Our regular newsletter highlighting recent developments in the law and practice around Tax Disputes and Investigations.
Profit Diversion Compliance Facility (“PDCF”)
HMRC has recently issued a new tranche of nudge letters prompting groups of companies to participate in their profit diversion compliance facility (“PDCF”).
The PDCF was introduced in January 2019 with the aim of addressing the long-neglected area of structural transfer pricing risk leading to understatement (or “diversion”) of UK taxable profits. Although a unilateral action by HMRC, alongside the accompanying Diverted Profits Tax, the PDCF sat squarely within the OECD and UN ring mastered efforts to improve, rationalise and coordinate taxation of multinational groups of companies (“MNEs”).
The PDCF is a focussed and accelerated programme for resolving complex transfer pricing and wider diverted profits issues. Participation is driven either by invitation, by way of an HMRC nudge letter, or on a proactive and voluntary basis. Importantly, the PDCF is driven by the business rather than by HMRC, in the first instance this is through submission to HMRC of a report covering the relevant issues and making proposals for settlement as appropriate.
Whilst experience shows that the PDCF can be an intense, intrusive, and difficult process, reception by businesses has generally been positive since the PDCF typically allows long term certainty to be achieved far more quickly and efficiently than would be the case through traditional transfer pricing enquiry.
In terms of its impact to date:
HMRC has issued 167 PDCF nudge letters,
121 groups of companies have registered for the PDCF,
76 cases have been resolved as at March 2023,
Over £723 million additional revenue has been generated for HMRC,
97% of final proposals submitted by businesses under the PDCF have been accepted by HMRC,
Average time from registration to decision is approximately 20 months (for a Transfer Pricing enquiry this is currently closer to 3.5 years!)
Looking to the immediate future, whilst HMRC’s early diverted profits enquiries and PDCFs targeted some of the largest multinational groups, their focus since then, and increasingly so, has been on much smaller groups and a much wider diversity of businesses and industries. Our experience of handling these enquiries is that they can be extremely time-consuming and resource intensive, we expect it will be necessary for smaller groups to adopt a flexible and pragmatic approach in order to successfully navigate the process.
Nudge letters
HMRC also continue to issue ‘nudge’ letters with the intention of prompting disclosures in a range of other areas. The most recent examples are –
1. Letters to taxpayers who they believe have not returned capital gains on disposals of shares. The letters have been sent based on information which HMRC have obtained from public records,
2. Letters to shareholders of companies who HMRC believe may have received dividends or distributions but not returned them. The letters have been issued where HMRC have identified large reductions in retained profits from company accounts.
As in all cases where clients receive nudge letters, it will be imperative to obtain a full understanding of the circumstances before deciding how best to respond.
UK rental income – The interaction of Transfer of Assets Abroad rules with UK corporation tax
UK rental income received by a non-UK resident company has been subject to UK corporation tax since 6 April 2020. This income can also give rise to personal tax liabilities for a UK resident shareholder or settlor of a settlor interested trust under the Transfer of Assets Abroad (“TOAA”) rules.
HMRC currently allows individuals to take a credit for the UK corporation tax paid against their personal liabilities. However, some have questioned whether this is the correct position and are suggesting that section 3(1) CTA 2009 might remove this income tax charge altogether.
There is a lack of clear guidance from HMRC on this point and it is causing issues for taxpayers and advisers. The CIOT have recently approached HMRC with a technical question asking them to address this issue. Whilst HMRC’s response will clarify the position going forward, it is possible that this will also highlight historic issues for some. The uncertainty is likely to mean that some previous filing positions will need to be reviewed and corrected.
Spotlight 63
Events continue to move at pace in relation to HMRC Spotlight 63, aimed at LT4L, Property 118 and similar hybrid property business structures.
The good news
Our engagement with HMRC on this continues to be constructive and productive. We believe we are aligned on the desirability of an efficient and pragmatic approach to reaching settlement for those individuals who are keen to bring their tax affairs up to date.
In particular, we believe there is a good prospect of a solution to the prospect of unintended SDLT / LBTT charges being triggered by entry into and variation of the arrangements. This is now under active discussion with HMRC.
We now have a number of clients actively under way in preparing detailed disclosure reports and settlement proposals for HMRC, which are aimed at achieving settlement on the most favourable terms we believe HMRC can accept. Whilst the main principles of the settlement terms HMRC will accept are now clear, there are various areas of potential flexibility which are being explored.
The not so good news
Many people have yet to commit to active engagement with HMRC on a realistic premise (broadly this means agreeing a settlement based on HMRC’s clear position as set out in Spotlight 63).
Consequently, HMRC is alive to the need to take a variety of actions to protect their ability to collect the tax and interest due where active engagement and cooperation has not been forthcoming. This is likely to include an extensive programme of enquiries and assessments between now and mid-April.
Interest on additional tax due to HMRC continues to accrue at a current rate of 7.75%. There is very little prospect of any interest being reduced or mitigated as part of a settlement agreement with HMRC. Several of our clients have consequently made substantial payments on account to freeze the final interest bill.
Case law update
Roy Baker v HMRC [2024] UKFTT 00126 (TC) dealt with penalties due under Follower Notices. Follower Notices were introduced alongside Accelerated Payment Notices (“APN’s”) in FA 2014. The provisions broadly allow HMRC to issue a notice requiring a taxpayer to amend their return, accept that an assessment is valid or withdraw a claim (defined as taking ‘corrective action’) where the taxpayer has been involved in a tax avoidance scheme and there has been a final decision of the courts or tribunal which demonstrates that the scheme does not work.
