Nudge, nudge: HMRC invite non-doms and multinationals to put their tax affairs in order

United Kingdom

In the last few weeks, HMRC have reportedly sent hundreds of ‘nudge letters’ to both UK resident (non-domiciled) individuals (non-doms) and multinational businesses (MNEs), in each case inviting the recipients to amend previous tax returns and disclose errors. Nudge letters are not randomly generated and any recipients (including those who believe they have done nothing wrong) should seek professional advice as soon as possible to avoid potentially tough sanctions and protracted investigations into their tax affairs.

Nudge one - Non-doms and the remittance basis charge

UK resident taxpayers are generally liable to UK tax on their worldwide income and gains.  However, individuals treated as resident in, but domiciled outside of, the UK (i.e., non-doms) are instead taxed on the remittance basis - meaning they are only liable to UK tax on any overseas income and gains to the extent remitted to the UK. 

The ability to benefit from non-dom status is subject to strict conditions and will depend on an individual’s specific circumstances.  Importantly, there is a requirement for non-doms to pay a £30,000 annual ‘remittance basis charge’ if they have been resident in the UK for at least seven out of the last nine tax years (rising to £60,000 for those resident in the UK for at least 12 out of the last 14 tax years).

In official figures published earlier this year, HMRC estimated that there were around 75,000 individuals claiming non-dom status in the UK for the tax year ending April 2020, together liable for approximately £7.85 billion in personal taxes.  HMRC suspect that not all these individuals have correctly reflected the remittance basis charge in their self-assessment tax returns, and are now encouraging those affected to amend their returns accordingly.  Recipients have been given 60 days to take action.

Nudge two - MNEs and diverted profits

The UK’s diverted profits tax (DPT) is targeted at contrived arrangements whereby MNEs seek to divert profits earned in the UK to other jurisdictions where they pay little or no tax.  Broadly, the purpose of DPT is to counteract the diversion of profits from the UK by MNEs that either:

  • use entities or arrangements lacking in economic substance to exploit tax mismatches; or

  • seek to avoid the creation of a UK permanent establishment that would bring a non-UK company within the charge to UK corporation tax.

DPT is a separate tax from UK corporation tax and therefore subject to different rules (including being set at a higher main rate of 25%).  However, DPT is intended to work alongside the UK transfer pricing regime and, in many cases, MNEs can avoid a liability to DPT by making an appropriate transfer pricing adjustment.

It is not uncommon for an MNE to find itself with outdated transfer pricing policies that do not reflect the reality of how its business operates in practice.  MNEs making this mistake could find themselves subjected to a new type of forensic investigation by HMRC to test whether profits have been artificially diverted from the UK, as well as an upfront charge to DPT with no immediate right of appeal (usually involving very large amounts of tax).

The Profit Diversion Compliance Facility (PDCF) is a voluntary disclosure facility that allows MNEs to disclose any tax errors relating to profits diverted out of the UK.  Once registered under the PDCF, taxpayers have a period of six months to make a full disclosure.  There are various advantages of doing so (as explained below). 

HMRC have now issued nudge letters to those MNEs still regarded as high risk of being within the scope of DPT, encouraging registration under the PDCF.  Previous batches of similar letters (four in total, most recently in September 2020) are understood to have been relatively successful from HMRC’s perspective, with around two thirds of recipients reportedly registering for the PDCF.  MNEs are typically given 90 days from the date of the letter to take action.

Targeting taxpayers

Nudge letters are rarely sent at random.  The idea behind them derives from ‘nudge theory’, a behavioural science concept that first rose to popularity in 2008.  The basic principle of the theory is that people can be better directed towards a desired course of action through suggestion rather than obligation. 

Nudge theory has become an increasingly used weapon in HMRC’s arsenal over the last decade or so.  Aside from numerous nudge letter campaigns, UK taxpayers may have noticed the same concept at work when completing their online tax returns, where certain information is now pre-populated based on figures held by HMRC (the idea being that the taxpayer will likely accept those figures by default).

Therefore, whilst nudge letters do not make specific accusations and are rarely overly threatening in tone, they are generally based on actual data held by HMRC.  Taxpayers who ignore these letters do so at their peril – failure to take action or respond is likely to mean that there is an imminent risk of HMRC starting an investigation (either under civil procedures or, in cases of suspected fraud, using their criminal powers).

Action points

Any taxpayers who receive a nudge letter should check their tax position and seek professional advice as soon as possible. 

HMRC can charge penalties to any taxpayer who carelessly or deliberately provides HMRC with an inaccurate document (e.g., a tax return).  The amount of the penalties charged can be material – in some cases up to 100% of the additional tax due (or even 200% for certain offshore matters).  However, the penalty system is designed to encourage transparency and cooperation, meaning that penalties can be heavily mitigated by taxpayer disclosure (and, in many cases, eliminated altogether).  In some cases, the potential penalty reductions will far outweigh any professional fees involved in making a disclosure.  A full and accurate disclosure should also prevent taxpayers from being publicly ‘named and shamed’ for any deliberate errors and, where applicable, reduce the risk of HMRC starting a criminal investigation. 

For diverted profits errors, HMRC have also confirmed that registration under the PDCF will mean that HMRC will not start a DPT investigation before the disclosure report is submitted (meaning that, although an in-depth investigation is still required, it will be managed by advisers rather than HMRC).  There is also an accelerated process for resolution, with HMRC aiming to respond to submitted disclosure reports within three months. 

Equally, even those taxpayers who receive a nudge letter but are confident of their tax position would be well-advised to take action.  As noted above, if HMRC have sent a nudge letter, it is because they hold data to suggest that errors have been made.  If, having checked the position with advisers, it is concluded that no errors have occurred, it would be better to correct HMRC’s misunderstanding through proactive engagement.

Finally, it is worth flagging that not all HMRC investigations will start with a nudge letter.  Any taxpayers who think they may have made errors in the past or are otherwise unsure of their tax position should seek professional advice as soon as possible.

CMS Tax Disputes & Investigations

As part of the CMS global network with tax capability in over 70 offices, the CMS Tax Disputes & Investigations team is well-placed to advise on all forms of (direct and indirect) contentious tax matters.  Our dedicated specialists have a wealth of experience guiding both individuals and corporates (across a wide range of sectors) through all aspects of tax dispute prevention, management and resolution. 

Our team manages multi-jurisdictional internal investigations to identify tax errors for clients and, where applicable, make detailed disclosures in order to regularise the position (including under official disclosure facilities such as the PDCF, Worldwide Disclosure Facility and Contractual Disclosure Facility).