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HMRC internal manual

Business Income Manual

HM Revenue & Customs
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Wholly and exclusively: artificial prices

S34 Income Tax (Trading and Other Income) Act 2005, S54 Corporation Tax Act 2009

The excess over the commercial price is not for the purposes of the trade

Where something passes between two parties under common control other than at an arm’s length price, the transfer pricing provisions in Pt 4 Taxation (International and Other Provisions) Act 2010 may apply (see INTM410000 onwards). (See also BIM42140 for the application of this legislation in the context of group service companies.)

But it is important to note that those provisions do not apply to all transactions between connected persons. The case law detailed here is still appropriate.

Where an inflated, or otherwise artificial price, is apparently paid for trading stock there is usually some other purpose involved.

Lord Cross gave a good example at page 100 in the linked cases of Ransom v Higgs and Kilmorie (Aldridge) Ltd v Dickinson [1974] 50 TC 1. Lord Cross talked about a retailer buying stock from a relative at more than the commercial price in order to help the relative get started in business.

Where, as part of a scheme for tax avoidance, a sum in excess of the commercial price is paid, there is a presumption that the excess is not expended for the purposes of the trade. Roskill LJ explained that the payment made by Kilmorie was not made in order to increase the company’s profits but rather to try to reduce them so that they appeared in a non-taxable form in someone else’s hands.

Ransom v Higgs concerned an avoidance scheme designed to develop properties but secure that any profits were capital receipts rather than income receipts. The events took place before the introduction of Capital Gains Tax in 1965, which meant that, if the receipts were capital, no tax would be due.

Lord Reid explained that, whilst the Revenue cannot second guess the quantum of payment made where there are sound commercial reasons, in a case of tax avoidance the claimed deduction will not be wholly and exclusively for the purposes of the trade. The judge mentioned the possibility that a finding of duality of purpose could lead to disallowance of the whole of the expenditure, including that which was for a trade purpose. But, in this case, the Revenue agreed to allow the market value (which was less than the sum paid).

The part of Lord Reid’s judgment in the Kilmorie case on which the above guidance is based is set out below:

`It was argued that we must presume that the directors, or whoever made the agreement on behalf of the two companies, acted properly in what they believed to be the interests of the companies. In the ordinary course we would presume that in the absence of evidence to the contrary. But here it is quite obvious that neither the Downes nor the Harlox companies [key players in the overall scheme] acted in their own interests. They did just what Mr Downes and Harlox wanted. I would agree that if a trader is actuated by none but commercial motives the Revenue cannot merely say that he has paid too much. He may have been foolish or he may have had what could fairly be regarded as a good commercial reason for paying too much. But if it is proved that some non-commercial reason caused the trader to pay more than he otherwise would have done, then it seems to me quite clear that the payment can no longer be held to have been wholly and exclusively expended for the purposes of the trade. No authority is needed for so obvious a proposition.’