Not reasonable to refuse closure notices because DPT review period ongoing

Out-Law News | 21 Oct 2021 | 2:39 pm | 4 min. read

It was not reasonable for HM Revenue and Customs (HMRC) to refuse to issue closure notices in respect of corporation tax enquiries on the basis that a diverted profits tax (DPT) review period was ongoing, the UK’s First-tier Tribunal (FTT) has ruled.

The FTT, in a case concerning a Swiss-owned corporate group, directed HMRC to issue the notices. It found that HMRC had made an informed decision as to the matters under enquiry, as in correspondence with the taxpayers HMRC had set out its conclusions and the basis on which amendments could be made to the returns.

“This is an important decision on the interaction between corporation tax and DPT,” said Steven Porter, a tax disputes expert at Pinsent Masons, the law firm behind Out-Law.

“It is helpful for taxpayers, but it does not mean that in all circumstances HMRC will have to issue closure notices where a DPT review period is ongoing. In this case, the facts showed that HMRC was in a position to issue the closure notices and amend the returns, but that will not always be the case,” he said.

HMRC had issued DPT charging notices and opened enquires into the corporation tax returns for several group companies, following an application by the companies for an advance pricing agreement. HMRC refused to issue closure notices in respect of the corporation tax enquiries because the DPT review period was still ongoing and so the companies concerned applied to the FTT for HMRC to be directed to issue the notices.

The only outstanding matter in the corporation tax enquiries related to the proper arm’s length price which should be charged by two UK group companies for services supplied between themselves and their Swiss parent company in accordance with UK transfer pricing and permanent establishment legislation. This is the same issue which gave rise to the DPT charging notices.

A DPT liability can be removed if the company makes a transfer pricing adjustment in its corporation tax return during the first 12 months of the review period. Making a transfer pricing adjustment means that tax is paid at the corporation tax rate, currently 19% rather than the DPT rate of 25%.

“Understandably the companies in this case wanted to pay any tax due as corporation tax rather than DPT, because of the rate differential,” said Sam Wardleworth, another tax disputes expert at Pinsent Masons.

“However, they were still in disagreement with HMRC over the transfer pricing adjustment and so they did not want to amend the returns themselves. They wanted HMRC to amend the returns following the issue of closure notices so the companies could appeal the closure notices to the FTT or engage the mutual agreement procedure in the UK/Switzerland double tax treaty. If HMRC did not issue closure notices before the end of the DPT periods then the company would be obliged to appeal the DPT notice,” he said.

“By refusing to issue the corporation tax closure notices, HMRC could make this a dispute over DPT rather than corporation tax, effectively putting pressure on the companies to accept its view on transfer pricing and settle the dispute by amending the corporation tax return themselves and increasing the tax at stake,” Wardleworth said.

If closure notices were not issued during the DPT review period, the companies would be out of time to amend the returns and so their only course of action would be to appeal the DPT notice at the end of the review period, but that would mean any tax would be payable at the higher DPT rate.

The judge said that the FTT has no general supervisory jurisdiction of HMRC and so could not consider whether HMRC's policy of not closing enquiries where there is an ongoing DPT review period is reasonable in general terms. She could only consider the point in relation to the circumstances of the companies concerned.

The judge said that the law did not require the taxpayers to put forward reasonable or appropriate grounds to request a closure notice. The burden of proof is on HMRC to demonstrate that it has reasonable grounds for not giving a closure notice. HMRC argued that the companies had not provided all the information HMRC had requested and that the issue of closure notices would pre-empt the end of the DPT review period.

Judge Anne Fairpo dismissed HMRC’s arguments that it is required to bring profits into charge to DPT rather than corporation tax.

“If Parliament had intended that such profits should preferentially be taxed under DPT rather than corporation tax, I consider that it would not have provided companies with the ability to amend their return within the review period outside the normal window given for amendment of a return. Potentially, Parliament could even have excluded companies from making DPT-related amendments even during the normal amendment window if it intended for such profits to be subject to DPT. It did not do so,” she said.

DPT is aimed at multinationals operating in the UK who structure their affairs to avoid creating a UK permanent establishment or where there are arrangements between connected parties, which 'lack economic substance' in order to exploit tax mismatches. It is a separate tax to corporation tax.

If HMRC considers that DPT is payable it issues a charging notice stating the amount of DPT payable. Following receipt of a charging notice, a company has 30 days to pay any DPT due and HMRC has 15 months to review the charge to DPT. The review period gives HMRC an opportunity to try to reach an agreement on the amount of DPT due.

When HMRC opens an enquiry into a corporation tax return, the enquiry does not end until HMRC issues a closure notice amending the return or stating that no amendment is necessary. Once a closure notice is received the company can then appeal against any conclusion stated or amendment made by the notice. If HMRC refuses to issue a closure notice, the taxpayer can apply to the FTT for a direction that HMRC should issue a closure notice, as happened in this case.