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Diverted profits tax UK: When companies need to worry

Diverted profits tax UK is a topic that can feel remote to many small and medium sized businesses, but it deserves attention when your group has cross border arrangements or related party transactions. This article explains what diverted profits tax UK covers, when a DPT charge may arise and practical steps directors should take to reduce risk.

What is diverted profits tax and why it exists

Diverted profits tax is an anti avoidance measure introduced to discourage arrangements that artificially shift profits away from the UK tax base. HMRC targets schemes that seek to reduce UK corporation tax by routing profits to low tax jurisdictions or where a company avoids creating a taxable presence in the UK by using contrived structures.

The DPT regime is focused on the economic substance of transactions. Where profits have been diverted through related parties or contrived agreements, HMRC can apply a DPT charge that is intentionally punitive compared with normal corporation tax. The aim is to ensure profits attributable to UK activity are taxed in the UK rather than being shifted offshore.

Who is in scope – not just multinationals

Many people assume diverted profits tax only hits large multinationals. That is not strictly true. The regime is most often used against larger groups and cross border arrangements, but smaller UK companies still need to worry when they:

  • interact with related parties in low tax jurisdictions
  • use intermediary companies to contract with UK customers
  • receive or pay commissions, royalties or management charges that strip profit from UK trading activity
  • operate through arrangements that might be seen as avoiding a permanent establishment in the UK

If your business is part of a group with overseas affiliates, or if a non UK parent or supplier is involved in your sales chain, you should consider DPT exposure alongside transfer pricing and corporation tax reviews.

Key concepts you need to understand

Artificial profit diversion

Artificial profit diversion covers cases where profits that should be taxed in the UK are instead shifted to related parties or contrived arrangements. Common examples include charging high management fees into low tax jurisdictions, funneling customer-facing activities through an offshore affiliate or using commissionaire structures to avoid UK tax.

Permanent establishment UK risk

Permanent establishment UK is a core principle when assessing DPT. If a non UK business operates in the UK in a way that creates a taxable presence, profits should be taxed in the UK. Tax avoidance diverted profits often look to design structures that deny a permanent establishment even though substantive business activity occurs in the UK.

When reviewing arrangements, consider where the key commercial decisions are made and where significant people functions are performed. These factual assessments influence whether HMRC will seek to assess profits in the UK.

The DPT charge and how it differs from corporation tax

A DPT charge is separate from a standard corporation tax adjustment. It is applied when HMRC determines that profits have been diverted through arrangements lacking commercial substance or aimed at avoiding a UK taxable presence. The practical effect is that the DPT charge can be higher than the ordinary corporation tax liability and is intended to deter avoidance.

Note that a successful transfer pricing adjustment or corporation tax assessment may reduce or remove the need for DPT, but each case depends on the facts and HMRC practice.

Typical triggers that attract HMRC attention

Understanding typical red flags helps directors prioritise risk reviews. HMRC is particularly interested in arrangements that have one or more of the following features:

  • Related party payments to low tax jurisdictions without clear commercial reasons
  • Transactions that separate key customer facing activities from the entity that recognises revenue
  • Commissionaire or similar sales models where title and invoicing are routed offshore
  • Management or service charges that appear designed to move profit rather than reflect real costs
  • Use of intercompany loans, royalties or cost sharing with unclear documentation

If your business uses these structures, you should document commercial reasons and supporting evidence for pricing and contractual decision making.

Practical steps for small and medium sized companies

You do not need to be a large multinational to take sensible precautions. Practical steps include:

  • Perform a structured risk review of cross border contracts and related party transactions
  • Ensure transfer pricing documentation exists that explains pricing policies and comparables where relevant
  • Map where key people and decision making are located and document the business reasons for structure choices
  • Reassess management and service charges to confirm they reflect real costs and benefits
  • Check whether overseas subsidiaries or agents create a permanent establishment UK exposure
  • Consider advance pricing agreements or disclosure if arrangements are novel or high risk

These steps will strengthen your position if HMRC asks questions and may prevent small issues growing into formal disputes.

Record keeping and documentation – your first line of defence

Good documentation is often decisive in HMRC enquiries. Records you should keep include:

  • Written commercial rationale for related party arrangements
  • Contracts, service level agreements and evidence of actual services delivered
  • Transfer pricing policies and contemporaneous studies where applicable
  • Board minutes and delegation of authority covering cross border transactions
  • Supporting invoices, expense claims and evidence that charges reflect real activity

When HMRC investigates, having contemporaneous documents that explain why a structure was chosen and how charges were calculated reduces the likelihood of a DPT charge or helps mitigate penalties.

How HMRC investigates DPT issues

HMRC uses a combination of information gathering, risk profiling and targeted enquiries. Steps you may see include:

  • Requests for information and documentation from HMRC corporate tax teams
  • Wider discovery during a compliance check or transfer pricing review
  • Application of transfer pricing adjustments followed by consideration of a DPT charge where diversion is suspected
  • Negotiation of a settlement or, in contested matters, escalation to formal appeal or litigation

If HMRC opens an inquiry, respond promptly and seek professional advice early. Delay or partial disclosure can increase penalties and interest.

Examples of arrangements that caused DPT issues

Illustrative scenarios help explain the practical risks. The following are typical patterns that have attracted HMRC interest in the past:

  • A UK sales team secures customers but sales contracts are routed through an offshore affiliate that invoices customers. The affiliate retains most profit while the UK team is paid a small commission.
  • A UK company receives central services from a related low tax jurisdiction that charges high management fees with little evidence of value provided.
  • A non UK parent uses a commissionaire or similar model to sell in the UK while arguing no permanent establishment exists despite sales activities carried out by people based in the UK.

