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HMRC internal manual

Double Taxation Relief Manual

Non-residents: UK income: Arm's length

The Article requires that the profits which are attributed to the permanent establishment are those which it would be expected to make if the permanent establishment was dealing at arm’s length with the enterprise of which it is a permanent establishment. This includes dealings with the enterprise’s other permanent establishments and its associated companies and their permanent establishments.

ICTA88/S28AA (ICTA88/S770 for accounting periods ending on or before 30 June 1999) does not apply to transactions between a permanent establishment of a non-resident enterprise and the enterprise itself, (see IM4655 and IM4659(h)). Where goods are transferred between head office and the permanent establishment or services are provided by head office or vice versa the costs or income attributable to the establishment must be arrived at on the arm’s length principle. This may require a price to be attributed in the case of transfer of stock or merely a division of costs in the case of certain services such as head office management services. The Commentary on Article 7 of the OECD Model agreement comments on this. Where an Inspector considers that the transactions between the permanent establishment and the enterprise may not be on an arm’s length basis, the instructions at IM4650 onwards give some guidance as to how an arm’s length basis can be established. You should bear in mind, however, that the country of which the non-resident enterprise is a resident may be a high tax country so that there may be little or no benefit to the enterprise in having transactions with its permanent establishment not on an arm’s length basis unless the country in question offers special incentives or reduced rates of tax to certain classes of taxpayer or the enterprise as a whole is making a loss.

Although the United Kingdom is in all cases entitled to its proper share of the enterprise’s total tax liability, Inspectors should not enter into lengthy discussions about the basis on which the profits of the United Kingdom permanent establishment have been arrived at, unless there are substantial amounts involved and there is prima facie evidence of transactions not being at arm’s length. In such cases, once the main facts have been established, but before any detailed enquiries are started, refer the case to International Division, Melbourne House.

Where the United Kingdom branch or agency is a branch or agency of a resident of a country with which the United Kingdom has no double taxation agreement, see DT1760.