Research and analysis

Customers' experience of the Profit Diversion Compliance Facility and Diverted Profits Enquiry Process 

Published 7 February 2023

HM Revenue and Customs (HMRC)

Research Report 680

Research conducted and prepared by IFF Research (Rob Warren, Alistair Kuechel, Nicholas Mitchell, Joseph Charsley and Shannon Earl) for HMRC

August 2022

Disclaimer: The views in this report are the author’s own and do not necessarily reflect those of HM Revenue and Customs

1. Executive Summary

1.1 Introduction

Profit diversion represents HMRC’s largest Corporation Tax risk, and, as such, tackling profit diversion is a priority for HMRC. In 2015 the government introduced the Diverted Profits Tax (DPT) to limit UK tax avoidance through the diversion of UK profits overseas. In addition to DPT, HMRC also created 2 intervention approaches to tackle profit diversion: Diverted Profits Enquiries and the Profit Diversion Compliance Facility (PDCF).

HMRC commissioned this research to gain a greater understanding of customers’ experience of these 2 intervention processes, how the processes might be improved and whether they impact customers’ behaviour.

In order to meet these objectives a qualitative in-depth interview approach was adopted. This consisted of 35 in-depth interviews with customers that had gone through these processes: 19 with those that had undergone an enquiry and 16 with those that had completed the PDCF process. A full breakdown of achieved interviews is provided in Table 2.1 and Table 2.2.

1.2 Profit Diversion Compliance Facility (PDCF)

The majority of businesses first became aware of HMRC’s interest in their tax affairs through the invitation letter to register for the PDCF. The majority of businesses expressed surprise to have received the letter, stating reasons such as they felt their business was ‘clean’ or that they had small UK operations.

Most businesses said the decision to register was an easy one. The main factor driving the decision to register was to prevent what was assumed to be a more invasive, costly and potentially publicly damaging audit, which they were confident would happen if they did not register.

The majority of businesses reported that the registration meeting was an effective, positive and open discussion that enabled them to focus on what HMRC specifically wanted in the report. However, some felt the meeting should have been more indicative of what areas HMRC were specifically interested in, and these businesses tended to report the meeting as ‘exhaustive’. However, it was acknowledged that HMRC could not give too much direction on the scope of the disclosure as the PDCF process is voluntary. A voluntary disclosure is treated as unprompted and gives access to greater potential penalty reduction than would be the case if the HMRC intervention was prompted.

The majority of businesses that registered for the PDCF stated that the timescales for delivery of their report were realistic and provided enough time for businesses to gather the necessary evidence.

The majority of businesses also felt that HMRC’s review of the draft business proposals was beneficial and essential to the process, allowing opportunities to provide additional information and receive helpful feedback from HMRC to encourage a resolution. But, a minority noted that having a greater understanding of what HMRC were looking for and examples of what was expected in the reports would have been useful.

All businesses interviewed came to a settlement, with the majority, including those that had to pay penalties, perceiving the settlement to be reasonable. For the businesses who had to make a payment as part of the settlement, the majority felt it was a satisfactory settlement and that the reasoning behind HMRC’s final decision to accept the businesses’ proposals was clear.

The majority of businesses reported that their use of agents was essential throughout the PDCF process. Businesses reported that agents were heavily involved in the self-investigation stage of the process. This stage was noted by many to be the most resource-intensive stage and requiring ‘extra hands,’ as it would have been difficult to conduct this with internal staff only. Agents also often contributed to the report drafting.

Of the businesses who experienced financial costs throughout the PDCF process, the majority of costs came primarily through the use of agents and advisory costs, which often involved costs into the hundreds of thousands in either Pound Sterling (GBP) or United States Dollars (USD). Internally for businesses, costs were focused on administrative resources and time, with the majority reporting the process to be resource intensive as they had to fulfil their normal day-to-day roles alongside working on the PDCF process.

The majority of businesses reported that, although the process was cost and resource intensive, this was seen as preferable when compared to the expected costs of a HMRC led Diverted Profits Enquiry.

1.3 Diverted Profits Enquiry

Over half of the businesses interviewed were informed that they would be undergoing an enquiry by HMRC, mostly from an enquiry commencement letter. Of the remainder, other businesses initiated contact with HMRC regarding Advanced Pricing Agreements (APA), or alerting HMRC of DPT uncertainty, and this triggered HMRC enquiries.

Around half the businesses interviewed felt that the evidence gathering stage of the enquiry was focused and that, at least initially, HMRC targeted the specific areas of the business that were most relevant to the enquiry. However, a similar number felt the evidence gathering was untargeted and exhaustive. Large businesses that underwent enquiries shortly after the DPT legislation was introduced, were more likely to report this finding.

When it came to sharing technical positions with HMRC, most businesses felt HMRC understood the position the business proposed. Despite this, the majority identified areas at this stage of the process could be improved. Among the areas for improvements suggested were: HMRC showing greater understanding of the legislation (though this was mostly suggested by businesses that took part in earlier enquiries); HMRC’s positions including factual errors and lack of commercial understanding of the industry of the business; and HMRC better explaining their technical position.

However, some businesses noted that they felt HMRC were collaborative and proactive in sharing their technical positions, and shared detailed positions.

There was a general consensus among respondents that the final solution was acceptable in light of how the enquiry had progressed. Most businesses disagreed with some element of HMRC’s position and the ultimate resolution, but were willing to agree either because the additional tax payable was deemed acceptable or to avoid spending more time on the enquiry or potential litigation.

