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Investigations and the new profit diversion compliance facility

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HMRC’s investigations into large businesses are now taking on average more than three and a half years to settle, taking a record 43 months on average in the year ended 31 March 2019, according to figures obtained by Pinsent Masons. This is a 10% increase from 39 months in 2017/18 and a 26% increase from 34 months in 2016/17.

This is worrying because tax investigations can be very disruptive. An investigation is likely to involve significant information requests from HMRC, interviews with staff (and possibly customers or suppliers of the business) and maybe email reviews. The investigation will relate to something which took place a number of years ago and key staff may well have left the business, adding to the challenges.

Lengthy investigations can drain management time, distract the focus of the business and cause lengthy periods of financial uncertainty. Businesses need certainty to plan efficiently – putting them in legal limbo for years on end undermines that certainty. Listed companies may also need to make stock exchange disclosures which can attract adverse publicity.

HMRC’s strategy for dealing with tax investigations can work against reaching quick resolution of an inquiry. The litigation and settlement strategy makes it difficult for individual HMRC teams to settle disputes for less than the full amount of tax initially identified by HMRC as potentially underpaid. HMRC’s inflexible approach drives delays, making it difficult to settle even the simplest dispute.

HMRC is increasingly pursuing complex tax investigations with a cross-border element, which typically take longer to settle. These investigations will often be transfer pricing disputes, which do not depend upon the meaning of a piece of legislation, so there is no yes or no answer, but rather a range of possible outcomes. Transfer pricing disputes also tend to be heavily fact based, with the contractual position being much less important than what actually happened in practice.

HMRC’s new profit diversion compliance facility (‘the facility’) gives multinational businesses the opportunity to avoid an HMRC investigation and settle any tax owed in relation to ‘profit diversion’, which covers diverted profits tax (DPT) liabilities or transfer pricing irregularities. The facility offers reduced penalties (possibly to zero) for unprompted disclosure and no DPT failure to notify penalties.

However, the most significant potential benefit of the facility is that it offers the prospect of a speedier resolution, with the business also having much more control over the investigation process.

Businesses registering for the facility (who cannot already be under investigation) have six months to submit a report with a full and accurate disclosure of the facts and a proposal for settling the tax and any penalties. HMRC will not open an investigation within this period and aims to respond to the proposal within three months. Even allowing for agreed extensions of time to submit the report, this timescale looks very attractive when compared to the average of three and a half years for resolving an HMRC investigation.

The facility requires the business to carry out a proper investigation so that staff will still need to be interviewed and emails analysed in order to collect full evidence of how the business was conducted. This will still take management time and involve costs (as the business will be paying for advisers to do the investigating rather than HMRC), but the process will be much more within the control of the business. Whilst being formally interviewed will be stressful for any employee, it is likely to be less stressful if the person doing the interviewing is a professional adviser rather than an HMRC investigator.

HMRC is devoting significant resource to investigating large businesses it suspects of diverting profits from the UK. It says it has already launched investigations into businesses which have not registered for the facility after receiving an HMRC ‘nudge’ letter. HMRC is currently sending out the next wave of letters and says it intends to open investigations more quickly into those who do not register for the facility. Will these new investigations add further to the backlog? If the time taken to resolve disputes into large businesses continues to increase at current rates, we could be looking at an average of around four years by 31 March 2020.