The BEPS project was endorsed by the UK and other G20 finance ministers in July 2013. HM Revenue and Customs (HMRC), the UK tax authority and HM Treasury are heavily involved in the OECD's 15 point action plan. HMRC has mentioned in its report on tackling aggressive tax planning in the global economy that it hopes the BEPS actions will "succeed in fundamentally changing the international tax landscape, and shift the balance of the rules in favour of tax authorities…". The UK government also looks forward to the introduction of new rules which will deal with this issue on a global basis. HMRC is increasing efforts to defend the local tax base and has been given extra funding for transfer pricing (TP) enquiries which it estimates will bring in £2 billion in receipts by 2018.
On the plus side the UK government is keen to market the UK as open for business and attract investment to kick-start growth, through a series of incentivisation plans. These include the patent box (eventual tax rate of 10%), research and development (R&D) expenditure credits and a single 20% corporation tax rate from April 2015.
The UK's TP legislation is to be found at Part 4 of the Taxation (International and Other Provisions) Act 2010 (TIOPA 2010), and is based on the arm's-length principle as stated in Article 9 of the OECD Model Tax Convention on Income and Capital. The legislation not only applies to international transactions between related parties but also encompasses transactions between two UK related parties (including branches and permanent establishments). Thus UK businesses will need to ensure that services, finance, goods and intellectual property provided from one to another or jointly developed or exploited are taking place on arm's-length terms and be prepared to demonstrate this to HMRC.
The UK's corporation tax self-assessment regime in respect of transfer pricing puts the onus on the taxpayer to verify the arm's-length price in respect of all related-party transactions, including UK-UK transactions. Interest and penalties may be imposed for non-compliance, even for companies with losses. There are exemptions for small and medium-sized enterprises (SMEs), although these exemptions are set aside where the transaction is with certain countries, and in some other circumstances. There is also an exemption for some transactions involving dormant companies.
UK TP legislation expressly refers to the OECD transfer pricing guidelines (OECD guidelines) in terms of interpretation. Therefore, updates to some of the OECD guidelines shall automatically be inserted into UK tax legislation and the BEPS changes will take effect in the UK well before they are enacted (if ever) in other countries.
Where double tax arises from cross-border transfer pricing, the mutual assistance procedure (MAP) in the UK's wide network of treaties can be invoked, and is generally a well-run process. MAP is not available for UK-UK transactions. However, if both parties are subject to UK tax and the transfer pricing rules apply to adjust prices to increase the taxable profits of one party, then the counterparty can normally make a claim to reduce its taxable profits accordingly. Such an adjustment is known as a compensating adjustment.
On October 25 2013, HMRC issued draft legislation preventing future claims for compensating adjustments by any person within the charge to income tax other than a company, where the counterparty to the transaction is a company. This legislation effectively means that, as of October 25 2013, individuals and partnerships will no longer be able to claim compensating adjustments, where the counterparty to the transaction is a company. Significantly, the restriction will not be limited to tax avoidance arrangements and there will be no exceptions for genuine commercial arrangements.
HMRC has issued guidance on how it interprets the record-keeping requirements of the self-assessment provisions for the purposes of transfer pricing. Unlike other countries, the UK does not have a prescribed list of documentation requirements and detailed disclosures are not currently required within tax returns.
One key reform of action 13 of the BEPS project is the introduction of country-by-country reporting. The UK government has played a leading role in initiating the proposal for a country-by-country reporting template to be produced. It believes that this will enhance transparency between business and tax authorities and provide tax authorities with high-level information to help them efficiently identify and assess risks.
There is concern from taxpayers on the confidentiality issues raised by sharing commercially sensitive information with other territories. There also remains a risk that these reforms may not be adopted by all countries and therefore UK taxpayers may see little benefit from their extra work.
The UK accepts the EU transfer pricing documentation (EU TPD) model which provides multinational groups with the option to create a master file, containing high level information relating to the group, and a country file, which documents the local entities in detail. This is similar, but not identical to the master file and local country file approach being recommended as part of action 13 of the BEPS project.
A tax return will not be considered correct by HMRC unless transactions reflected within it are at arm's-length. It is necessary to determine the correct arm's-length price before the filing date, for each separate tax return.
While evidence to demonstrate an arm's-length result need only be produced upon HMRC's request, such requests are frequently accompanied by deadlines (typically 30 days from the date of the enquiry letter). In practice, therefore, it is advisable to maintain contemporaneous TP documentation.
Advanced pricing agreements (APAs)
UK taxpayers can agree with HMRC a basis to determine the arm's-length pricing that should be applied in the UK tax return, typically for up to five years. APAs may be unilateral or bilateral. There is no associated fee. Overt preference for bilateral APAs has now been removed. However, there is a complexity threshold, below which HMRC can refuse to accept an APA application. This results in some uncertainty and a lower take-up of APAs than in some other countries.
There were 45 applications made during 2012/2013 and 27 agreements with HMRC made during the same period.
Thin capitalisation and financing
There are several ways that HMRC may limit interest deductions for UK resident companies, including anti-arbitrage and worldwide debt cap rules.
The thin capitalisation rules within the UK's transfer pricing legislation also act to limit the extent to which a tax deduction can be obtained for interest payable on borrowings between related entities. These rules apply to financing arrangements between two UK related parties and also in some cases, borrowings from a third party. Acting-together provisions extend the UK thin capitalisation rules to bring lending between parties that are not otherwise connected for the purposes of UK tax within the legislation.