Almost all businesses used agents at some point during the process and a large majority had a working relationship with the agent prior to the enquiry. Most agents were seen as valuable though expensive. They were able to provide expert insight and plug knowledge gaps that were missing within the business. In most instances agents were heavily involved in the process, attending meetings and helping with evidence collection and proposal drafts.

Most businesses struggled to come to a total cost for the enquiry and rough estimates were mainly used. Among those that felt they could give a total figure, of both internal and external costs, most businesses totalled the cost to be in the £200,000 to £1 million range. Businesses with the heaviest costs used agents and tended to undergo longer enquiries.

1.4 Impact on future behaviour

The majority of businesses that underwent an enquiry implemented changes to their transfer pricing policies in the UK as a result of their experience during their enquiry. The changes implemented varied from establishing a specific transfer pricing policy team, to adjusting their transfer pricing policy, either globally or in the UK only.

The majority of businesses that underwent an enquiry felt the enquiry process had not had an impact on their relationship with HMRC. A few businesses said that the enquiry had led to an improved and closer relationship with HMRC, as they felt it had created greater certainty and transparency.

Businesses that underwent an enquiry seemed receptive to the idea of the PDCF and assumed it would be a less invasive investigation than the enquiry. A few that were aware reported spontaneously that they would have disclosed through the PDCF had it existed at the time.

None of the businesses involved said the PDCF process had a negative impact on their relationship with HMRC. The majority of businesses felt the PDCF process had a positive impact on their relationship with HMRC, as HMRC now have a better understanding of how the business operates and it created familiarity between both parties.

The majority of businesses involved in the PDCF process felt it was an effective approach to resolving tax uncertainty as it put the responsibility upon the business to undertake most of the investigation and reporting. However, half reported that if it was to be used to resolve tax uncertainty more often in the future, the process was said to be less appropriate for less complex issues and smaller amounts of tax involved given the current required work involved in the PDCF process.

2. Introduction

2.1 Background

Profit diversion represents HMRC’s largest Corporation Tax risk. HMRC has found that some Multinational Enterprises (MNEs) have adopted cross border pricing arrangements which are either based on an incorrect fact pattern, or are not consistent with the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines (TPG), or both.

These arrangements often result in a reduction of UK profits and may involve the diversion of UK profits to an overseas entity where the profits are taxed at lower rates or not at all.

In 2015 the government introduced the Diverted Profits Tax (DPT) to limit UK tax avoidance through the diversion of UK profits overseas. HMRC publishes annual statistics on its compliance work in this space, which, to the end of March 2021, showed an impact of over £7.5 billion tax has been secured since introduction of DPT.

Tackling profit diversion is a priority for HMRC and 2 intervention approaches have been created to tackle this issue:

• Diverted Profit (DP) Enquiries: This will involve an investigation of the customer’s cross border pricing arrangements. Customers may face a potential DPT charge, which requires an upfront cash payment whilst the enquiry is ongoing. In most cases, the enquiries conclude with additional tax due

• Profit Diversion Compliance Facility (PDCF): Introduced in January 2019 to encourage MNEs with profit diversion arrangements to analyse their transfer pricing and compile a report and resolution proposal, and disclose any unpaid liabilities. Alerted by letter, MNEs that have been identified as having features of profit diversion have 90 days to register for the PDCF or risk a DP Enquiry. In most cases additional liabilities are due

It was in this context that HMRC commissioned this research. The core objectives of the research are:

• to gain a greater understanding of customers’ experiences of the 2 types of intervention approaches to tackling profit diversion: DP Enquiry; and PDCF

• to understand what works well, the obstacles and barriers faced and how HMRC can change the processes to improve customers’ experience of the 2 processes

• to improve HMRC’s understanding of how both types of approaches impact the behaviour of customers

To meet the objectives outlined above, a qualitative in-depth interview approach was adopted.

2.2 Methodology

Sample

The starting sample was provided to IFF Research by HMRC in April 2022. It included the contact details of MNEs that had settled either a DP enquiry or PDCF case within a certain time period and had not opted out of the research. HMRC carried out an opt out exercise lasting 2 weeks in which a sample of businesses that settled across the 2 processes in the time period chosen were contacted and given the opportunity to opt out of being contacted for the research.

Information provided on the sample:

• business name

• key contacts for the process and contact details

• year case was settled

• type of intervention process (DP enquiry or PDCF). No further detail on the intervention itself was provided to IFF Research

• large or mid-sized business

All businesses that had not opted out of the research were contacted as part of the recruitment for the qualitative interviews. In order to achieve sufficient feedback on each intervention approach, a proportionate number of interviews with businesses that had undergone each process were selected with sufficient variation of business size (large or mid-size) and year of case settlement. A full breakdown of achieved interviews is provided in Table 2.1 and Table 2.2.

Fieldwork

All interviews were conducted between 4 April and 20 May 2022. Interviews were typically conducted by Microsoft Teams and Zoom; and lasted for one hour on average. Topic guides were developed by IFF Research in collaboration with HMRC. Separate topic guides were used for DP enquiry interviews and PDCF interviews, although there were shared questions in both.

In total, 35 interviews were completed; 19 with those that had undergone an enquiry and 16 with those that had completed the PDCF process. A full breakdown of achieved interviews is provided in Table 2.1 and Table 2.2.

