds that HMRC will be focusing on the tax affairs of all the businesses covered by its Large Business Directorate (LBD) in the coming year and not just multinational groups. HMRC’s LBD covers the top 2,100 largest and most complex businesses in the UK.

Jason Collins, Partner at Pinsent Masons, says: “HMRC is under enormous pressure to collect extra revenue and that is leading to more pressure on businesses both from domestic and foreign authorities.”

“Often the large amount HMRC initially believes has been underpaid boils down to basic misunderstandings with businesses and past experience is that HMRC will only collect half the amount it initially sets out.”

“It is not just multinational businesses on HMRC’s radar – the affairs of all large businesses are under growing scrutiny. The amount of tax HMRC thinks was underpaid last year was a record high and it will be looking to act on this.”

“The wide application of profit diversion initiatives shows that businesses across all sectors would be wise to review their cross-border arrangements.”

"HMRC expects all businesses operating cross-border to have revisited their transfer pricing policies to check they accord with what is actually happening in practice."

HMRC launches disclosure facility for multinational businesses

Pinsent Masons says HMRC has opened a new 'profit diversion' compliance facility that gives businesses the opportunity to restructure cross-border arrangements that divert profits overseas and pay back any tax that they owe.

If a business makes a disclosure then they will face lower penalties than they otherwise would have and will not be subject to investigation. Penalties could be up to 30% of the tax that HMRC considers is owed and up to 100% in cases of fraud.

Pinsent Masons adds HMRC already has a 'hit list' of businesses it suspects are diverting profits and intends to issue 'nudge letters' to those it has identified as non-compliant.

Jason Collins adds: “Although making a disclosure under HMRC’s facility can be time consuming for businesses as it means carrying out an intensive investigation and preparing a detailed report, this is not on the same scale as the cost and disruption caused by a full-blown HMRC investigation.”

"HMRC is already putting a huge amount of resource into counteracting profit diversion. No business operating cross-border to a significant extent can afford to be complacent."

New tax aimed at digital companies

As part of its efforts to increase the tax paid by technology groups, the UK Government has proposed a new Digital Services Tax (DST) which will come into force in April 2020. DST is a 2% tax on the revenues of businesses that are considered to derive significant value from the participation of their users. It will catch search engines, social media platforms and online marketplaces.

"The implementation of DST is fraught with difficulties, like how a business works out what proportion of its revenues are linked to the participation of UK users when those users are not paying to use the platform and some will be much more active than others."

"DST is only intended to be a temporary tax, until the OECD can come up with a solution which gets international buy-in. It would be much better if the UK and the other countries pressing ahead with their own measures, held fire until an internationally agreed solution emerges."

The OECD intends to reach a solution by the end of 2020.  France, Italy, Spain and Austria are all proceeding with their own measures for a 3% tax on the revenues of certain digital companies.

*Year-end 31^st March. Figures refer to Tax Under Consideration which is an estimate of the maximum potential additional tax liability across all inquiries, before full investigations are completed. Typically, after investigation of individual cases, the amount actually due tends to be around half the original estimate. Refers to the 2,100 businesses managed by HMRC’s Large Business Directorate