(An article entitled “The HMRC ATCA Process” was published on this website on 12 February 2018, with an accompanying slide presentation on my YouTube channel.)
Transfer pricing should be a concern for all multinational enterprises (MNEs) operating in the UK.
The UK’s corporation tax self-assessment regime requires the taxpayer to ensure that their transfer pricing reflects ‘arm’s length’ prices on all related-party transactions, including UK-UK.
Interest and penalties may be imposed for non-compliance, even for businesses with losses, so there could be serious financial implications if a business does not take its transfer pricing obligations seriously.
A business is said to be thinly capitalised when it has more debt than equity. In the context of this note it refers to a UK business with more debt than it could and would have borrowed on its own resources, because it is borrowing either from or with the support of connected persons.
The UK’s transfer pricing legislation acts to limit the extent to which a tax deduction can be obtained for interest payable on the financing arrangements between connected parties and also, in some cases, borrowings from a third party.
An Advance Thin Capitalisation Agreement (ATCA) with HM Revenue & Customs (HMRC) will give a business certainty regarding the UK deductibility of interest arising on connected party debt and whether the amount, terms and conditions of that debt comply with the UK’s transfer pricing regime.
Thin capitalisation is a complex area of transfer pricing and so HMRC encourages the use of ATCAs as an effective way to discuss and resolve thin capitalisation matters in real time.
An ATCA can eliminate the prospect of HMRC opening an enquiry into any of the years covered by the ATCA assuming, of course, that the information provided by the business in respect of the ATCA application is correct and complete and the business adheres to its terms.
If not, and HMRC subsequently discovers that tax has been under-assessed, the lost tax may be recovered with interest and financial penalties.
However, provided the business is completely open and honest in its application and adheres to the agreed terms, an ATCA provides certainty.
The ATCA process is designed to give certainty on financial transfer pricing issues:
– which have a significant commercial impact on a business’s results, or
– where the issues would be unlikely to be regarded as ‘low risk’ by HMRC, or
– where the arm’s length provision is a matter of doubt.
So, the benefits to a business of agreeing an ATCA with HMRC are clear.
HMRC Statement of Practice 1/2012 replaced Statement of Practice 4/2007, which introduced the practice of providing ATCAs under the Advance Pricing Agreement legislation.
SP01/12 updated the legislative references, largely to the Taxation (International and Other Provisions) Act (TIOPA) 2010, and reflects HMRC current practice to determine in advance the transfer pricing of financial transactions within Part 4 of TIOPA 2010.
SP01/12 also includes a “model” ATCA, available as annex 1 to SP01/12, to try to ensure greater consistency between agreements and to shorten the period of time it takes to reach agreement. It is recognised that the model will not be appropriate for all applications, but it should provide a useful framework for adapting to the particular needs of the applicant.
HMRC may require the inclusion of an additional clause in new ATCAs to accommodate future legislation changes, in particular those driven by the OECD BEPS project.
Agreements under SP01/12 are restricted to the allowability of financing provisions, e.g. intra-group loans. This specific approach is understandable in the context of the anti-avoidance rules, such as the unallowable purpose test and anti-arbitrage. Just because a business is not thinly capitalised does not mean that one of its main purposes for taking on connected party debt is not otherwise unallowable.
For most businesses an ATCA includes agreement on the amounts borrowed, the applicable interest rates and other terms & conditions of the debt, such as the term and PiK notes. It will also include monitoring covenants, for example debt/EBITDA and EBITDA/interest which, if breached, will result in a disallowance of interest.
It can also include agreement of imputed interest where the UK business is the lender or an appropriate margin or spread for UK finance and treasury companies.
HMRC relies on the general transfer pricing provisions contained in TIOPA10 to deal with thin capitalisation issues. There are no safe harbours for interest deductions, i.e. allowing interest deduction up to a preset limit, absolute value or ratio.
So the UK regime is based solely on the arm’s-length principle, which is in effect a test of whether a business could and would have borrowed the same amount from an independent party without the support of connected persons.