Table 2.1 Achieved interviews by process and customer group

	DP Enquiry	PDCF	Total
Mid-sized businesses	7	9	16
Large businesses	12	7	19
Total	19	16	35

Table 2.2 Achieved interviews by intervention process and year settled

	DP Enquiry	PDCF	Total
2018 to 2019	4	0	4
2019 to 2020	6	0	6
2020 to 2021	4	6	10
2021 to 2022	5	10	15
Total	19	16	35

During the recruitment process all interviewees confirmed that their business had undergone the profit diversion intervention process noted on the sample and that they were either the main point of contact or one of the main points of contact for this process on behalf of the business. All interviewees worked for the named business. As HMRC wanted to capture the perspective of the customer specifically, all interviewees worked for the named business, and no external agents or advisors were interviewed.

Where the business felt it was appropriate or there were multiple key contacts, group interviews were conducted with up to 3 interviewees. However, the vast majority of interviews were conducted with one interviewee.

The titles of those participating in the interviews tended to be Heads or Directors of Tax, either for the group as a whole or for the Europe, Middle East and Africa (EMEA) region. Other titles included Tax Manager, Tax Vice President (VP) and Finance Director.

2.3 Reporting conventions

It should be noted that findings from qualitative fieldwork provide insight into perceptions, feelings and behaviours rather than quantifiable findings from a statistically representative sample. Qualitative samples are small and purposively designed, therefore the findings cannot be considered to be representative of the views of all businesses in the sampled population.

In the absence of statistical measurement, terms such as ‘many’, ‘majority’, ‘some’, ‘minority’, or ‘a few’ are used to give a relative indication of the extent to which views were expressed or behaviours reported among the particular group of customers interviewed.

The term ‘many’ is used to mean that a view or behaviour is fairly widespread within a particular group of customers; while, at the other extreme, ‘few’ indicates that a finding applied only to a small handful. In some cases, just one respondent is drawn out and referred to as ‘one’. ‘Some’ is used to indicate a middle-ground between ‘many’ and ‘few’.

3. Profit Diversion Compliance Facility (PDCF)

3.1 PDCF letter and decision to register

The majority of businesses first became aware of HMRC’s interest in their tax affairs through the invitation letter to register for the PDCF. The majority of businesses expressed surprise to have received the letter, stating reasons such as they felt their business was ‘clean’ or that they had small UK operations.

Most businesses said the decision to register was an easy one. The main factor driving the decision to register was to prevent what was assumed to be a more invasive, costly and potentially publicly damaging audit, which they were confident would happen if they didn’t register. This was despite the majority of businesses feeling they were compliant.

“It is not really a decision. Once you get over the initial shock factor of it, there is no decision – it is what it is … [if we did not sign up] we would have gone through exactly the same process except instead of an element of collaboration it would have been adversarial.” (Large Business)

“If you don’t register then revenue will assume you are guilty and come after you … it was a fait accompli … you have to register.” (Large Business)

A minority of businesses reported that their decision to register was a bid to take control of the process and hopefully reduce the amount of administration and time involved compared to that of a full DP enquiry.

“Control was the main one…control of the process, the timing, the depth of the review.” (Mid-sized Business)

“The stick of knowing that you could find yourself in a horrible audit. Plus the carrot of knowing that this is a formal, consensual process where there’s a degree of co-operation and control in reaching the right answer and so co-operative compliance and obviously the penalty threat is much diminished.” (Large Business)

3.2 Registration meeting

The majority of businesses reported that it was an effective, positive and open discussion. They felt the meeting was helpful as it enabled businesses to focus in on what they specifically wanted in the report, what would be relevant and what they wanted to see.

“They called out specific areas that they would like to see us go in to detail in the report, we took those recommendations away ensuring we didn’t go down any rabbit holes… And gave us a steer on where to go.” (Mid-sized Business)

“It gave us more focus and how to direct the report and what they wanted included and what they wanted to see.” (Mid-sized Business)

“They did home in on a couple of items and I did walk out of the meeting getting a better sense of what they might be focused on and what might be interesting for them.” (Large Business)

Some businesses felt that having the opportunity to introduce the company, and their activities was beneficial as it allowed them to provide context to their business. It also demonstrated that HMRC were willing to listen.

A minority of businesses reported that the meeting should have been more indicative of what areas HMRC were specifically interested in, allowing for more targeted self-investigation. This was reported by a range of businesses by size, year of PDCF and adjustment paid.

“Given that we weren’t aware of what they wanted we tried to second guess what their concerns were…” (Large Business)

These businesses generally felt that the meeting was ‘exhaustive’ and this had been driven by ‘unfocused and irrelevant’ questions. A couple of businesses felt that even after the meeting they still had no clearer idea as to why they received the letter. However, it was acknowledged that HMRC could not give too much direction on the scope of the disclosure as the PDCF was a voluntary process.

“The kick off meeting could be better. The taxpayer needs to come to that meeting knowing they’re barking up the right tree.” (Mid-sized Business)

3.3 Drafting the report and proposals

The majority stated that the timescales were realistic and provided enough time for businesses to gather evidence and provide a draft report. A minority of businesses spontaneously flagged that HMRC were flexible with timescales during the COVID-19 pandemic and felt this was helpful due to the impact upon the business.

