Countering profit fragmentation: HMRC’s new weapon

Over the past ten years, the UK has introduced a number of new anti-avoidance rules aimed at cross-border transactions, such as worldwide debt cap or the diverted profits tax, but it has ‘spared’ SMEs and individuals the pain of dealing with them. However, on 10 April 2018, HMRC launched a consultation on a new anti-avoidance measure aimed at ‘profit fragmentation’ that more than redresses the balance.

 

The mischief HMRC is aiming at is when a person has a skill or expertise from which they are able to generate income from clients or customers outside the UK and some of the income doesn’t reach home turf. HMRC acknowledges that it already has a number of anti-avoidance measures in its well-stocked arsenal which can counter this sort of ‘arrangement’, but they are too time consuming and fiddly to deploy – I paraphrase HMRC’s justification a little here. (I wonder if HMRC considers the GAAR to be in this bracket too, as it is not mentioned at all in the consultation!)

 

Therefore, rather than extend the current anti-avoidance measures, such as transfer pricing, or adapt others, such as transfer of assets abroad rules, HMRC is bringing in a new rule.

 

The consultation suggests three conditions for the rule to apply:

 

The consultation is a little cheeky in suggesting that there will be a fourth condition ‘that is intended to give these businesses immediate certainty as to whether the legislation applies to them.’ The cheekiness comes from the fact that the condition is a subjective test. It will work on the basis that ‘it must be reasonable to conclude that some or all of Z’s (the entity) profit is excessive having regard to the profit-making functions it performs with that excess being attributable instead to the connection between it and A (the individual).’

 

What it is ‘reasonable to conclude’ is a phrase that the First-tier Tribunal (FTT) often uses; for instance, see D Watson v HMRC [2016] UKFTT 729 (TC) or D & V Kent [2016] UKFTT 228 (TC). But when it comes to excessive profits we are into new, very complex territory: the OECD’s transfer pricing guidelines now stretch to over 600 pages to give you a range of outcomes. I struggle to see how a subject that causes tax authorities and business so much heartache can somehow suddenly be found to give an immediate and stress-free answer.

 

 

Flushed with the success of accelerated payment notices (APNs), partner payment notices and follower notices, the proposed new rule will have a similar mechanism of notifying HMRC. If HMRC thinks the rule bites, a notice will be issued requiring payment of the tax that HMRC considers to be due within 30 days.

 

I mention again here that whether profit levels between connected parties are excessive is such a complex subject that HMRC has an entire governance process before enquiries can be opened in the area. The enquiries are then worked by a small number of specialist staff (and again, I play the OECD’s 600+ pages of guidelines card). Despite this, HMRC is going to be able to decide in short order whether the returned figures are correct and then issue a notice to pay. This will, as ever, be open to representations, so what is HMRC going to do when it receives transfer pricing reports in response to the notices? It will have to give them sufficient thought, as surely to do otherwise would be ‘Wednesbury unreasonable’, as the judicial review terminology has it. The question is, has HMRC thought of this?

 

A further issue is what happens then? The consultation talks about cases going to appeal. Is the FTT ready for its second transfer pricing case (the first being DSG Retail Ltd and others v HMRC [2009] STC (SCD) 397)? Is HMRC?

 

 

I have noticed a strange disconnect between the language of the consultation and the size of the issue. The introduction talks about HMRC ‘recovering significant amounts of tax’. This recovery though is at the cost of ‘considerable resource’ and enquiries that take ‘several years to resolve’. Indeed, at para 2.17, HMRC says: ‘The amount of tax in dispute is normally substantial…’

 

This doesn’t quite fit with the impact assessment section of the consultation. The rule is expected to increase the tax take by up to £50m a year, from 8,000 to 10,000 people or 4,000 to 5,000 businesses. This equates to £5,000 to £6,250 per person or £10,000 to £13,000 per business. Compare this to the ‘Working Wheels’ scheme (where radio DJ Chris Moyles and many others came unstuck), which was £290m from 450 people or £644,444 per user, or with APNs which are said to have raised £3bn from 60,000 people or £50,000 a pop. So, a regime that is potentially much more complex to administer for around 1/10th of the tax seems to be a strange use of resource.