In this case, Mr Baker had taken part in a scheme designed to prevent his income being taxable by structuring his activities through an Isle of Man Partnership. The scheme was widely used in the mid-2000’s and was used both by contractors and by property developers. Mr Baker was a contractor. HMRC contended that Mr Baker should take corrective action following the decision in Huitson [2017] UKUT 0075 which confirmed that the scheme did not work as intended. Usually, Follower Notices are accompanied by APNs’ which require any disputed tax to be paid. Mr Baker also received APN’s which he agreed to pay over time through a payment plan. He did not however take corrective action. The tribunal was required to consider whether that was reasonable in all the circumstances. The tribunal examined Mr Baker’s motivation carefully and took the view that, on balance, he had relied on the advice of his then-advisers that he should not take corrective action. The tribunal were persuaded that it was objectively reasonable for Mr Baker not to take corrective action in light of numerous errors and changes of position made by HMRC throughout the course of his dealings with them. In particular, HMRC changed their position on whether NIC’s would be payable several times and incorrectly issued Mr Baker with penalties for failing to comply with the APN’s. We are still seeing a range of cases where Follower Notices are in point and penalties under the Follower Notice regime can be very significant (up to 50% of the tax liability). The case illustrates the risks involved where Follower Notices have been issued but also provides useful guidance on what is and is not reasonable in the context of reliance on advice.
J Keighley and Primeur Ltd [2024] UKFTT 30 (TC) involved consideration of a range of issues arising from an HMRC enquiry. Two points are of particular interest.
Firstly, HMRC issued assessments in connection with the use of a company credit card for personal expenditure over an extended period of time. HMRC relied on the extended 20 year assessing time limit for deliberate inaccuracy. The assessments were based on the ‘presumption of continuity’ under which HMRC are entitled to presume that conduct occurring in one tax year or accounting period is likely to have occurred in earlier periods. The presumption is rebuttable, and the taxpayers argued that the presumption should not apply to all of the years for which assessments had been issued. The tribunal found that there had been a deliberate error in failing to properly account for tax on personal credit card expenses and the burden of proof to address the presumption of continuity then fell on the taxpayer. The taxpayer was unable to discharge that burden on the evidence. In particular, the company sought to rely on an HMRC PAYE review which had been conducted in an earlier period which it was asserted included a review of the use of company credit cards to indicate that the treatment of company credit card expenses had been given a ‘clean bill of health’ at that date. The tribunal did not accept that was the case and upheld the assessments for the whole period, extending back to 2001. The decision illustrates the importance of being able to evidence changes in practice or circumstances in order to rebut the presumption of continuity.
A further technical point arose around the application of the ‘unallowable purpose’ rules. Broadly speaking, these provisions prevent a company from taking a deduction in connection with lending (such as interest costs or the writing off of a loan between unconnected parties) where the lending or a related transaction has an unallowable purpose. An unallowable purpose is a purpose which is not amongst the business or other commercial purposes of the company. In this case, the company had lent money to another company with some common shareholders. The other company had failed, and arrangements were made to repay its creditors. It was agreed that Primeur Ltd would receive some but not all of the funds it had lent but that the shareholders and directors would receive repayment of the amounts they were owed in full. Primeur Ltd claimed a deduction for the partial write-off of the loan. The tribunal held that this partial write-off was for an unallowable purpose because it was intended to benefit the shareholder/director lenders rather than Primeur Ltd. The unallowable purpose rule is generally regarded as an anti-avoidance provision addressing schemes creating artificial financing costs, usually in the context of larger groups of companies. It is therefore interesting to see the provision being applied in the context of owner-managed businesses.
Lastly, a point arose as to whether the company or its advisers had failed to take reasonable care. This is because the assessment to recover tax arising because of the unallowable purpose rules was made outside the normal 4-year time limit. The borrower company had obtained tax advice in respect of the distribution of funds to creditors, but this advice did not address the unallowable purpose issue. The tribunal’s view was that a failure to do so constituted carelessness on the part of the advisers who prepared the advice and therefore the extended 6 year time limit for assessment applied.
Finally, an application for admission of a late RDEC (Research and Development Expenditure Credit) claim was considered in the Scottish Court of Session in Bureau Workspace Ltd v Advocate General for the Commissioners of HMRC [2024] CSOH 1. In that case, an amended Corporation Tax return was filed with HMRC which did not include a Corporation Tax computation. The court held that a Corporation Tax computation was required along with the return in order for it to have been validly made. The Corporation Tax computation was then submitted some 20 days after the statutory deadline. HMRC refused to accept the RDEC claim as they asserted it was made outside the statutory time limits. The court was asked to consider whether HMRC’s decision not to accept the claim was unreasonable. HMRC’s discretion to accept late claims is set out in Statement of Practice 05/01 and the court found that HMRC’s decision took account of the principles set out in the statement. The only basis on which the company could argue that the late claim should be accepted was that HMRC’s decision to refuse it was ‘unreasonable’. A decision is only unreasonable in this context if it is a decision which no reasonable person acting reasonably could have made (referred to as ‘Wednesbury’ unreasonableness after the leading case in this area). This is an extremely high bar and one which would be almost impossible to reach in circumstances where HMRC had applied the principles in the Statement of Practice.
It is clear that HMRC’s approach to accepting late claims has significantly hardened over time and we are seeing an increasing number of examples of clients finding themselves in difficulty. This case provides a clear example of how difficult it will be to persuade a court that a late claim should be admitted where HMRC have rejected the application.
If you would like to discuss the implications of any of the above, please do not hesitate to get in touch.
