UK tax officials have US multinationals in their sights after new figures revealed suspected tax underpayments from large overseas firms are rising.
According to a freedom of information request from Pinsent Masons, US firms’ share of total “tax under consideration”, which concerns ongoing investigatory work, has climbed significantly over the past five years, up from 12% in 2013-14 to 17% in the 2017-18 tax year.
HMRC estimates that £27.8bn is owed from large UK and international firms, with US multinationals accounting for £4.6bn of the total tax underpaid. The figure was £3.4bn in 2016-17 and has more than doubled from £1.8bn in 2013-14. Swiss-based businesses represented the second highest at 6% of underpaid tax, followed by Ireland (3%) and France (2%).
“HMRC is under enormous pressure to collect extra revenue and that is leading to more pressure on businesses both from domestic and foreign authorities,” said Jason Collins, tax partner at Pinsent Masons.
Experts have reported that multinational businesses are increasingly being targeted by HMRC’s investigations into procedures which allow multinationals to divert profits to lower-taxed regimes.
“We have seen a real ramp-up by HMRC in enforcement activities against multinationals in recent years, through new taxes such as the diverted profits tax, new initiatives such as the profit diversion compliance facility, and by taking increasingly aggressive positions on a range of technical tax issues (including transfer pricing),” said Robert Sharpe, international tax expert at law firm Clifford Chance.
This growing scrutiny on the diversion of profits comes after recommendations made by the Organisation for Economic Co-operation and Development (OECD) in 2015 as part of its programme for reducing international tax avoidance by corporates – its Base Erosion & Profit Shifting (BEPS) 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 UK 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.
The DPT directly raised £388m in 2017-18, but Collins said it had had a big effect on companies’ behaviour because it had allowed officials to challenge and penalise arrangements where the chief motive was to minimise corporation tax payments.
International rules on profit shifting have been stuck in the weeds for many years, leading individual governments to attempt various ways to stop multinationals structuring affairs in order to divert profits to low tax jurisdictions.
Untaxed pot of gold
Of particular concern are strategies executed by large technology groups such as Google, Facebook, Amazon and Apple, that have little physical presence and therefore, under current international tax rules established in a pre-digital era, a limited tax liability.
The UK government has committed to introducing a digital services tax by 2020 that will explicitly target the Silicon Valley luminaries, along with other search engines, social media sites and online market places.
“HMRC is emboldened by their recent series of victories in tax avoidance cases before the courts, and their estimates of the tax gap mean they believe there is an untaxed pot of gold waiting to be recovered from multinationals,” Sharpe told AccountingWEB. “However, our experience is that HMRC is adopting aggressive (and highly questionable) technical positions against multinationals on issues which have nothing to do with tax avoidance.”
It is doubtful that HMRC would win many of these points before the courts, Sharpe said, and if officials are accounting for the tax at stake in these cases as part of the tax gap, then the tax gap is certainly not as wide as HMRC believe.
Tax enforcers describe estimates of potential tax underpayment as a “tool to guide inquiries”, outlining where it views the biggest risks and where it is likely to target efforts.
“HMRC has said historically that on average only around half of the ‘tax under consideration’ ends up being tax which is actually due,” Sharpe said. “We expect that this figure will start to drop as HMRC continues to pursue more aggressive/marginal points, as in relation to those issues taxpayers are less likely to agree settlements, and courts are less likely to agree with HMRC.”
Profit diversion compliance
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, added Collins. HMRC’s LBD covers the 2,100 largest and most complex businesses in the UK.
“It is not just multinational businesses on HMRC’s radar – the affairs of all large businesses are under growing scrutiny,” Collins said. “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, Collins added.
“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,” he said.
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, it can face lower penalties 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.
HMRC has a “hit list” of businesses it suspects are diverting profits, Collins said and intends to issue ‘nudge letters’ to those it has identified as non-compliant.
“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.”