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Notification of the uncertain tax treatment by large businesses

Ravi Basra (Corporate Tax Senior Manager) analyses the Government’s proposed rules on uncertain tax treatments and outlines what businesses need to do to prepare for these changes.

In March 2020 the Government consulted on the proposed requirement for large businesses to notify HM Revenue & Customs (HMRC) where they have adopted an uncertain tax treatment. This was followed up by a second consultation in March 2021 with proposed changes including a set of triggers for identifying whether a tax treatment is uncertain.

On 20 July 2021, HMRC published a summary of responses received to the second consultation. In response, the Government will be making further changes to the design of the policy in order to minimise uncertainty and the administrative burden on taxpayers.

HMRC estimates that £4.9bn of annual tax loss is attributable to the legal interpretation tax gap, which is the difference between the tax that would have been collected under HMRC’s interpretation of the law (whether or not that interpretation is correct) and the tax that was actually collected.

The Government’s intention is that the notification requirement will be legislated in Finance Bill 2022 and apply to transactions in returns due to be filed after April 2022. This could potentially extend to pre-existing ongoing tax treatments even when the treatment in question has been applied for many years.

Large businesses need to be aware of these rules and should review transactions and, where relevant, start preparing for the need to notify.

Which Businesses are in scope?

The rules will only apply to large businesses, including corporates, partnerships, and Limited Liability Partnerships. The Government intends to exclude collective investment schemes which meet the turnover or asset test from the scope of the legislation.

A large business is one with either, or both, a turnover above £200m and a balance sheet total over £2bn. This includes all businesses handled by HMRC’s large business directorate as well as the larger groups in its mid-sized business directorate.

Which taxes are in scope?

The range of taxes in scope was originally proposed to be modelled on the Senior Accounting Officer (SAO) regime but it is now proposed that the notification will only cover Corporation Tax, Income Tax (including PAYE) and VAT.

The proposals to include excise and customs duties, Stamp Duty Land Tax, stamp duty reserve tax, bank levy and petroleum revenue tax have now been removed. This is a welcome change.

Large businesses need to be aware of these rules and should review transactions and, where relevant, start preparing for the need to notify.

What is the definition of uncertain tax treatment?

A significant concern with the original proposals was that the definition of an uncertain tax treatment was unclear and too subjective.

The second consultation sought to address this by proposing a series of seven objective tests where, if any one of those tests are met, the large business will be required to notify HMRC. The Government is considering whether a specific list of examples of uncertain tax treatments should be published alongside HMRC guidance.

While it was originally proposed that the notification requirement would arise if one of seven triggers applies, the number of triggers has now been reduced to three:

  1. Where a provision has been recognised in the accounts of the company or partnership, in accordance with Generally Accepted Accounting Practice (GAAP), to reflect the probability that a different tax treatment will be applied to the transaction
  2. Where the tax position taken is different to HMRC’s known position (this includes information available from publicly available material and any statements made to the business by HMRC), or
  3. Where there is a ‘substantial possibility’ that the tax position taken would be found to be incorrect in one or more material respects by a court or tribunal.

The reduced number of triggers is likely to reduce the number of transactions requiring disclosure. However, the ‘substantial possibility’ in the third trigger is not defined in the legislation, and as such may be difficult for the taxpayer to assess. The explanatory note accompanying the draft legislation indicates that the ‘substantial possibility’ test will apply to situations where the taxpayer considers the threshold is not met for a provision in accordance with GAAP, but nevertheless there are grounds for considering that there is a substantial possibility that the treatment might not be sustained at tribunal. It is anticipated that HMRC’s upcoming draft guidance will provide more clarity on the application of this condition.

Are there any exceptions?

There are certain proposed exceptions from the requirement to notify.

The new rules are designed to target businesses which are not open in their relationship with HMRC. Large businesses which have already had discussions with HMRC about the uncertainty, such as approaching HMRC for tax clearance and agreement in advance of adopting an uncertain treatment, will not be required to bring it to HMRC’s attention again through the notification process, unless the business treats the transaction contrary to HMRC’s recommendation.

Banks that have signed up to the banking code of conduct are not required to notify uncertain tax treatments that they discuss with HMRC under the code.

The Government is considering whether businesses considered low risk for the business risk review process could be excluded; and whether notification of transfer pricing uncertainty might be excluded in certain circumstances

The practical difficulty for many businesses will be in deciding whether their existing disclosures are sufficient. This could be a particular problem for businesses who are not dealt with in HMRC’s Large Business Service, as they do not currently have an easy route to discuss uncertain issues with HMRC.  HMRC have promised to make additional resource available to such businesses, but it remains to be seen whether this can be delivered in practice.

What is the threshold?

An important change which will be welcomed by businesses is the proposed increase in the de-minimis threshold from £1m to £5m. A tax treatment will only be uncertain if it results in a difference of more than £5m between the taxpayer’s calculation of their tax liability and HMRC’s calculation of their tax liability. This will apply consistently across all three taxes in scope and is based on the tax amount.

In practice, the threshold may be more of an issue for VAT, where the cumulative effect of issues such as partial exemption can be large, more so than for Corporation Tax where it will be easier to identify whether a transaction is large enough to be disclosed.

What are the notifications and penalties?

The first consultation proposed that the notification should be a single, annual process covering all the relevant taxes, due at the same time as the SAO certificate. Under the current consultation, it is proposed that there is a separate notification for each tax regime and the notification is required at the same time as the relevant return.

A group notification option is being proposed for VAT which would exclude tax-neutral inter-entity transactions. The same could apply to direct taxes with group companies.

The proposed penalty for non-compliance with the new regime remains £5,000, but this will now only be levied on the business rather than on the individual person(s) responsible. This can be appealed and there will be a ‘reasonable excuse’ defence.

The Government now intends to refine the penalty for failure to notify an uncertain tax treatment so that a larger penalty may be charged for repeated failures.

What should you do next?

The consultation closed on 1 June. Draft legislation will be published for further comment ahead of inclusion in Finance Bill 2022.

Taxpayers within the regime should consider whether any ongoing or anticipated tax positions will fall within the new legislation following its publication.

Large businesses should undertake an initial review to identify any tax positions which exceed the £5m threshold and will need to be included in a return filed after April 2022. Consideration should be given to whether these are disclosable under the new regime, bearing in mind that this could relate to transactions which have already taken place (a Corporation Tax return for the year to 31 December 2021 is likely to be filed after the relevant date, for example). Those large businesses that do not have a Customer Compliance Manager should give early consideration to these rules as we predict this will give rise to more challenging debate around the impact on transactions given no/minimal open dialogue with HMRC.

In our view, these proposals are likely to increase the compliance burden on businesses, with little additional revenue being generated for HMRC. Most businesses want certainty and are not trying to hide their position from HMRC but will now make additional disclosures to avoid the risk of penalties. Meanwhile, any business which has a ‘high risk’ approach to its tax strategy, and routinely seeks to take aggressive positions, is unlikely to be deterred by these measures. Yet again, the Government appears to be adding red tape and complexity to the tax system for little real benefit.

The proposed changes in the design of the rules in response to the second consultation, while welcome, do not go far enough to reduce the red tape and complexity arising from the proposals.

If you would like to learn more or discuss how this could potentially impact your business, please get in touch with your usual Blick Rothenberg contact or one of our experts using the details on this page.