INTM489415 - The Unassessed Transfer Pricing Profits Examples: Example 5 - Series of transactions

Facts

  • Company A is an offshore parent in Country A with three subsidiaries: Companies B and C are resident in Country B and Country C respectively. Company D is UK resident.
  • Country A has high tax rates. Country C has similar tax rates to the UK but Country B is a zero-tax jurisdiction.
  • The group generates the majority of its revenue from online services based around valuable intellectual property (IP). 
  • Company A owns the IP and holds the rights to exploit it within Country A. Company A has granted Company B a licence to exploit the IP in the rest of the world. 
  • Company B licenses the IP to Company C, which in turn sub-licenses to Company D.
  • Company D is the European sales and service hub, co-ordinating the group’s activities in Europe and working closely with its parent Company A. Although Company D has large sales revenues, its profits are relatively small because it pays substantial royalties to Company C for the use of the IP.
  • Company C’s profits are also small because it pays nearly all those royalties onto Company B (where they are untaxed). If the royalties were paid directly from Company D to Company A they would be subject to withholding tax. However, Country C does not impose withholding taxes and has a favourable tax convention with Country B, such that there is no withholding tax on royalty payments from Company C to Company B.

Analysis

  • The provision is license of IP from Company A to Company D, via a series of sub-license transactions with Company B and Company C.
  • HMRC considers that under the transfer pricing requirement, the royalty payments made by Company D are in excess of the arm’s length amount such that there are unassessed transfer pricing profits.
  • The unassessed transfer pricing profits are the difference between the excessive royalty payments made by Company D, and the arm’s length amount of royalties due.
  • There is an ETMO because although Company C recognises the full royalty income and profits are charged at a similar corporation tax rate to the UK, the receipt is offset by the royalty expense paid onwards to Company B which means that Company C has paid little tax on the profits which correspond to the unassessed transfer pricing profits.
  • When considering the TDC, it is reasonable to assume that the sub-licensing transactions are predominantly designed to reduce liability to withholding tax and corporation tax by Company A in Country A. The complex structure of the group’s sub-licencing arrangements does not have commercial or economic value, and the main benefit is the tax savings achieved by Company A. This is not directly relevant for the purposes of considering whether the structure of the series of transactions were designed to reduce, eliminate or delay the liability of any person to pay UK tax, but it is evidence of a wider contrivance behind the arrangements. 
  • However, Company D’s UK taxable profits are also reduced by the excessive royalty payments. It is reasonable to assume that within the tax-motivated design of the group’s structuring that this is not an incidental benefit, but part of the reason for the structure. The complex sub-licencing arrangements serve to obfuscate Company D’s key role in the business and justify its lower tax profit.
  • Therefore the TDC is met because it is reasonable to assume that the series of transactions by which the provision between Company D and Company A is imposed are designed to reduce Company D’s UK corporation tax liability.
  • The sub-licensing transactions are designed to also reduce liability to withholding tax and corporation tax in Country A. Although this is not relevant to considering whether the structure of the series of transactions were designed to reduce, eliminate or delay the liability of any person to pay UK tax, it is evidence of contrivance within the group’s arrangements.