Transfer pricing: Operational guidance: alternatives to consider before transfer pricing
How does TIOPA10/Part 4 interact with other legislation?
There are alternative ways of challenging the position if it appears that a group may not have followed the arm’s length principle in determining its transfer pricing. Compared to TIOPA10/Part 4 (previously ICTA88/SCH28AA) these alternatives can sometimes be more straightforward and less time-consuming. The points below are not listed in any order of prominence.
A company which states it is resident outside the UK and which is transacting business with a UK resident person, may be vulnerable to a fundamental challenge to its residence status. If it can be established that the central management and control of that company is in the United Kingdom, it can be taxed accordingly. This subject is dealt with in detail at INTM120000 onwards.
Even if subsidiary companies are not resident in the UK, the Controlled Foreign Companies (‘CFC’) legislation may apply. Detailed guidance on the UK’s CFC regime can be found at INTM190000 onwards.
When faced with a non resident company outside the scope of the CFC legislation, it is usually sensible to concentrate on transactions between the non-resident company and its UK affiliates applying all relevant legislation (whether or not it is transfer pricing specific).
A permanent establishment (‘PE’) is “a fixed place of business through which the business of an enterprise is wholly or partly carried on” (as stated in Article 5 of the OECD Model Tax Convention). Facts and circumstances may indicate that a foreign business operating in the UK through an agency, a branch or an associated or subsidiary company may have a UK PE. There is detailed guidance about PEs at INTM281000 onwards.
Characterising transactions as being on capital account is particularly pertinent in the case of companies in start-up mode. ‘Once and for all’ payments can sometimes be properly disallowed on capital/revenue grounds.
Asset Transfers - Capital Gains
The TCGA 1992 legislation on the transfer of assets applies only to transactions on capital account. But, by applying the arm’s length standard to non-arm’s length transactions, it effectively deals with profit shifts that occur by virtue of the transfer pricing of asset transfers.
For guidance on TCGA92/S18 (Transfers of assets between connected persons) and TCGA92/S173 (Transfers of assets within groups) see CG14480 onwards.
Asset Transfers - Distributions
CTA10/S1020 (formerly ICTA88/S209(4)) can be useful in certain cases. It deals with the situation where a company transfers an asset (or liability) to one of its members at undervalue (or overvalue). Unless both are companies resident in the UK, CTA10/S1020 treats the difference as a distribution. Notwithstanding that transfer pricing principles may be applied to uplift the UK profits, a deemed distribution under CTA10/S1020 is a ‘qualifying distribution’.
Inward Financial Transactions - ITA2007/S874
See the guidance on Thin Capitalisation (INTM510000 onwards) and Intra-group funding (INTM500000 onwards) for advice on the use of ITA07/S874 (formerly ICTA88/S349) in circumstances where the terms of a loan would have been different at arm’s length but the requisite control test of TIOPA10/Part 4 is not satisfied. It may be possible to establish an income tax charge on the recipient (and deny any request for the interest to flow gross) if the amount of interest can be shown to be excessive by virtue of a special relationship between the parties. But this will depend on the precise terms of any relevant tax treaty.
Financial Avoidance - CTA09/S441
Where financial avoidance is involved, it may be appropriate to consider use of the anti-avoidance provision at CTA09/S441 (formerly FA96/SCH9/PARA13). It operates by disallowing debits where in an accounting period a loan relationship has an unallowable purpose.
Whilst CSTD Corporation Tax and Business Income Tax has assumed responsibility for overall policy and domestic operation of the legislation, Business, Assets & International should always be consulted before the section is used in relation to cross-border transactions.
CTA09/S54 and other computational rules
Before applying TIOPA10/Part 4 consideration must be given to the normal computation rules, in particular CTA09/S54 (previously ICTA88/S74(1)(a)) which prohibits the deduction of disbursements or expenses not wholly and exclusively laid out or expended for the purposes of the trade. If there are specific rules denying a deduction for particular expenditure, then these rules take precedence; there is no need to consider the arm’s length nature of the particular provision in question.
Broadly for any trade, profession or vocation expenditure is subject to CTA09/S54. Expenditure not incurred wholly and exclusively for business purposes is not allowable. So for example, a UK company may be recharged the cost of a particular service by another group member. If the company did not actually receive that service, any payment would be disallowed under CTA09/S54. If the company did receive the service then the question of price would be subject to TIOPA10/Part 4; even if nothing was actually charged or, conversely, if the arm’s length price turned out to be nil.
Alternatively if a UK company, trading as a service provider for other group companies, incurs expenditure on behalf of those group companies as part of its trade, the quantum of the recharge will be considered under TIOPA10/Part 4.
The fact that the original recharge was zero is insufficient, of itself, to establish that the transaction is not within the UK company’s trade. Thus, in such situations, the matter would be considered under TIOPA10/Part 4, unless other factors suggest that the transaction is not within the UK company’s trade.
This flowchart illustrates the process which should be followed in considering whether CTA09/S54 (or CTA09/S1219 in respect of management expenses - see CTM08180) applies in situations to which TIOPA10/Part 4 would otherwise apply:
Other computational rules may also be in point, such as CTA09/S1298 regarding business entertaining expenditure. If an affiliate provides entertaining to a company, no deduction could be claimed for any recharge to the company.