In each case, careful documentation, arm's length pricing and clear evidence of where value is generated are the decisive elements for HMRC.

Interaction with transfer pricing and corporation tax

DPT sits alongside transfer pricing rules. In many cases, a transfer pricing adjustment that correctly reassigns profit to the UK will remove the rationale for a DPT charge. However, where the arrangement is contrived or lacks commercial substance, DPT may still be considered.

Directors should therefore not view transfer pricing documentation as optional. For groups with significant cross border trading, contemporaneous transfer pricing reports and benchmarking reduce the chance that HMRC will characterise a structure as profit diversion.

When a company should contact HMRC or disclose arrangements

There is no single threshold that forces disclosure of every cross border arrangement. Consider voluntary disclosure or early engagement with HMRC when:

  • arrangements are novel or complex and could be seen as aimed at avoiding a UK taxable presence
  • the tax position is material to your business but uncertain
  • you want certainty and are considering negotiated outcomes such as an advance pricing agreement

You can sign in to HMRC services to check your company tax accounts and respond to requests. For sign in and setup, see the HMRC online services page: https://www.gov.uk/log-in-register-hmrc-online-services

Early dialogue often reduces the risk of a punitive outcome, but always seek professional tax advice before making formal disclosures.

Penalties, interest and reputational risk

HMRC may apply interest and penalties where tax is assessed late or underpaid. A DPT assessment is often accompanied by penalties if HMRC believes the taxpayer did not take reasonable care or has deliberately sought to avoid tax.

Beyond cash costs, the reputational impact of being associated with tax avoidance can be significant for customer and investor relations. Directors should weigh the commercial benefits of aggressive tax structures against these wider risks.

Red flags for directors and board reporting

Board level oversight helps ensure robust decision making. Directors should look for these red flags in management reports:

  • Significant related party transactions with offshore entities
  • Rapid growth in intercompany charges or royalties without clear business drivers
  • Contracts that separate customer facing functions and profit recognition across jurisdictions
  • Absence of contemporaneous transfer pricing documentation

If red flags are present, escalate the issue to the board and seek a Fractional CFO or external tax adviser to undertake a focused review. Regular updates in your Management Reporting pack will help keep the board informed.

Practical checklist for a quick internal review

Use this short checklist to decide whether you need deeper analysis:

  • Do you have related party transactions with entities in low tax jurisdictions?
  • Are there offshore companies invoicing UK customers for sales made by UK staff?
  • Do management charges or royalties seem disproportionate to services received?
  • Is there contemporaneous documentation for transfer pricing and commercial rationale?
  • Could HMRC argue your group avoids creating a permanent establishment UK?

If you answer yes to one or more questions, perform a full review and consult a specialist accountant.

How Figures can help

At Figures we advise directors and finance teams on cross border tax risk, transfer pricing and documentation tailored to UK small businesses. Our Statutory Accounts & Tax service can help ensure your year end filings align with your commercial position. If you need structured analysis of intercompany arrangements or board level reporting on risk, our Statutory Accounts & Tax and Management Reporting services are designed for that need.

If you want to discuss diverted profits risk in confidence, book a discovery call with our team.

UK tax and legal accuracy

This article is for informational purposes only and does not constitute professional tax or financial advice. Please speak to a qualified accountant before taking action. Tax year referenced: 2026/27.

Frequently asked questions

What is the difference between a DPT charge and a transfer pricing adjustment?

  • A transfer pricing adjustment reallocates profit between group entities to reflect arm's length pricing. A DPT charge is an anti avoidance measure used where HMRC considers profits have been artificially diverted or where structures avoid a UK taxable presence. Both can arise from the same facts but serve different statutory purposes.

Does diverted profits tax UK apply to small UK companies?

  • DPT is primarily targeted at cross border profit diversion and structures used to avoid UK tax. Small companies that operate purely within the UK and without related party offshore arrangements are unlikely to be in scope. However, small companies in international groups or with offshore billing arrangements should assess exposure.

How can I reduce the risk of a DPT charge?

  • Keep strong contemporaneous documentation, ensure transfer pricing reflects commercial reality, avoid contrived routing of sales and ensure management fees are justified and supported by evidence. Early professional advice is important where arrangements are novel.

If HMRC opens an inquiry, what should I do first?

  • Engage a specialist tax adviser promptly, gather contemporaneous documentation, and respond to HMRC within required deadlines. Do not unilaterally destroy or withhold documents, and consider voluntary disclosure if errors are identified.

Can a non UK company be liable for DPT in the UK?

  • Yes. DPT can be relevant to non UK companies that structure their UK activities in ways that avoid a UK taxable presence. The permanent establishment UK concept and the factual allocation of profits are critical to these assessments.

Summary and next steps

Diverted profits tax UK is a serious risk where profits are routed away from UK taxation through related party or contrived structures. Directors should treat cross border arrangements, intercompany charges and potential permanent establishment issues as part of routine tax governance. Keep contemporaneous records, review transfer pricing policy and get specialist advice where arrangements are complex or novel.

If you want tailored help assessing your group exposure or preparing documentation for the 2026/27 year, get in touch with Figures. We can review your arrangements as part of our Statutory Accounts & Tax or Management Reporting engagements, or you can book a discovery call to start the conversation.