Diverted profits – UK Government announces legislation to counteract First-tier Tribunal decision

United Kingdom

At the Autumn Budget 2021, the UK Government announced that legislation applicable to diverted profits tax (DPT) will be amended to make clear that corporation tax enquiries cannot be closed during a DPT review period.  These changes, coming into force with immediate effect, have been introduced in direct response to a recent decision of the First-tier Tribunal (the FTT) and have important consequences for any taxpayers facing diverted profits investigations.

The DPT regime

Introduced by the Finance Act 2015 (FA 2015), DPT is targeted at contrived arrangements whereby multinational groups 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 multinational groups 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 separate from corporation tax and therefore subject to different rules.  However, DPT is intended to work alongside the UK’s transfer pricing regime and, in many cases, taxpayers can avoid a liability to DPT by making appropriate transfer pricing adjustments in their corporation tax returns.    Taxpayers are heavily incentivised to do so, with DPT set at a higher rate than corporation tax (with taxable diverted profits currently charged at a main rate of 25%).

The charging and appeals process for DPT is broadly as follows:

  • If HMRC have reason to believe that a company is liable to DPT, they must first issue a ‘preliminary’ notice (including the grounds for such belief and the basis on which the proposed charge is calculated, based on certain assumptions). 

  • Once a preliminary notice has been issued, the taxpayer has 30 days to make written representations to HMRC (although the representations that HMRC must consider at this stage are limited to certain obvious factual issues, such as any arithmetical errors in HMRC’s calculations). 

  • Following the 30-day period for the taxpayer to make written representations, HMRC have a further 30 days to issue a final charging notice and, once issued, DPT must be paid within 30 days (with no right of postponement on any grounds).

  • There is then a further period of 15 months for HMRC to review the charging notice and make any necessary adjustments to the amount of DPT paid (either up or down).  This review period is designed to encourage taxpayers to reach an agreement with HMRC in respect of transfer pricing and amend their corporation tax returns accordingly (and taxpayers are specifically afforded an extended period in which to amend their returns).

  • It is only at the end of the 15-month review period, if no agreement has been reached beforehand, that the taxpayer has the right to appeal against the charging notice (i.e., some considerable time after DPT has already been paid).  The ‘upfront’ nature of DPT was designed to promote disclosure from multinational groups and constructive early engagement with HMRC on transfer pricing issues.

Early termination of the DPT review period

HMRC’s position is that no corporation tax closure notice should be issued where there is an ongoing DPT review period for the same period, unless the taxpayer agrees to amend its corresponding corporation tax return (i.e., to make appropriate transfer pricing adjustments).  If the taxpayer agrees to do so, HMRC will reduce the amount of DPT accordingly (i.e., to nil) and then issue a corporation tax closure notice for the relevant period.

The problem with this position is that any closure notice issued by HMRC simply gives effect to amendments made by the taxpayer to its own corporation tax return and, consequently, the taxpayer has no right of appeal against that closure notice.  In other words, HMRC will only agree to early termination of the DPT review period if the taxpayer agrees to settle the dispute on HMRC’s terms. 

The FTT Decision

In Vitol Aviation UK Ltd & Others v HMRC [2021] UKFTT 0353 (TC) (the FTT Decision), the taxpayers (several group companies) were the subject of open corporation tax enquiries and DPT charging notices.  As the parties had not been able to reach an agreement on transfer pricing, the taxpayers applied to the FTT to direct HMRC to issue closure notices in respect of the corporation tax enquiries.  The benefit of doing so was that the taxpayers would then be able to appeal the closure notices as a corporation tax matter, rather than waiting until the end of the 15-month DPT review period to appeal against the (higher) DPT charge. 

The FTT granted the taxpayers’ application for closure notices to be issued on the grounds that HMRC already had sufficient information to close the relevant enquiries and had failed to show that there were reasonable grounds for refusing the application.  HMRC were directed to issue the relevant closure notices within 30 days of the FTT Decision (dated 27 September 2021).  Critically, the FTT also rejected HMRC’s various submissions that the issuance of closure notices would in some way ‘pre-empt’ the end of the DPT review periods.

Prior to the developments discussed below, the FTT Decision was potentially important as it provided taxpayers in certain circumstances with a mechanic to create an appeal right without having to wait the normal 15 months required under FA 2015, and to effectively elect into the corporation tax regime without having to agree transfer pricing adjustments with HMRC.

Autumn Budget 2021

It was widely expected that HMRC would appeal the FTT Decision on the basis that it contradicted their clear policy position.

However, in a surprise move, last week’s Autumn Budget announced new legislation to amend FA 2015 to make clear that corporation tax enquiries cannot be closed during a DPT review period.  There are also certain consequential amendments, including to allow taxpayers to amend their tax returns at any time within the 15-month DPT review period save for the last 30 days (and not just the first 12 months as was the case previously), and to ensure that such taxpayer amendments have immediate effect (and not just on the issue of a subsequent closure notice at the end of the DPT review period).

The draft legislation and explanatory notes do not contain any specific reference to the FTT Decision.  However, the changes are stated to come into force as at the date of the Autumn Budget on 27 October 2021 (rather than waiting for the final legislation to be passed) and will apply to any corporation tax closure notice made on or after 27 September 2021 (i.e., the date of the FTT Decision).  It seems clear, therefore, that HMRC decided not to risk a flurry of similar closure notice applications being made by other taxpayers pending any successful appeal of the FTT Decision.  It is unclear whether HMRC will still seek to appeal the FTT Decision. 

In another unexpected move, it was also announced at the Autumn Budget that new legislation would be introduced to enable HMRC to implement Mutual Agreement Procedure (MAP) decisions relating to DPT (effective for any MAP decisions reached after 27 October 2021).  It is currently not clear how this might affect HMRC’s long-held view that DPT does not fall within the scope of double tax treaties.


The announced changes make it seemingly impossible for taxpayers to escape the normal 15-month DPT review period without first reaching an agreement with HMRC on transfer pricing, meaning there is now an even stronger incentive for taxpayers to settle.

Even where a transfer pricing methodology has been agreed with HMRC, taxpayers could still find themselves impacted by the new rules where such methodology potentially gives rise to tax losses.  Pursuant to the ‘one-way street’ principle under UK transfer pricing rules (i.e., that taxpayers are not permitted to make adjustments that result in decreased taxable profits or greater allowable losses), such losses can only be given effect through a relevant double tax treaty (or, in the case of UK-to-UK adjustments, through compensating adjustments).  Taxpayers intending to engage MAP under a relevant double tax treaty to recover tax losses will invariably seek to postpone payment of any tax pending the outcome of that process.  However, formal postponement applications generally cannot be made unless there is an associated appeal to the FTT – which the new changes effectively make impossible – meaning taxpayers may have to rely on HMRC’s discretionary powers to postpone payment of tax.  Subject to seeking their own professional advice, taxpayers in that unenviable position may wish to enter into a formal agreement with HMRC to seek binding assurances regarding postponement.

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.  We can help clients respond effectively to diverted profits investigations and to make disclosures under the Profit Diversion Compliance Facility.