The majority of businesses felt that HMRC’s review of the draft business proposals was beneficial and essential to the process, allowing opportunities to provide additional information and receive helpful feedback from HMRC to encourage a resolution. This was mentioned as particularly useful when discussions were held face-to-face or through a virtual meeting, as opposed to correspondence through email and letters.

“It was useful to review the draft report… HMRC knew what they were looking for… and it was useful to have that insight.” (Mid-sized Business)

“We gave them our draft report and sat down and discussed it with them having the ability to discuss things face to face is a lot easier than them sending us letters and us responding to letters, that side was quite good.” (Large Business)

A minority of businesses noted that the process could have been improved by having a greater understanding of what HMRC were looking for and observed that having examples of what HMRC were expecting in the reports would have been useful.

3.4 Final proposals and HMRC’s decision

All businesses interviewed came to a final agreement, with the majority, including those that had to pay penalties, perceiving the final agreement to be reasonable. For the businesses who had to make a payment as part of their final agreement, the majority felt it was a satisfactory settlement and that the reasoning behind HMRC’s final decision was clear.

“There had been a tax rule change we had missed because it was a very technical rule … okay we made a mistake, write the cheque.” (Mid-sized Business)

“The adjustments that we needed to make were reasonable and the approach the HMRC took to penalties and interest was reasonable. The benefit of going into the PDCF was the acknowledgement of good behaviours and that was reflected in the discussions on penalties.” (Large Business)

“I think it was reasonable, given that most cases in an audit you expect an adjustment; I think that given we were able to agree the larger items, I think was comforting and therefore if we had to agree something that we think is relatively reasonable, it was a good resolution.” (Mid-sized Business)

The majority of businesses stated there were no obstacles to reaching the final agreement with half of businesses reporting there were no changes made from their final proposals, but there were requests for additional information in the evidence gathering stage to clarify certain areas. Some businesses noted that the previous iterative approach to the report drafting meant that any obstacles were caught earlier allowing for a smooth resolution and reasonable decision for both sides.

“In transfer pricing there is always a range of outcomes…Of all of the range of things they could have disagreed with we could understand why they came to that conclusion…Having that narrowing of topics along the way was very helpful [in ensuring there were no obstacles in reaching a reasonable outcome].” (Mid-sized Business)

“[It was an iterative process] and there was some back-and-forth with HMRC…We kept offering them ways of resolving the remaining concerns that they had, when they were not 100% happy or they still had concerns.” (Large Business)

However, a couple of businesses felt that HMRC were under-resourced at this stage with the sense they had a lot of live cases leading to the process slowing down in the final stage, with one business reporting their agent had informed them of this.

“It [getting the agreement settled by HMRC] took longer than expected. [My agent] told me that HMRC was backlogged because they had more people sign up than expected.” (Mid-sized Business)

3.5 Use of agents

The majority of businesses reported that their use of agents was essential throughout the PDCF process, with most reporting having made contact with agents immediately after receiving the letter to attain further detail on the PDCF process.

“[They were involved] right from the outset … it was a year and a half … they had been doing this with other clients so had knowledge of the process and how to approach it and had deep transfer pricing technical knowledge on this particular issue … ultimately at this level you need specialists.” (Large Business)

Businesses reported that agents were heavily involved in the self-investigation stage of the process. This stage was noted by many to be the most resource-intensive stage and requiring ‘extra hands,’ as it would have been difficult to conduct this with internal staff only.

Agents also often contributed to the report drafting, with around half of businesses noting that most of the report was drafted by their agents. But ultimately, it was the business that reviewed or made any final decisions.

“Agent provided advice and guidance on what was reasonable to include in the proposals. But it was actually down to us in the business to say what we wanted to do.” (Mid-sized Business)

Throughout the process, there was a mixture of use of both new agents and agents previously used. New agents were used for providing an objective standpoint as a ‘fresh face’ or for specialist technical knowledge in the transfer pricing area, whilst previous agents were used due to their pre-existing knowledge of the business.

3.6 Costs

Of the businesses who experienced financial costs throughout the PDCF process, the majority of costs came primarily through the use of agents and advisory costs, which often involved costs into the hundreds of thousands in either Pound Sterling (GBP) or United States Dollars (USD). Cost was a key consideration for most businesses in deciding which agent to engage for the PDCF.

“We used AGENT 1 in the UK for our tax return and they also helped with our previous audit. We try to work with our tax return preparer because we don’t want to make a big deal out of it … also their fee was lower than AGENT 2 … we were quite shocked by their proposal.” (Mid-sized Business)

Internally for businesses, costs were focused on administrative resources and time, with the majority reporting the process to be resource intensive as they had to fulfil their normal day-to-day roles alongside working on the PDCF process.

The majority of businesses reported that, although the process was cost and resource intensive, this was seen as preferable when compared to the expected costs of a full enquiry.

A couple of businesses noted there were opportunity costs to under-going the PDCF process as they could not focus entirely on their business and had to devote time to the process. In these cases, the business was referring to their tax or finance team, rather than the business’ wider operations.

“It’s not just the dollar cost, which was very significant, but certainly you know some of the stuff that we were looking at trying to do in that year, we weren’t able to do because we were focused on PDCF.” (Large Business)

“That means they can’t spend those thousand hours generating profits, which would ultimately lead to more tax for the UK Tax Authority.” (Large Business)

4. Diverted Profits Enquiry

4.1 How businesses became informed of Diverted Profits Enquiry

Over half of the businesses interviewed were informed that they would be undergoing an enquiry by HMRC, mostly from an enquiry commencement letter, though a smaller number were informed by HMRC at a regular meeting with them with enquiry letters following thereafter.

