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Is double taxation the new normal for multi-nationals?

Wendy Nicholls Wendy Nicholls

With a global recession coming, governments will be looking to recover costs through new taxes. Wendy Nicholls explains what multi-nationals can do to prepare for potential double taxation.

It will come as no surprise to anybody that, after a prolonged period of spending, governments tend to try and recover money by raising taxes or in some cases, introducing new ones. This has been the case since Pitt the Younger introduced income tax in 1798 to pay for the Napoleonic wars.

In the 10 years following the 2008 global recession, HMRC introduced eight major, brand-new taxes, a 25% rise on the number of major taxes imposed on UK tax-payers. Research shows that these eight taxes, the majority of which are aimed at businesses, generated an additional £27.9 billion in revenue for the government. This is relatively little in comparison to the nearly £500-billion rescue package announced on 8 October 2008, but it is nonetheless additional revenue the government would not have otherwise had.

Now the world faces what could be the worst global recession the majority of us will have known in our lifetimes, will we see the same trend of higher and double taxation when the dust settles? The short answer is yes.

COVID-19 recovery could lead to double taxation

Before the impact of the pandemic was even considered, the Office for Budget Responsibility forecast borrowing to reach £55 billion in the 2020/21 financial year, which is roughly 2.4% of national income. However, the government has since unveiled a multi-billion-pound scheme in order to ease the financial impact of the coronavirus pandemic.

When life returns to ‘normal’, whatever that may look like, it is likely that we will see a similar pattern of increased taxation in the form or higher, or even new, taxes. Multi-nationals may even have to deal with double taxation. One potential increase that large multi-national enterprises (MNEs) are likely to see is HMRC stepping up its efforts in relation to diverted profits tax (‘DPT’), which was one of the eight new taxes introduced in the wake of the 2008 financial crisis.

Diverted profits tax

DPT is a tax aimed at preventing large multi-national corporations from using contrived arrangements designed to erode the UK tax base. Its primary aim is to ensure that the profits taxed in the UK are fully reflective of the economic activity taking place, which is consistent with the aims of the OECD Base Erosion and Profit Shifting project (BEPS). The rate of DPT (25%) is higher than that of corporation tax to encourage businesses with arrangements within the scope of DPT to change those arrangements and pay corporation tax on profits in-line with economic activity.

In the wake of the coronavirus pandemic, regardless of the scale of the damage, we are far more likely to see the government increasing efforts to tax large MNEs than domestically owned businesses or UK residents, already struggling in the financial downturn, and so DPT could be a particular target area for HMRC.

HMRC nudge letters

Since its introduction under in the Finance Act 2015, HMRC has sent out a number of ‘nudge’ letters to taxpayers it believes could have arrangements within the scope of DPT, requiring those taxpayers to register with its Profit Diversion Compliance Facility (PDCF). This is a disclosure facility, which provides a degree of tax ‘amnesty’, whereby the targeted taxpayer can propose to make an adjustment and pay the additional corporation tax, rather than pay the higher rate of DPT.

If the tax-payer is unwilling to propose an adjustment, HMRC frequently opens and conducts very detailed, prolonged and costly enquiries to ascertain whether and to what extent DPT is chargeable. It is very likely that we will see more and more of these nudge letters in the future as HMRC comes under increased pressure to generate tax revenues from large multi-national businesses.

Mutual agreement procedure

While HMRC will undoubtedly seek to collect as much tax revenue as possible to fund government borrowing following the pandemic, this pattern will be replicated by governments all around the world who will be trying to do the same thing. If MNEs agree to make adjustments to their UK profits in order to ensure they are outside of the scope of DPT, this could lead to double taxation, as those same profits could still be subject to taxes in other jurisdictions.

Where taxpayers have suffered double taxation, the Mutual Agreement Procedure (MAP) is a mechanism available to resolve tax treaty-based disputes between different jurisdictions. The MAP has become increasingly popular and well-used in recent years and, as with DPT, this trend is likely to continue post-COVID-19, as governments across the world will look towards increasing their share of the taxable profits of large MNEs, leading to a rise in double taxation.

MAP cases are taking longer to resolve

Unfortunately, with an increase in popularity has also come an increase in the length of time it takes to resolve MAP cases, with the OECD statistics highlighting that, on average, in 2018 it took approximately 33 months for transfer pricing MAP cases to be resolved in the UK, compared to 30 months in 2017. If HMRC’s MAP caseload increased dramatically then this trend could continue, leading to a possible delay in taxpayers recovering double-tax relief going forward.

In particularly significant cases, therefore, it may be worth considering seeking an advanced pricing agreement (APA), to obtain certainty of treatment for transfer pricing purposes, a number of years in advance. An APA can be with HMRC or any other single jurisdiction (unilateral APA), two jurisdictions (bi-lateral APA) or with a larger number of jurisdictions (multi-lateral APA).

Although, this process may take longer, it may be attractive if more MNEs are looking for certainty in what is currently a very uncertain world.

Preparing for double taxation

While the economic fallout of COVID-19 is likely to have many and wide-spread impacts on UK taxpayers, a marked increase in DPT and linked corporation tax enquiries is something that large multi-national businesses should be conscious of. All MNCs should be reviewing their potential exposure to transfer pricing enquiries and DPT and updating documentation accordingly.

Nobody knows the extent to which the world will fall into recession, but a surge in the efforts of HMRC to recover their share of the global tax base is something that we can be certain of, and more importantly, start to prepare for.

To discuss double taxation further, contact Wendy Nicholls

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