The legal basis for ATCAs is provided at TIOPA10 sections 218 to 230, which provide for Advance Pricing Agreements (APAs) in relation to transfer pricing more broadly.
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.
The ATCA process is initiated by the business, in accordance with section 223, as an application for clarification by agreement of the effect of applying the arm’s length principle to the financial provisions between the business and its lender(s). There may also be circumstances where HMRC encourages a business to apply, for example during an enquiry.
Applications are more likely to be accepted without query where the information provided is comprehensive, clearly presented, with rational conclusions supported by credible and specific third party comparable evidence and accompanied by a draft agreement that is consistent with the model ATCA.
The application must include:
– a statement that agreement under S218 TIOPA 2010 is being sought,
– information concerning the UK business seeking the agreement and the wider group,
– a group structure diagram,
– the background to the business and industry,
– details of the finance in question,
– details of the uncertainty and the business’s view on how that uncertainty should be treated,
– a financial model that includes projected earnings and cash generation for the period,
– third party comparability evidence in support of the connected party terms and conditions and
– a draft ATCA based closely on the model where possible.
HMRC will undertake a review of the information provided and ask for any additional information that it feels is necessary to form an opinion as to the arm’s-length position.
Both HMRC and the business have the right to walk away from the ATCA process if either party feels an agreement cannot be reached. In this instance, the thin-cap issue will revert back to an annual self-assessment exercise.
ATCAs will normally be for future (and possibly current) periods, depending on the timing of the application, but may also extend to periods which have ended if the facts and circumstances are sufficiently similar. Self Assessment returns may be amended and enquiries into earlier years resolved on the basis of an ATCA.
HMRC regards five years as the maximum period for which it is reasonable to assume that the method agreed for dealing with the relevant issues will remain appropriate, so ATCAs will typically be agreed for a period of between three and five years, depending on the circumstances.
Applications may be made before transactions are carried out, but HMRC will only enter discussions for an ATCA if the terms of the proposed transactions have been finalised, such that the steps involved are clear and the debt has been quantified and priced.
A signed ATCA between the business and HMRC represents a binding undertaking on the parties that the treatment of the transfer pricing issues covered by the agreement will for a specified period be determined in accordance with the agreement. Therefore, a self-assessment return made by the business on any other basis in relation to those matters during the period of the ATCA will constitute an incorrect return, with possible penalty consequences.
In addition, the ATCA shall cease to have effect if its terms are not observed and the provisions leading to revocation, nullification, revision, etc. are triggered.
UK ATCA applications are normally received from UK businesses borrowing from connected overseas lenders. This means that any related application for clearance for the loan interest to be paid at a rate in accordance with a double taxation agreement will need to be made by the non-UK resident interest recipient. These two processes are entirely distinct and separate.
In such circumstances the UK borrower is obliged to withhold Income Tax at the basic rate until notified by HMRC to do otherwise. HMRC will only issue such a notice following a valid application by the overseas lender under the relevant Double Taxation Agreement.
As noted above, an ATCA can only apply to the transfer pricing of debt. All other provisions in the UK Taxes Acts will continue to apply. For example, compliance with the terms of an ATCA would not prevent restriction of interest under anti-avoidance provisions.
To summarise, the ATCA process is designed to help resolve financial transfer pricing issues which have a significant commercial impact on a business’s results, or where the issues would be unlikely to be regarded as ‘low risk’ by HMRC, or where the arm’s length provision is a matter of doubt.
Provided the business is completely open and honest in its application and adheres to the agreed terms, an ATCA provides certainty on the UK deductibility of interest.
So, the benefits to a business of agreeing an ATCA are clear.
HMRC also benefits because otherwise it would have to expend time and effort testing annually whether the amount, terms and conditions of the business’s debt comply with the UK’s transfer pricing regime.
Bye for now.
PwC: article “ATCAs – an update”, first published in the September 2011 edition of Accounting and Business Magazine.
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