INTM489410 - The Unassessed Transfer Pricing Profits Examples: Examples 3 and 4 - Tangible assets, and oil contractor ringfence

Example 3 – Tangible assets

 

Facts

  • Company A is an overseas parent of a manufacturing group, with two subsidiaries Company B (in the UK) and Company C (in a zero tax territory).
  • Company B needs to invest in new expensive fixed plant and machinery (P&M) to carry on its trade in the UK. It enters into discussions with a supplier to set the specifications and negotiate the contractual details.
  • Company A injects equity into Company C, enabling it to purchase the necessary P&M. Company B then enters into an operating lease with Company C.
  • The payments under that lease will leave Company B with relatively small profits over the period of the arrangements. At the end of the lease period the P&M ownership will revert to Company C.
  • Company C has no full-time staff and the only functions it performs are to own the P&M and some routine administration in relation to the leasing payments it receives. 
  • The P&M was delivered directly to Company B, Company B is responsible for setting up the machinery, operating and maintaining it.

Analysis

  • The provision is the leasing of P&M by Company B from Company C. The provision is imposed by the series of transactions by which Company A provides an equity injection into Company C, in order for it to purchase the P&M which is leased to Company B.
  • HMRC considers that under the transfer pricing requirement, Company B is paying more than the arm’s length amount to Company C for the leasing of the P&M.
  • In reaching this view, HMRC has considered the benefits of the arrangements, including the P&M and the way it is used in the group. The functions relating to the P&M, particularly decision-making relating to DEMPE functions, are performed by Company B. Company C does not have the functions to perform these tasks.
  • The risks associated with the asset, including the maintenance costs and any disruption to business operations as a result of P&M failure, are assumed by Company B.
  • HMRC have considered the group’s arrangements in relation to other assets of the same class, and have established other items of P&M have been purchased by the group’s manufacturers directly, with equity funding provided by the group’s parent.
  • Looking at the options realistically available it would have been more profitable and commercially rational for Company B to have obtained funding to purchase the P&M itself, rather than enter into a leasing agreement which will effectively eliminate its profits.
  • Here Company B is assuming the risks of the P&M, without receiving the full amount of profits generated by the P&M, as a result of the lease payments to Company C.
  • The unassessed transfer pricing profits are therefore the amount that Company B pays Company C to lease the P&M less the nominal amount that Company B would pay to Company C as the legal owner of the P&M.
  • There is an ETMO because the excessive lease payments would have been charged to UK corporation tax if they were included in Company B’s taxable profits, but are not taxed in the hands of Company C.
  • The purpose of the provision is to provide P&M for commercial use in Company B’s business, but the design of the series of transactions by which the provision has been imposed have been structured in such a way to divert the profits of Company B to a zero-tax jurisdiction. There is an element of contrivance, because the ownership of the asset by Company C (and the separation of the asset from the functions associated with it) does not create commercial or economic value other than a reduction in UK tax. It is therefore reasonable to assume that the arrangements were designed to secure that UK tax reduction.

Example 4 – Oil contractor ring fence

The legislation at CTA10/Part8ZA (see OT50000) operates to restrict allowable deductions for the hire of certain types of mobile assets (‘relevant assets’) for the purpose of calculating a contractor’s ring fence profits (those from its oil contractor activities). The amount of the hire cap is set at 7.5% of the total recognised cost of the asset. Amounts in excess of the cap can be set against profits arising outside the contractor ring fence or by surrender as group relief.

Whether any arrangements for leasing assets that are subject to the hire cap also give rise to a UTPP charge will depend on the specific facts and circumstances of each case. The tax effect of the hire cap also needs to be taken into account, as can be illustrated by using the facts of Example 3 as if it involved the leasing of an asset that was subject to a restriction of allowable deductions under CTA10/Part8/ZA:

Facts:

  • Company B needs to invest in new fixed P&M costing £1bn to carry on its trade in the UK.
  • The payments under that lease are £120m per year. This will leave Company B with relatively small profits over the period of the arrangements.
  • The relevant percentage for calculating the contractor’s ring fence profits each year is £75m (7.5% of £1bn). This means that the amount available for relief other than against contractor ring fence profits is £45m (£120m - £75m).

Analysis:

  • The analysis is the same as INTM489415 – under the transfer pricing requirement Company B is paying more than the arm’s length amount to Company C for the P&M.
  • The starting point in calculating the unassessed transfer pricing profits is £120m less the nominal reward that Company B would pay to Company C as the legal owner of the P&M.
  • However, the calculation should then consider the extent to which the £45m hire cap restriction has been tax effective.
  • If the £45m has all been relieved against other profits in the return or surrendered as group relief then the unassessed transfer pricing profits would be the £120m less the nominal reward. If only £25m had been relieved against other profits in the return or surrendered as group relief then the unassessed transfer pricing profits would be £100m (because £20m of expenses were not utilised).
  • If none of the £45m could be relieved against other profits in the return or surrendered as group relief then the unassessed transfer pricing profits would be £75m less the nominal reward.
  • In more complex circumstances (for example if all or part of the £45m was relieved at a lower rate than that which Company B was subject to on the profits derived from the use of the asset) then it would be necessary to take account of the tax effect of the hire cap restriction when calculating the underlying corporation tax rate in TIOPA10/S2174(a).