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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Derivative contracts: tax avoidance: transfer pricing and derivative contracts

Derivative contracts not on arm’s length terms

Previously the Taxes Acts contained an anti-avoidance provision aimed at transfers of value between connected companies by means of derivatives (FA94/S165 and FA94/S166). At its simplest, company A (in the UK) could transfer value to company B (in a tax haven) by entering into a derivative contract on non arm’s length terms. For example, B could grant an option to A, for which A pays a premium in excess of the market value of the option; or the parties could enter into an interest rate swap under which A makes periodic payments based on LIBOR, but receives fixed-rate payments at a below-market rate.

This provision was not reproduced in FA02/SCH26 or CTA09/PART7. This is because the transfer pricing rules in TIOPA10/Part 4 apply to derivatives as they apply to any other form of ‘provision’ between connected companies - although there is an important exception for exchange gains or losses on derivative contracts (see CFM56060). Part 4 applies to derivatives between two UK companies with effect from 1 April 2004.

In considering whether the transfer pricing rules apply to particular arrangements involving derivatives, you should look at the general guidance on Part 4 in INTM43200 onwards, and the practical advice at INTM464130 onwards.

For periods beginning on or after 1 April 2004, CTA09/S693 ensures that any profit or loss imputed on a derivative contract under Part 4 (including any adjustment to charges or expenses in connection with the contract) is treated as a credit or debit under CTA09/PART7, and all of the rules for computing or bringing into account credits or debits on derivative contracts will apply to such amounts.