What Is the Diverted Profits Tax and How Does It Work?

The Diverted Profits Tax (DPT) is a measure designed to counteract tax avoidance by large multinational corporations that artificially move profits to low-tax jurisdictions to erode a country’s tax base. The DPT is not a standard tax on profits but a targeted tool to penalize specific profit-shifting behaviors.

Pioneered in the United Kingdom in 2015 and later adopted by Australia, the DPT was a response to global enterprises generating significant revenue within a country while paying minimal corporate tax. These strategies often involved complex structures, royalty payments, and transfer pricing mechanisms that, while technically legal, were seen as going against the spirit of tax law.

Scope of the Diverted Profits Tax

The Diverted Profits Tax targets large multinational enterprises (MNEs) and does not apply to small or medium-sized businesses. The specific thresholds that trigger the DPT vary by jurisdiction but involve significant revenue. For instance, in Australia, it applies to entities with an annual global income of A$1 billion or more. In the UK, a threshold can involve a non-UK company’s sales to UK customers, with an exemption if revenues do not exceed £10 million in a year.

Two primary conditions can trigger a DPT charge. The first involves arrangements that lack sufficient economic substance. This rule targets transactions between related parties where the structure was designed to secure a tax reduction, and the non-tax financial benefits are less than the tax benefit. It scrutinizes whether the entities involved contribute genuine economic value relative to the tax savings gained.

A hypothetical example would be a UK-based company making large, tax-deductible royalty payments to a related entity in a low-tax jurisdiction. If this foreign entity has minimal staff, performs few genuine functions, and its primary purpose appears to be holding intellectual property to collect royalties, a tax authority could argue the arrangement lacks sufficient economic substance. The core issue is that the transaction lacks a legitimate commercial purpose beyond minimizing the group’s tax liability.

The second trigger is the “tax mismatch” condition. This applies when a transaction between related parties results in a significant tax reduction for one party without a corresponding increase for the other. A common benchmark is if the tax paid by the overseas entity is less than 80% of the tax that would have been paid in the higher-tax jurisdiction. For example, if a company in a 25% tax country pays a connected company in a 5% tax jurisdiction, this condition may be met.

The DPT Charging Mechanism

Once a tax authority determines a company’s arrangements fall within the DPT’s scope, a specific procedural framework is initiated that is distinct from standard tax assessments. The exact procedure varies by country. In the UK, His Majesty’s Revenue & Customs (HMRC) issues a preliminary notice, giving the company 30 days to make representations. In Australia, the Australian Taxation Office (ATO) issues a provisional DPT assessment, and the company has 60 days to respond.

If the tax authority is not satisfied with the company’s representations, it issues a formal charging notice. This notice confirms the DPT amount due and triggers the “pay now, argue later” principle. The company must pay the full assessed tax within a short period, such as 30 days in the UK or 21 days in Australia. No postponement of the tax is permitted during any subsequent appeal.

After the DPT is paid, a review period commences, which is 15 months in the UK and 12 months in Australia. During this phase, the tax authority examines the facts, and the company can provide more evidence to support its position. The DPT charge can be adjusted based on new information, and only after this review can the company formally appeal the final assessment. This system shifts the financial leverage to the tax authority, encouraging companies to cooperate.

Calculating the Tax Liability

The DPT rate is set higher than the standard corporation tax rate. In the UK, the DPT rate is 31%, compared to the 25% corporation tax rate. However, the UK government has proposed repealing the DPT as a separate tax from 2026 and incorporating a similar charge into the corporation tax framework at the higher rate. In Australia, the DPT is levied at 40%, significantly higher than the 30% corporate tax rate.

The taxable base for the DPT is the profit amount the tax authority estimates has been artificially diverted. The calculation method depends on which DPT condition was triggered. If triggered by arrangements lacking economic substance, the calculation adjusts the company’s profits to what they would have been if tax reduction was not a primary driver. Tax authorities may also make presumptive adjustments, such as HMRC in the UK disallowing up to 30% of certain tax-deductible expenses.

The initial calculation is not a precise science, as tax authorities often work with limited information when issuing the charging notice. The calculation is therefore based on a best-estimate basis. The burden then shifts to the taxpayer during the review period to provide more complete and accurate information to refine the calculation. This approach allows the tax authority to act quickly without being delayed by information-gathering.

Interaction with Corporation Tax and Transfer Pricing

The DPT’s primary purpose is to influence a company’s behavior regarding its main corporation tax and transfer pricing obligations. This interaction is most apparent during the review period following a DPT payment. For example, during the first 12 months of the UK’s 15-month review, a company can amend its corporation tax return. If the company makes a sufficient adjustment to its filing and pays the associated tax, the DPT charge is reduced accordingly.

If a company amends its return and pays the additional corporation tax, it receives credit for the DPT already paid, ensuring the same profits are not taxed twice. For example, if a company paid a DPT charge on $100 million of diverted profits, then amends its return to include that $100 million, the DPT liability is extinguished. The amount paid is used to satisfy the new corporation tax liability.

This system creates a strong preference for settling disputes through the standard corporation tax system. By amending a return, a company pays tax at the standard corporate rate rather than the higher DPT rate. The DPT thus functions as a backstop, compelling companies to engage with transfer pricing rules.