INTM489420 - The Unassessed Transfer Pricing Profits Examples: Examples 6 and 7 - Commissionaires

The background to the facts in examples 6 and 7 is that they involve a multinational group which manufactures and distributes products which have embedded IP.

The group has manufacturing entities which produce the products and pay a royalty to the group parent that generated the IP.

There is an established wholesale price for the product because, as well as using its own supply chain, the multinational group distributes products through independent distributors.

The manufacturers sell the products to regional sales hubs for the independently validated wholesale price.

The regional sales hubs then conduct sales via local distribution companies on the ground in each territory in which sales are made. The regional sales hubs pay a commission to the local distribution companies and retain the remaining distribution profits.

Sales within Europe are made by a single hub Company A which is located in a low tax jurisdiction. After paying the commission to the local distribution companies, Company A retains 60% of the distribution profits on the basis that it is taking on contractual commitments.

Example 6 – Commissionaire arrangements without accurate delineation

Facts

  • Company B is responsible for distribution in the UK. From an examination of the facts and circumstances around the arrangements in relation to customer contracts, it is found that the Company B’s functionality is more complex than the responsibilities set out in the contract (which has been used to justify the low reward).
  • The evidence also shows that in addition to providing distribution services, all the work in negotiating the key commercial aspects of UK customer contracts is performed by Company B. Company B has a large team of experienced customer-relationships managers who have built trusted relationships with large UK retailers.
  • Company A has a small team of administrative staff. The person who signs the contract in Company A merely makes sure that the contract complies with the general standard form before signing it.

Analysis

  • The provision is the sales support and distribution services provided by Company B to Company A.
  • HMRC considers that under the transfer pricing requirement, Company B is not rewarded at arm’s length for the services that it performs.
  • Company B is the more complex party to the transaction, and therefore for transfer pricing purposes Company A should be the tested party. This would mean that Company B recognises the full distribution profits, with Company A rewarded on a cost-plus basis for any administrative services it performs.
  • The unassessed transfer pricing profits are the difference between the 40% of distribution profits awarded to Company B, and the reward due to Company B at arm’s length.
  • There is an ETMO because the profits relating to the unassessed transfer pricing profits were subject to a substantively lower tax rate in Company A than the UK’s corporation tax rate.
  • When considering the TDC, it is reasonable to assume that the representations of the functions of Company A and Company B in the distribution contracts is intended to justify treating Company B as a tested party and under-rewarding the services it provides.
  • Company A has little functionality and does not add value to the sales process. The combination of its empty role in the structure, the contrived nature by which its staff signs contracts, and the failure to correctly delineate and reward the activities of Company B for transfer pricing purposes, strongly suggests that the arrangements were designed to minimise UK tax liability, such that the TDC is met.

Example 7 –Commissionaire arrangements with accurate delineation

Facts

  • The facts are the same as example 6 except, after a thorough review carried out by HMRC, it is established that Company A has a large staff of qualified people who carry on material activities in relation to sales such as:
    • Having regular contact with the UK sales support staff and providing regular input into their activities.
    • Having regular contact and authority to negotiate the key commercial terms of sale contracts with UK and other European customers and actually performing this function.
    • Orchestrating sales across Europe by various product promotions, advertising campaigns and sport sponsorship.
    • Managing relations with major customers who have a presence in several European countries including the UK.
    • Actively managing the local European sales support companies.
  • The review also confirmed that it is not reasonable to assume that the activities of Company A or Company B, in particular the signing of sale contracts by Company A, was designed to reduce UK tax liability. Rather, the activities of the two companies support their commercial roles within the group.
  • The allocation of profit between Company A and Company B reflect their contribution to the generation of profits from activities in the UK.

Analysis

On the above facts the transfer pricing requirement has been fully reflected and UTPP does not apply.