A further smaller number of businesses initially contacted HMRC with a request for an Advanced Pricing Agreement (APA) prior to the Diverted Profits Tax (DPT) legislation being introduced. As part of this process HMRC identified concerns that the DPT legislation may apply to the arrangements, as well as potential transfer pricing concerns, and as a result HMRC opened an enquiry.

A minority initiated the process themselves shortly after the introduction of DPT legislation, which required businesses to notify HMRC if their arrangements were potentially in scope. These businesses wanted to check if the tax applied to them, and in some cases suspected it might. These businesses wanted to minimise the tax risk, and most were upset that this developed into a full enquiry that was exhaustive, especially as they felt they were doing the correct thing by declaring their tax uncertainty.

“We made a self-declaration in 2016 to 2017 and were notified about [the enquiry] 6 to 12 months later. We thought, okay we do fall under this regime … we then had notification they were going to look into us … obviously I was a bit concerned because of the potential DPT charge.” (Mid-sized Business)

Only one business interviewed received a letter about the PDCF and chose not to follow this process. This was because they felt their case was quite straightforward and the PDCF process might take a long time.

“We felt it was something we really didn’t need to go for because it was quite straightforward in terms of demonstrating there is no diversion. I think the feeling was that if we went through the [PDCF] process it would be unduly lengthy and probably brings no benefit to [us] or indeed HMRC … I took that advice from our lawyers.” (Large Business, PDCF Non-registrant)

4.2 Evidence gathering

While some felt the evidence gathering stage worked well, around half of the businesses were unhappy with this stage as a whole. However, more than half were able to identify some elements of this stage that were useful.

Around half the businesses interviewed felt that, at least initially, HMRC targeted the specific areas of the business that were most relevant to the enquiry, meaning the investigation could be more focused.

“They didn’t come in blunt and say ‘we want to speak to X, Y, Z, and see their emails.’ They said ‘does it make sense to see this person’s emails?’ And that was helpful” (Large Business)

“They asked a lot of questions. A lot of it was just the basics … then it became more conversational around functions and the bigger picture … they wanted to know what their roles and responsibilities were and their interaction with the IP (Intellectual Property) and [REDACTED] and the owner” (Large Business)

A few businesses added that the specific targeting occurred because HMRC worked collaboratively with them to identify the pertinent evidence and people.

“I’m trying to think about whether there’s any information or people they met with that wasn’t really warranted and I’m not sure. We took a lot of the work on our own shoulders and HMRC had to work through a lot less information as we were able to steer most of it. I think that’s quite different, maybe, from their normal process it wasn’t like ‘give us your employee file, give us this, give us this’ we kind of gave it to them, because we knew what they were trying to get to.” (Large Business)

While many businesses felt that HMRC’s evidence stage was targeted, a similar number felt the requests were untargeted and exhaustive. Large businesses that underwent enquiries shortly after the DPT legislation was introduced, were more likely to report this finding.

“They did ask for a huge amount of information, which we provided, but there was a question in my mind as to how relevant the information was. It felt a bit like a fishing expedition, like they were asking for a whole bunch of stuff to see if anything was interesting.” (Large Business)

Furthermore, a minority of businesses reported that HMRC did not understand the scale of the requests they were seeking from businesses, and that HMRC often took a long time to respond despite setting tight deadlines in their requests.

“We did everything we could, turned everything round in 30 days, even wrote a letter to HMRC to ask them to speed up…The best person wasn’t always available and every time someone new got involved it took time for them to get up to speed.” (Large Business)

A minority of those in enquiry cases that were settled in 2020 or earlier perceived the HMRC team to not fully understand the legislation and that HMRC were not specific in what they were searching for.

“We felt as though there were a very limited number of people well versed in the legislation. It was like they’d taken the new toy out to play with.” (Large Business)

Specifically, staff interviews were often quoted as being the most pertinent and valuable aspect of the evidence gathering stage and, generally businesses were happy with the people spoken to and the questions asked.

“HMRC conducted function interviews with individuals, and they were able to frame a very clear understanding of the people, assets and risks in the business from those function interviews they conducted … they were the most enlightening for HMRC in terms of understanding what was going on, ‘on the ground’.” (Mid-sized Business)

Alternatively, many businesses were unhappy with the volume of emails requested and a couple questioned whether HMRC had gained anything useful from them.

“[HMRC] wanted to see evidence of emails … that was very arduous and I don’t even know what they got out of looking for emails because they asked for a lot of information … [in terms of effectiveness] we don’t even know if they looked at the emails.” (Mid-sized Business)

“We are a very email centric company and 3 of us went through 70,000 emails. What is frustrating is it feels like they think we have unlimited time and resources when they drop this stuff on any company, we are trying to run a business.” (Mid-sized Business)

Most mid-sized businesses struggled to provide all the information requested by HMRC, because they were more likely to rely on specific members of staff or have less sophisticated methods of record keeping.

“The audit for those years, I would say [we were] very unstructured in operational leadership. There was a lack of minute taking and something we have improved on … we would get in a room, whiteboard something and say let’s do it.” (Mid-sized Business)

Most businesses were given formal information notices. Most reacted neutrally to this, but a small number of businesses felt that they were threatening.

