INTM489650 | Diverted Profits Tax: application of Diverted Profits Tax: legislation – Finance Act 2015 – core provisions: estimating profits for notices – section 80 or 81 cases

Section 96 applies for the purpose of estimating the taxable diverted profits to be included in a notice in a section 80 or 81 case. The basic rule is that the designated officer is to make a best of judgment estimate of the amount that is chargeable in accordance with sections 84 or 85.

However, specific rules apply for determining the estimated charge where the “inflated expenses condition” is met. Under these rules there is an upfront 30% disallowance of payments that have been routed through the contrived arrangements and are relevant to the calculation of taxable diverted profits.

The inflated expenses condition is met if:

• the material provision results in expenses of the company for which a deduction has been taken into account for corporation tax purposes;

• those expenses, or part of them, are responsible for the effective tax mismatch outcome (DPT1180); and

• as a result the designated officer considers that those expenses, or part of them, might exceed an arm’s length amount.

If the condition is met, the amount of the relevant expenses that would have been taken into account in estimating the taxable diverted profits in the notice are to be reduced by 30%, without regard to the transfer pricing rules in Part 4 of TIOPA.

However, the company may have made an adjustment to the deduction for the expenses under Part 4 of TIOPA 2010 (transfer pricing) in calculating its profits for corporation tax in a return made before the notice is issued. If this is the case any reduction in the amount of the deduction would be taken into account in applying the 30% reduction but not so as to reduce the amount below nil.

The calculation of the diverted profits can be adjusted during the review period, on the basis of evidence received, by the issue of either a supplementary charging notice or an amending notice (see INTM489924 and INTM489926). The special rules for making estimated calculations are ignored when computing the amount of taxable diverted profits to be included in such a notice.

The inflated expenses condition can be applied only if either the actual provision condition is met or the only reason that the condition is not met is that the relevant alternative provision would have resulted in relevant taxable income. In any other case, that is, where the relevant alternative provision would not have resulted in the relevant company incurring expenses of the same type and for the same purpose - the designated HMRC officer will issue the notice based on a best estimate of the additional profits arising under the relevant alternative provision.

Example of inflated expenses condition where there is relevant taxable income

A UK resident company is making rental payments for a valuable asset used by it in the course of its trade to a connected UK company that owns the asset. The ownership of the asset is subsequently transferred to an affiliate in a low tax territory, and the rental payments are then increased, on the alleged grounds that with the change of ownership the group is taking the opportunity to review the rental payments and move them to current market rates.

The mismatch condition is met and it is also assumed that the insufficient economic substance test is met. It should be assumed that, in this case, the actual provision condition would be met but for the fact that the relevant alternative provision would have resulted in relevant taxable income for a connected UK company – the original owner of the asset which continues to manage it. In consequence of those facts, and taking into account the increase in rentals at the time of transfer to the low tax territory, it is likely to be reasonable for the designated officer to conclude that the inflated expenses condition is met. Accordingly, the initial estimated charge to taxable diverted profits will be equal to

• 30% of the rental payment

• less any amount adjusted by the company under Part 4 of TIOPA 2010 and included in its tax return before the notice is issued

Plus

• the rent which would have been received by the UK connected company (which would also take into account the inflated expenses condition adjustment).