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HMRC internal manual

International Manual

HM Revenue & Customs
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Transfer Pricing: Transactions and Structures: business structures: marketing and distribution - other structures

Limited risk distributor

The main characteristic of a distribution company, buying goods and then marketing them to customers, still applies for a limited risk distributor. However there is a contract between the distributor and principal under which the principal will indemnify certain costs. Other functions and risks will be transferred to the principal.

So while the distributor still has risks relating to inventory and debtors, these will be covered by the principal, for example obsolescent stock will be bought back, bad debts will be reimbursed, etc.

It might be possible from the facts to treat the distributor as if it is acting as a principal, but outsourcing some functions and insuring against business risks. However this means accepting that the distributor both could and would transfer functions and risks. The theme of transferring risk is explored further in INTM441030.

Alternatively, there may be a principal which wants to be involved in the selling operation, and earn profits from this activity. In this situation, the distributor resembles an agent acting on behalf of someone else. If the distributor makes a sale in its own name, but there are legal contracts in place to subsume the risks and profits to the principal, then the distributor could be an agent making contracts on behalf of someone else.

The arguments to counter this type of business structure are very similar to those discussed in relation to structures involving commissionaires (see INTM441040) and, for a foreign principal, will include considering whether the principal is trading in the UK through a permanent establishment as well as whether such a structure using contracts to transfer functions and risks would be found at arm’s length.

Commission agent

The facts may show that a company is acting as a disclosed agent. The agent canvasses for sales and interacts with the customers, but the terms of the sale, and the contract for sale itself are agreed and concluded by the principal. The agent does not take title to the goods, which may in some cases be dispatched from a central warehouse .

Sales staff in the “agent” have a diminished role - they are not to agree any terms of the sales; they will only be introducing the customer and establishing his needs.

In these cases, the functions of the sales staff in the ”agent” and those of the principal need to be looked at critically. Points to consider include:

  • Have any sales staff been made redundant?
  • Have the salaries of the staff been reduced to reflect their reduced status? Are new staff taken on remunerated in the same way?
  • Does the principal employ sales staff? If so, what are their duties and how much are they paid?
  • Are there set price lists for the goods being sold? If a discount is offered, who makes the decision to offer the discount?
  • What are the goods being sold - are they off the shelf tangible goods or bespoke services?
  • What do the sales invoices to customers show?
  • How do customers perceive the arrangements? Approaching third party customers should be done with restraint to preserve confidentiality but in some cases it will be necessary to establish how the sales are actually made in practice, particularly where it is claimed that the principal negotiates terms.

The formal conclusion of a contract of sale by a foreign principal outside the UK does not necessarily mean that for tax purposes the sale is made outside the UK. The less ‘complicated’ the goods, the more chance there is that the customer knows exactly what the terms of the deal are before they sign on the dotted line. The more ‘complicated’ the goods, the more likelihood of the “agent”’s sales staff having to market and promote the sale. The courts have on occasions had to consider where a sale is actually made. Case teams should consider all the facts and circumstances surrounding the interaction between buyer and seller. It is unlikely that between third parties the reward for a sale would accrue only to the entity which had signed the contract with a customer rather than to the entity that had persuaded the customer to make the purchase.

There are independent commission agents in the UK, but they tend to be relatively small and are generally unsuitable for purposes of comparison. Case teams should look to use the same principles that would be applied when looking to establish the arm’s length reward for a commissionaire.

Following the approach with commissionaire structures, the possibility that a foreign principal trading might be trading in the UK through a permanent establishment may need to be considered.

The selling function treated as a provision of services

A selling entity is rewarded on a cost plus basis by a connected party. Any claims that the business has no risk and is merely introducing the customer should be scrutinised carefully, as should suggestions that the business is helping to maintain existing customer relations - that it’s providing a service to the principal who is actually selling the goods.

Between independents, selling is usually a critical, entrepreneurial part of any trade rather than a low level service type activity.

Such cases may range from a small representational office with a few employees to a large presence involving hundreds of staff. In the selling world, even a relatively small concern would expect some form of reward related to the sales made. The larger the presence, the more unlikely it is that the company is just providing a service.

It is of course possible to think of services that might be provided to someone carrying on the business of selling, for example the selling company will very likely pay someone to advertise their goods. However, the act of soliciting and securing a sale goes beyond the provision of services to the selling activity; instead it is a fundamental aspect of the selling activity itself. A cost plus method of reward is unlikely to be appropriate. A better way of establishing an arm’s length reward will be to use a price linked to the sale of the goods.

As with other cases involving selling activity, case teams should consider whether there is another party trading (eg a UK permanent establishment of a foreign principal).