Transfer Pricing: Transactions and Structures: business structures: other legislation
Other tax issues
Multinational enterprises (‘MNEs’) will have to think very carefully about how they implement cross-border transactions. The more obvious tax issues are considered below.
Controlled foreign companies legislation
The UK CFC legislation charges UK shareholders to tax on the profits of certain overseas participations. There are a number of exclusions, which take certain overseas subsidiaries out of the CFC net. For example, a UK group may have a hundred or more overseas subsidiaries - many of which will fall outside the UK CFC legislation because they are resident in countries that are on the excluded countries list, e.g. France and Germany. See INTM203000 onwards.
The CFC legislation may allow the taxation of profits which have accrued in an overseas affiliate. For example, a valuable intangible (maybe the rights to a particular trade mark, or a patent) is sold by UK Plc to its 100% newly formed subsidiary based in a low tax territory for £100 million. The capital gain made by UK Plc is covered by capital losses brought forward. The new subsidiary then grants UK Plc a licence to use that valuable intangible, in return for an annual royalty. The subsidiary owns no other assets and carries out no other activities. The UK CFC legislation will almost certainly apply to the profit on the royalties received by the subsidiary, with the effect that they will be taxed as part of UK Plc’s profits.
Profits may be made by an overseas company which is already engaged in a business activity, which allows the UK group to claim that the overseas company is carrying on an exempt activity. In the example above, consider the scenario where the subsidiary already owns and runs a hotel in the low tax territory. The company will very likely pass the exempt activities test, and the profits will not be taxed as part of UK Plc’s profits. UK Plc may decide to transfer the brand name used by the whole group to the subsidiary; who in turn will then charge royalties to the whole group, royalties which were previously received by the UK.
The company might claim that the main activity of the subsidiary remained that of owning and running the hotel there. In such a situation case teams should look very carefully at all the facts to consider whether the company could continue to claim the benefit of the exempt activities test.
In situations where an existing overseas subsidiary, operating in a low tax territory, starts receiving a new source of income, all the facts should be obtained and the case should then be discussed with CSTD Business, Assets & International.
Taxation at source
The payment of royalties by a UK company may be subject to taxation at source under ITA07/S903. The UK has double taxation agreements (‘DTAs’) with well over 100 countries, and while each DTA is different, generally our DTAs allow for royalties to be paid out of the UK gross, i.e. S903 is set aside.
Case teams should scrutinise carefully any claim that a payment is in fact not a royalty or is outside the scope of ITA07/S903. If the payment has the characteristics of a royalty then S903 can apply.
Providing additional services may be a device to try and show that the payment is not pure income profit in the hands of the recipient. Any claims should be reviewed carefully.
It is easy to carry out a tax efficient restructuring on paper and put in place the various contracts that will give it effect. However, such restructuring inevitably calls for people to be in place to carry out the functions that have been transferred out of the UK. This has a very real cost in that staff in the UK may lose their jobs involving expensive redundancy costs. New staff will have to taken on in the new location, or existing staff relocated, involving more costs. There may well be disruption to the business as a whole while the restructuring is carried out and for a period of time thereafter.
While some strategies can be implemented with little costs other than legal fees, the structures discussed in this chapter generally come at a more substantial cost to the business. Even if actual jobs are moved, the resulting structure can still be at risk from challenge from tax authorities.
In order to avoid these resource costs, the restructuring may be carried out in a way that results in little or no loss of jobs in the UK, but equally there will probably be little of substance in the territory to which the functions and risks are purportedly transferred.
Legislation applying to the disposal of intangible assets
Valuable intangible assets may have little or no base cost, or recent market values may be much higher than March 1982 market valuations. Transferring a valuable intangible asset offshore could in the past have crystallised a large capital gain. However, typically, a lot of large UK groups have had a pool of capital losses to absorb any such gain.
The new legislation will tax disposals of intangibles after 1 April 2002 as income, rather than capital gains. Transfer pricing takes precedence over the intangible asset regime (see the Corporate Intangibles Research and Development Manual at CIRD47000, in particular CIRD47060). Any claims that a transfer has occurred without a disposal charge should be referred to CSTD, Structure, Incentives & Reliefs team.