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HMRC internal manual

International Manual

Transfer Pricing: methodologies: Mutual Agreement Procedure: SP1/11: scope for granting relief

Statement of Practice 1/11: scope for granting relief

The terms of the Article establishing MAP in UK tax treaties and the Arbitration Convention circumscribe the competent authorities’ freedom of action. The Article provides no guarantee of relief from double taxation via MAP, although in the future some UK tax treaties will provide for arbitration. The Arbitration Convention (where it applies - see ‘Arbitration Stage’ below), of course also provides for arbitration. However, the competent authorities are enjoined to consult each other and to endeavour to resolve each case with a view to the avoidance of double taxation. In the UK, MAP has proved very effective in doing this in cases involving transfer pricing adjustments.

On considering the case presented to it, the UK competent authority may conclude that the taxation of relevant transactions proposed or applied by a tax treaty partner is in accordance with the tax treaty and may grant relief on a unilateral basis at this point. This might be the case even if the treaty partner is unwilling to enter MAP or is unable to do so because it is unable to derogate from a decision reached in its domestic courts. Similarly, the competent authority of the tax treaty partner might decide to relieve unilaterally transfer pricing adjustments made by HMRC.

In respect of adjustments made by the UK’s tax treaty partners there are issues on which they and the UK hold different views. Some partners do not consider that the level of capitalisation of a corporate borrower, as opposed to the rate of interest paid on its debt, is an issue involving the arm’s length principle prescribed by the OECD and Arbitration Conventions. Because it does not view thin capitalisation as a transfer pricing issue, the tax treaty partner may be reluctant, or refuse, to enter MAP in respect of such adjustments. Conversely the UK takes the view that thin capitalisation is an issue requiring application of the arm’s length principle in order to achieve a correct transfer pricing result. To the extent therefore that the cost of funding in question exceeds what the UK considers to be an arm’s length amount the UK is prepared to enter MAP in respect of adjustments made by the tax treaty partner and will consider whether it is appropriate to give relief unilaterally for any disallowance of interest in excess of an arm’s length amount. One purpose of tax treaties is the elimination of fiscal evasion and in its considerations the UK will take into account all circumstances surrounding the decision of the treaty partner to make an adjustment, including issues such as the commercial purpose, or otherwise, of the funding provided.

If the UK considers that the adjustment does not accord with the provisions of the tax treaty, for example because it does not accept that a transfer pricing adjustment complies with the arm’s length principle, the UK competent authority will take up the matter with its counterpart in the treaty partner state. If negotiations between the competent authorities provide adequate evidence to satisfy the UK competent authority that an adjustment made by a tax treaty partner is in accordance with the tax treaty, and was required in order to comply with the arm’s length principle, there will normally be no difficulty in granting a corresponding adjustment. In many cases, the competent authorities can establish that the primary adjustment was in an excessive amount and agree a course whereby the primary adjustment is reduced and the remaining adjustment is relieved in an amount that reflects an arm’s length result. If, however, the UK remains dissatisfied, there is no obligation on it to grant relief and at the taxpayer’s request the matter may progress to arbitration if the Arbitration Convention is applicable or if the relevant treaty contains an arbitration article.

Experience has shown that it is advantageous for taxpayers involved in transfer pricing enquiries to present a case early to invoke MAP because early action by the competent authority can sometimes help to ensure that unrelievable double taxation does not arise from the actions of one fiscal authority. This might be the case, for example, where the UK’s treaty partner is adopting an inappropriate transfer pricing methodology during the course of an audit and the UK is able to persuade it to use the most appropriate methodology. As noted above, the taxpayer is not directly involved in the negotiations between the competent authorities but, as happens in the UK, it may participate indirectly through discussions with the competent authority of the state of residence/nationality. As is also stated above, the approach of the tax treaty partner in these matters is not at the discretion of the UK.

It is important to note that even though the competent authorities may begin discussions before a transfer pricing enquiry is completed, MAP is not an alternative to the normal enquiry process. MAP will seek to determine in principle how the double taxation of profits will be relieved by the tax treaty partners once the quantum of profits has been established by the transfer pricing enquiry. The competent authorities will not, however, conduct a transfer pricing enquiry as part of the MAP and MAP will not suspend or replace an enquiry. Equally, presenting a case for MAP should not of itself give rise to the opening of a transfer pricing enquiry, and it will not remove any of the UK‘s protections surrounding the opening of such enquiries. It may, however, be necessary for the UK to seek information from the taxpayer in order to determine whether a transfer pricing adjustment made by a tax treaty partner conforms to the arm’s length principle. Normally such information will exist as a result of the transfer pricing enquiry and/or be reflected in the case presented for MAP, but clarification of fact and /or economic analysis may be required as MAP negotiations develop.

Where a case has been settled under the UK’s judicial process before it is presented for MAP, the UK competent authority would expect, on request, to take the matter up under MAP. The UK considers that both a court and a tribunal form part of the judicial process.

MAP does not, however, provide a parallel avenue to the domestic appeals process, though early entry into MAP may be useful in helping a taxpayer determine whether the appeals process needs to operate. The UK follows the approach adopted by most countries and described in the Commentary on Article 25 at Paragraph 76. Under this approach a person cannot pursue simultaneously the MAP and domestic legal remedies. Thus a case may be presented and accepted for MAP while the domestic remedies are still available. In such cases, the UK competent authority will generally require that the taxpayer agrees to the suspension of these remedies or, if the taxpayer does not agree, will delay the MAP until these remedies are exhausted. Where the adjustment giving rise to MAP has been made in the other state the UK competent authority does recognise that whilst a taxpayer may be willing to suspend domestic legal remedies, the other fiscal authority may be unwilling to do so. Similarly, the UK competent authority may recognise that pursuit of domestic legal remedies in another state may take a considerable amount of time. In such cases the UK competent authority may be willing to continue the MAP while the domestic legal process continues, but of course cannot guarantee that the other competent authority will be willing to do so.

Where the MAP is first pursued and a mutual agreement has been reached, the taxpayer and other persons directly affected are offered the possibility to reject the agreement and pursue the domestic remedies that had been suspended. In such a case, the UK would consider that the efforts of the competent authorities to resolve the case by MAP to have been exhausted.