“Yes we received Schedule 36 notices, I can’t remember why they were offered but think they were offered to [all businesses undergoing enquiries], it was a bit ‘comply or die’, I suppose, but we were able to provide everything needed, albeit with one doc that was redacted.” (Large Business)

“We felt it was used as a weapon and a threat when they were asking for information that we weren’t convinced that they were entitled to. [When] we pushed back and said we know we don’t believe that this is relevant to the inquiry they responded by issuing a formal notice.” (Large Business)

4.3 Technical Positions

Most businesses felt that HMRC understood their technical position; however, in a few cases they were frustrated that HMRC had reached a different one.

“We both came out with an understanding that we were satisfied with.” (Large Business)

“I think we more or less understood their position although we didn’t necessary agree with them, and I think the same could be said for them [understanding our technical position].” (Large Business)

Despite most understanding HMRC’s position, the majority felt this stage of the process could be improved. Businesses that took part in enquiries closer to the introduction of DPT were more likely to feel that this stage could be improved, repeating the belief that most staff at HMRC were inexperienced in dealing with DP enquiries and legislation, particularly because the DPT legislation was new. All businesses that felt this stage could be improved had ended their enquiry by paying adjustments, DPT or both.

“There wasn’t an understanding initially, not on DPT, but I think that was because they didn’t understand the legislation properly… The DPT expert, couldn’t really have been an expert at that point because it was probably his first DPT enquiry.” (Large Business)

When businesses felt HMRC were collaborative and proactive in sharing their technical positions they were more likely to feel that this stage of the process worked well. Businesses that received a detailed position from HMRC were more likely to feel satisfied with this stage of the process even when there were gaps to bridge between the 2 positions.

“They gave us a position paper which was amazing to get their initial thoughts, we didn’t agree so gave them a lot of follow up information to explain why we didn’t agree… I think the team and I were all quite open on giving up ideas without worrying that was the final position.” (Large Business)

However, among businesses that felt this stage could be improved, there was frustration in how HMRC had reached their original position with a substantial minority mentioning HMRC’s position had errors or assertions that reflected a lack of understanding of the industry the business operated in.

“HMRC facts we felt were mingled with opinion and assertion. It was the assertion and we ended up arguing over technical points about what is a decision, who is a decision maker, what’s the decision-making process? In the end we reached an agreement, but it was more of an agree to disagree.” (Large Business)

Additionally, in a minority of enquiries, businesses felt that HMRC did not adequately explain their position, which added to the confusion as to why they would not accept the business’ draft.

“We expected that there would be an exchange of positions to be able to better understand the other side and see how far apart we are, and where we might move towards each other…We struggled to get back from them if they understood what we said.” (Large Business)

“We kept saying to HMRC, if you don’t agree with us please tell us what your proposal is because we kept saying here you go, and they would say we don’t agree and we would change it a little bit and they said don’t agree, so please tell us what you want. They were very slow to come up with a proposal.” (Mid-sized Business)

There was no noticeable difference in satisfaction between businesses that fall with large business or mid-sized business at this stage of the process, however mid-sized businesses were more likely to leave the sharing of positions exclusively to agents.

“Whilst I had a view of them and was kept informed, there were a lot of technical conversations directly between HMRC and our agent.” (Mid-sized Business)

4.4 Finding a resolution

Despite widespread feeling that the first 2 stages of the process could have been improved, there was a general consensus among respondents that the final solution was acceptable in light of how the enquiry had progressed.

“By the time you got to the end your feelings about it were so different from the start…You felt fine, I can accept that. I wouldn’t say we were happy with the settlement we reached but we got to a position where it was something we could agree to and move on from.” (Large Business)

Most businesses disagreed with some element of HMRC’s position and the ultimate resolution, but were willing to agree either because the amount was deemed acceptable or to avoid spending more time on the enquiry or to avoid potential litigation.

“Yes [agreement was reasonable] and something we need to accept and apply so the outcome was okay … we are applying that going forward … [The agreement] was more is this a policy we can accept for future years and also in other countries outside the UK – is this good enough as a global policy” (Mid-sized Business)

“The profit adjustments they requested were way too high … [but] the effect of those profit adjustments was not as adversely impactful as it could have been for us so that made us willing to accept and not continue to argue.” (Mid-sized Business)

“From a corporate point of view, it was a reasonable outcome in that HMRC accepted it. Do I agree with it – no, but you have to be pragmatic and move on. …Litigation is long, costly and uncertain.” (Large Business)

Around half of businesses mentioned that penalties were discussed or explored at this stage, with a couple receiving suspended penalties. For most of these enquiries, HMRC judged the penalties not to be appropriate and this tended to leave businesses more satisfied with the resolution even on occasions where DPT was paid.

“Penalties were discussed but we were able to demonstrate that we took reasonable care and that HMRC just had a different opinion. So we got to a position where we were comfortable - there was a small level of penalties which were suspended.”

4.5 Use of agents

Almost all businesses used agents at some point during the process and a large majority had a working relationship with the agent prior to the enquiry. A small number did bring agents not used previously in specifically for the enquiry, either to work alongside existing agents or to work solely on the enquiry.

Most agents were seen as valuable though expensive. They were able to provide expert insight and plug knowledge gaps that were missing within the business.

