Yields from HMRC transfer pricing enquiries soar

HMRC published its transfer pricing and diverted profits tax (DPT) statistics for the 2020-21 financial year in April 2022. The Government has not supplemented the data with significant additional detailed narrative, but transfer pricing, in particular, has been an area of rich pickings for HMRC in recent years and is likely to remain so for the foreseeable future.

Transfer pricing

A key metric for HMRC is transfer pricing yield, which it defines as additional tax revenues raised from transfer pricing enquiries together with advance pricing agreements (APAs), advance thin capitalisation agreements (ATCAs) and mutual agreement procedure (MAP) cases.

Increased yields

The data shows an increase in the yield of almost 50 per cent from the prior year – up from £1.454bn in 2019-20 to £2.162bn in 2020-21. Given that the number of enquiries settled in 2020-21 is broadly unchanged from 2019-20, this indicates that the average tax at stake in settled enquiry cases has increased significantly, which, in turn, may suggest a better targeting of enquiries by HMRC.

Slower progress

Another driver for the increased tax yield may be that the average time taken to resolve enquiries settled in the year increased to more than 36.0 months in 2020-21 from 31.4 months in 2019-20. Similarly, the average time taken to conclude APAs increased from 47.9 months in 2019-20 to 55.5 months in 2020-21, whilst the average time to agree ATCAs increased from 24.4 months in 2019-20 to 28.1 months in 2020-21. At the same time, the number of HMRC staff working on international tax issues (which includes not only transfer pricing and diverted profits tax, but also controlled foreign companies and cross-border debt matters) fell from 456 in 2019-20 to 431 in 2020-21.

It is unclear the extent to which the extended timescales are a function of a more rigorous and challenging approach applied by HMRC during enquiries, or a consequence of the reallocation of staff from all HMRC departments to support the Government’s response to the Covid-19 pandemic. For taxpayers, however, transfer pricing enquiries can be costly in terms of both management time and adviser fees, so it may also be the case that some have been prepared to agree larger adjustments than they may otherwise have been willing to accept simply to put an end to an enquiry.

Behavioural change

The statistics indicate some significant changes in behaviour. For example, only 24 APA applications were submitted in 2020-21: broadly half the number submitted in 2015-16. However, whilst the number of APAs agreed in 2020-21 kept pace with the number applied for, the number agreed was less than 50 per cent of the number applied for in 2015-16. More dramatically, the number of ATCAs agreed in 2020-21 was 23 – 86 per cent down on the 2015-16 figure. For businesses with significant levels of debt, the fall in the ATCA applications may, in part, be attributable to the introduction of the corporate interest restriction regime, which can reduce the deductible interest expense below the amount supportable for under thin capitalisation transfer pricing principles. This is further evidenced by the overall number of ATCAs in place in 2020-21, which has fallen to 97 from 568 in 2015-16.

The figures may also indicate that, despite the increased certainty of treatment offered through APAs and ATCAs, taxpayers are more reluctant to engage with HMRC through these mechanisms. This may again be a result of the time taken to secure agreement and/or a more demanding approach from HMRC. In practical terms, this would suggest that more taxpayers are willing to forego the increased certainty of treatment in favour of the use of robust transfer pricing documentation to support their filing position.

Diverted profits tax

The brief narrative provided with the data confirms that DPT is intended to complement the transfer pricing rules. The income from this tax has fluctuated significantly since it was introduced in 2015. It was as high as £219m in 2017–18, the year after the number of taxpayers that had notified arrangements that were potentially in scope of these rules had peaked 203. It is, therefore, interesting to see that whilst notifications have steadily fallen to just 25 in 2020–21, DPT income has climbed to £151m from £17m in 2019-20.

These figures suggest that taxpayers may have become less likely to notify HMRC of a potential DPT exposure - arguably further evidence of the growing reluctance of taxpayers to engage with HMRC. At the same time, however, the 2020–21 figures suggest that HMRC has reinvigorated its focus on the revenue-raising potential of this tax, with HMRC confirming that there were around 100 open DPT enquiries as at March 2021, with around £3.8bn tax at stake.

What can we conclude?

In the absence of more detailed explanation, it is difficult to draw clear conclusions from the data. For HMRC, it may tell the upbeat story of a successful year, which saw a significant increase in yields from both transfer pricing and DPT in the midst of severe resourcing pressures resulting from the Government’s necessary response to an unprecedented global pandemic.

In contrast, the data tells a different story from the taxpayer perspective – one of widespread and growing delays and an ongoing and increasing reticence to engage directly with HMRC.

For businesses to have the certainty on tax issues they need in order to thrive, it is important that HMRC is approachable and capable of providing timely responses. The government statistics suggest that there may be work for HMRC to do in both these areas. Nevertheless, it remains essential for businesses to regularly review their transfer pricing policies and documentation and engage with professional advisers to ensure it is up to date and suitably robust.

For more information, please get in touch with Suze McDonald or your usual RSM contact.