The effect of these rules includes the imposition of interest income or the denial of tax relief for interest payments, for loans between two UK parties or in situations where one is deemed to have guaranteed borrowing by another. However, it may be possible for parties to claim compensating adjustments to their taxable profits in some situations, as noted above.
It is possible to enter into a unilateral APA with HMRC, known as an advance thin capitalisation agreement (ATCA), to determine the arm's-length amount of interest that should be deductible in the UK taxpayer's tax return. ATCAs are fairly popular and there were 144 agreements with HMRC in 2012/2013.
Transfer pricing aspects of intangibles
The OECD guidelines update to chapter 6 on intangibles is now close to finalisation and, as noted above, will become relevant immediately to UK groups. It should be noted that the BEPS changes are not being adopted fully by many countries which have nevertheless had major input into the wording. The emphasis in the drafts on significant functions as opposed to ownership, capital and risk, is potentially a move away from the arm's-length principle. This may increase the number of disputes and MAP claims in the coming years.
Intellectual property incentives
As part of the UK government's strategy for reforming the corporate tax system to create the most competitive tax environment in the G20, it has introduced incentives for investment in intellectual property (IP) such as introducing the patent box and the R&D expenditure credit which is potentially payable in cash, even for larger companies.
Under the patent box legislation, profits that are attributable to sales of items including qualifying patents will be subject to a corporation tax rate as low as 10%. An important aspect is that the patent box rules can apply even where R&D tax relief has already been claimed on a project to develop the IP.
However, it should be noted that where a UK group company performs R&D services for an overseas group company, HMRC may consider that a cost-plus methodology is not always appropriate. For cost-plus to be appropriate, it would be expected that the recipient of the services should retain responsibility for the project and that the R&D service provider should bear little risk.
Branches of foreign entities operating in the UK are considered to be a separate legal entity operating as UK resident permanent establishments (PE) for corporation tax purposes. The BEPS project plans to develop changes to the definition of a PE to prevent what it refers to as "the artificial avoidance of PE status" in relation to BEPS.
Controlled foreign companies
BEPS action 3 is intended to strengthen controlled foreign company (CFC) rules. Recommendations on this action are expected in September 2015. However, it is not likely that these changes will have a large impact on multinationals operating in the UK as a result of the recent reforms to the UK CFC rules.
This action point should be of particular interest to companies operating within the digital economy. Specific guidance identifying the main difficulties and options to address them for such companies is in process as one of the 2014 actions for BEPS.
Businesses operating in the UK need to be alert to any changes made to the OECD guidelines and other aspects of BEPS, particularly as some of these changes may be incorporated automatically into UK tax legislation.
HMRC is a sophisticated tax authority and generally is open to discussion with businesses and other tax administrations around TP. Rather than setting out ever expanding lists of rules to tick off, it wants to see mindful compliance by taxpayers with the principles of TP. In the current environment, where BEPS is resulting in an increasing burden on taxpayers without a corresponding convergence of tax and TP rules internationally, this is a refreshing approach.
Wendy Nicholls is an experienced partner and leads Grant Thornton's UK transfer pricing practice and is based in the London office. Wendy has more than 25 years of international tax experience advising clients in the UK and overseas, and leads Grant Thornton's transfer pricing practice, which was named 2012, 2013 and 2014 UK Transfer Pricing Firm of the Year at the International Tax Review European Tax Awards. Before joining Grant Thornton in October 2009, she worked for a 'big 4' firm, responsible for transfer pricing for the South of England.
Wendy is a member of the Grant Thornton International Global Transfer Pricing Leadership team and is acknowledged in the Legal Media Guide as one of the World's Leading Transfer Pricing Advisers. She has also been recognised by the World's Leading Women in Business Law. She is on the Business and Industry Advisory Committee to the OECD, and presented at the recent OECD meetings on intangibles.
Wendy advises clients in a wide range of industries on transfer pricing planning, dispute resolution, advance pricing agreements, compliance and documentation. She is a regular speaker and author and has acted as an expert witness in relation to transfer pricing for a large pension fund. Wendy has particular expertise in sectors where intellectual property is important, including technology and brands.
Her recent projects have included transfer pricing advice to a major international retailer, royalty planning for a technology group, co-ordinating benchmarking studies across several countries for a FTSE 100 industrial products group and managing an enquiry into attribution of profits to permanent establishments. Wendy has a leading role in Grant Thornton's patent box specialism and was involved in the consultation process with HM Treasury and HMRC.
Liz Hughes is a transfer pricing director with over 14 years' experience of advising UK and international based groups on their transfer pricing affairs. Liz joined Grant Thornton in February 2006. Before joining Grant Thornton, Liz worked as a transfer pricing specialist at PwC, in their London and Zurich offices.
Liz has a wide experience of transfer pricing projects including tax efficient supply chain reorganisations, devising and implementing planning ideas, dispute resolution and audit defence, thin capitalisation, documentation and due diligence projects.
She has experience across a wide variety of industries helping clients to set and document their transfer pricing policies including profit splits, as well as TP defence work.
Liz has a particular interest in thin capitalisation and has negotiated advance thin capitalisation agreements on behalf of the firm's clients since the inception of the scheme. Liz is an invited member of HMRC's consultative panel on thin capitalisation matters.
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