“They’re experts in dealing with these kinds of situations and we don’t have the capacity to learn all the detail.” (Large Business)

“We couldn’t have done it without them. We, despite having qualified and experienced in-house tax teams, we felt ill equipped to handle the enquiry without the help of the agents.” (Large Business)

Only a couple of businesses did not use agents. Where business did not use agents, it was usually among businesses with a large tax team who didn’t feel that they could offer more expertise than they had already.

“We tried to seek some sort of support and guidance in the process, but it didn’t really strike me that the advisor was knowing much more than us and HMRC, so we didn’t use them in any of our correspondence or key positions.” (Large Business)

In most instances agents were heavily involved in the process, attending meetings, helping with evidence collection and proposal drafts. A minority used agents solely for reviewing work, while a similar number used agents as the sole point of contact with HMRC. All mid-sized business customers used an agent and all felt the use of an agent was important.

“We needed [an agent] because we do not have any group tax team members in the UK … we did not have the resource to write all the letters and the communications with HMRC.” (Mid-sized Business)

Around half used more than one agent during the enquiry. Some used a second agent as a sounding board for the primary agent, to sense check, advise, and provide a second opinion, while others split their roles, using one for advice and another to be part of the technical discussions with HMRC.

“We used one to advise on technical matters if they arose, because they had experience of our tax matters due to being involved in preparation of the tax returns. The other we used to assist with discussions with HMRC and the resolution part of enquiry, because they would have had experience of other similar enquiries in our industry.” (Large Business)

4.6 Costs

Most businesses struggled to come to a total cost for the enquiry and rough estimates were mainly used.

“I’m not able to put figure on it, but it was a very significant investment in resources to manage the enquiry.” (Large Business)

Among those that felt they could give a total figure, of both internal and external costs, the lowest was around £200,000 whilst costs rose to as much as £3 million, but most businesses totalled the cost to be in the £200,000 to £1 million range.

“I suspect my predecessors probably spent anything up to £2 million on agency fees, but it is hard to separate the enquiry from setting up the policy. While I was involved it would have been around £200,000 if I’m being generous. Internally it’s really hard to work out but certainly would have taken up an enormous amount of time. We had around 9 people working on and off on the enquiry. I suppose, ball park calculation would be 2 or 3 FTEs over the span of 3 or 4 years.” (Large Business)

Businesses with the heaviest costs, used agents and tended to undergo long enquiries, meaning agency fees ran into hundreds and thousands of pounds or more.

“Just thinking about external costs it was easily north of £500k probably £750 to £1 million before VAT. Then there’s obviously quite a lot of internal sunk cost, staff time, on top of that, which contributed to a drain within the team…. Over the 7 year enquiry probably 0.25 of an Full Time Equivalent per year” (Large Business, enquiry 7+ years)

“I did do a quick calculation and I’d say about £1 million, based on my salary, the team’s salary, the commercial team’s salary - which could even be more - and then quite a lot on advisor fees” (Large Business, enquiry 2+ years)

Internal costs were the most difficult for businesses to work out, though most agreed that it was substantial, requiring between a quarter and a half of the leads’ time as well as a significant proportions of other team members time and input from other parts of the organisation.

“I suppose it [the enquiry] stopped us focussing on other things so I guess it is a time drain, but I can’t say we didn’t do x, y and z because of it.” (Mid-sized Business)

Generally, wider disruption to the business was not mentioned, though one mentioned the enquiry contributed to a drain on the business and another spoke of how the tax team had not been able to focus on new opportunities while the enquiry was ongoing.

“I’m disappointed that we were so preoccupied with HMRC during this period because we should have been focused on those new opportunities for our business. I wouldn’t like to tell our shareholders that we weren’t focused on those new opportunities for our business, but part of me thinks that maybe our competitors have got a bit further ahead of us.” (Large Business)

5. Impact on future behaviour

5.1 Impact of a Diverted Profits Enquiry

The majority of businesses that underwent an enquiry implemented changes to their transfer pricing policies in the UK as a result of their experience during their enquiry. The changes implemented varied. A selection of changes are detailed in turn below.

One business established a specific transfer pricing policy team. Another noted that they moved to more detailed documentation of policies and actions, while one business spontaneously flagged that they moved to a return-on-sales policy from cost-plus.

“Instead of doing an OECD style report which is pretty simple we have [our agent] doing a very detailed TP (Transfer Pricing) annual report which involves doing a lot of functional interviews with people, so we definitely ramped up our TP and made us more aware of the need to do more localised reporting.” (Mid-sized Business)

Another business changed their policy within the UK but they are still to expand the process globally, while another noted they had to implement a UK-specific policy, separate from the global policy. Another business had planned to change their policy previously but could not implement the change while the enquiry was ongoing.

One business noted that there had been no impact upon their transfer pricing policies, but they felt that there is a limit to the updates they could potentially make to their policies due to the policy differences put in place by different tax authorities around the world.

“We actually think there’s a limit to what we can do now to mitigate against transfer pricing adjustments so that the best that we can do is make sure that we’re protecting against penalties and hope that if we get adjustments, the counterparty is in a territory where it will need to be resolved with a mutual agreement procedure and preferably one with a double tax treaty with a compulsory arbitration clause.” (Large Business)

A couple of businesses also reported there had been no impact on the transfer pricing policies as they felt they already had strict policies to follow, which they ensure are compliant with current regulations. Both businesses did make a ‘minor adjustment’ that had occurred due to what the businesses classified as administrative errors and due to entities that are no longer part of the multinational.

5.2 Impact of a Diverted Profits Enquiry on business’ relationship with HMRC

The majority of businesses felt the enquiry process had not had an impact on their relationship with HMRC. A couple noted it did not change their overall relationship as their day-to-day contacts were largely not involved in the enquiry.

A few businesses said that the enquiry had led to an improved and closer relationship with HMRC, as they felt it had created greater certainty and transparency. A positive impact on relationship with HMRC was not more prevalent among either customer group: some mid-sized businesses reported a closer relationship having previously had limited contact outside of enquiries due to their business not having a CCM (Customer Compliance Manager); while some large businesses also noted an improved relationship after the enquiry.

“I think it went so well that other teams in HMRC started coming to us about other items they wanted to talk about.” (Mid-sized Business)

One business reported that the relationship had deteriorated, and as a result they requested a change of CCM. The process had been fractious and resulted in an adjustment that the business did not view as reasonable.

5.3 Would those that went through a DP Enquiry use a Compliance Facility like the PDCF in future

Many of the businesses involved in the enquiry process were unaware of the PDCF process in detail but once prompted with a short explanation, businesses seemed receptive to the idea and assumed it would be a less invasive investigation than the enquiry.

A few that were aware reported spontaneously that they would have disclosed through the PDCF had it existed at the time. These were businesses that had initially disclosed their tax uncertainty to HMRC.

However, many of those involved in the enquiry process also stated it was difficult to comment on the PDCF process given that they have now sorted out tax inefficiencies and would like to think they would not have to go through a voluntary disclosure facility.

“Our view was that now, we wouldn’t come under PDCF - we’re not a business with major Transfer Pricing issues…We’d present the issue to our CCM [Customer Compliance Manager] first.” (Large Business)

5.4 Impact of the PDCF on business’ relationship with HMRC

None of the businesses involved said the PDCF process had a negative impact on their relationship with HMRC. The majority of businesses felt the PDCF process had a positive impact on their relationship with HMRC, as HMRC now have a better understanding of how the business operates and created familiarity between both parties.

“[The process] shows that we’re willing to engage and explain things to them and they see it as co-operative and helpful from their side. I think also they see that we’re not up to mischief, the things we state about arm’s length approach they’ve seen in detail that we’re consistent with what we’ve said publicly.” (Large Business)

“[The PDCF process] cemented our relationship and now HMRC have a much a better understanding of what’s the business does and how it works.” (Mid-sized Business)

“There were no adverse effects on the working relationship, I think it proves that if you collaborate with them [HMRC] it can be quite a good working relationship and they can be quite helpful.” (Mid-sized Business)

A minority of businesses felt that there been had no impact on their relationship with HMRC, although a few noted they had limited previous contact with HMRC to compare it to, with a couple saying this lack of contact had continued since. In most cases, but not all, these were mid-sized businesses, and it was mentioned that they felt the process had allowed them greater engagement with HMRC than usual, due to their business not having a CCM.

“I would say positive it’s definitely good to have individual faces, when you have different touch points across all the taxes it’s nice to put a face to the name, definitely a positive experience… We were happy overall”. (Mid-sized Business)

Most of the businesses involved in the PDCF process felt that it had provided the business with greater tax certainty and a better understanding of transfer pricing policies. Other businesses felt there was no impact on their tax certainty as they had no concerns before entering the process, though they did make adjustments through the process to resolve implementation or legacy issues.

“We’ve certainly made sure in the year since the settlement that we have operated in accordance with the terms that we agreed on during the process, and that gives you informal certainty if nothing else, and that has some benefit.” (Mid-sized Business)

5.5 Use of PDCF in the future

Businesses that underwent the PDCF process were asked if they think the PDCF is an approach HMRC should use more often if it identifies tax risk.

The majority of businesses involved in the PDCF process felt it was an effective approach to resolving tax uncertainty as it put the responsibility upon the business to undertake most of the investigation and reporting, rather than in an enquiry where the businesses felt it would be more resource and cost-intensive for HMRC.

“As a general taxpayer I think it’s a good use of resources for HMRC. If they identify a risk tell the taxpayer that they’ve identified the risk and ask them to ‘please explain why it isn’t a risk’. Putting the onus back on the business to explain things.” (Large Business)

“The PDCF is attractive because it’s not spending HMRC money - all the work is done by the business.” (Mid-sized Business)

Half of businesses involved in the PDCF process noted they felt that PDCF was more appropriate for large multinational businesses with large tax risks due to the complexities of international tax, and the time and resource needed to undergo the process. It was said to be less appropriate for small amounts of tax uncertainty and smaller companies given the work involved in the process.

“I don’t know [if it should be used more often], on one hand yes, but on the other hand it is so intense and time consuming you couldn’t use it for small issues.” (Large Business)

“If it is going to be used for very small things it is going to be time-consuming and draining on organisations, but if it is a genuine large risk and, again depending on the size of the organisation, it is worthwhile”. (Mid-sized Business)

A couple of businesses also noted that although the approach was reasonable for themselves, it was still time consuming and resource draining for HMRC to gain no tax in the end in their cases. One of these businesses noted that they believed it was likely to be the exception that they did not make an adjustment.

---