Transfer pricing is an important cross-border tax issue. The UK transfer pricing rules are contained in Part 4 of the Taxation (International and Other Provisions) Act 2010, normally referred to as TIOPA10.
This note considers the meaning of “provision” in UK transfer pricing, including the situation where the actual provision relates to debt, and asks you to consider what the allowable interest deduction should be in a simple (?) example.
Excluding certain oil & gas transactions which have their own rules, the UK transfer pricing legislation applies where:
– provision (“the actual provision”) has been made or imposed as between any two persons (“the affected persons”) by means of a transaction or series of transactions, and
– the affected persons were connected at the time the actual provision was made or, in the case of financing arrangements, within six months starting from that time , and
– the actual provision differs from the arm’s length provision which would have been made between independent enterprises, and
– the actual provision confers a potential advantage in relation to UK taxation, i.e. lower profits or higher losses, on one or both of the affected persons.
In the above circumstances the profits and losses of the affected person or persons are to be calculated for tax purposes as if the arm’s length provision had been made or imposed instead of the actual provision.
The UK transfer pricing rules are intended to reproduce the effect of Article 9 of the OECD Model Treaty, but in words more suited to UK statutory construction, i.e. they are complex and not always easy to interpret!
However, where double taxation arrangements are in place and consistent with Article 9 of the OECD model then the UK legislation must be interpreted in such manner as best secures consistency with the OECD transfer pricing guidelines.
Therefore “provision” is equivalent to the phrase “conditions made or imposed” in Article 9, which covers all the terms and conditions of a transaction or series of transactions.
“Provision” is not actually defined in the UK legislation, but “transaction” is defined, and includes any schemes or arrangements of any kind, understandings and mutual practices, whether or not they are, or are intended to be, legally enforceable.
In addition, a “series of transactions” includes reference to a number of transactions each entered into in relation to the same arrangement or scheme. The series may or may not include transactions to which both the affected persons are parties, in fact there may be transactions in the series to which neither of the affected persons are parties.
So it is clearly very difficult to structure business arrangements to avoid there being a transaction for UK transfer pricing purposes.
See, for example, the transfer pricing case of DSG Retail and others v HMRC where the Tribunal held that the relevant transactions in the case could be treated as a “series of transactions”, even though some were wholly between third parties, thus giving rise to a provision “as between” the affected parties.
And in the more recent case of Abbey National Treasury Services Ltd v HMRC the Tribunal confirmed the wide-ranging nature of the UK’s transfer pricing rules, finding that a share issue could amount to a provision.
So, “provision” has a very wide meaning and requires the wider consideration of all the terms and conditions that apply to the transaction or series of transactions when deciding whether the provision has been made or imposed on arm’s length terms.
In addition, where the actual provision is in relation to a loan there is a further legal requirement that the legislation must be read “as requiring account to be taken of all factors”. This includes whether, at arm’s length, the loan would have been made at all without the special relationship, the amount of the loan, the rate of interest and other terms.
Therefore all the component parts of the loan need to be reviewed when considering whether or not the actual provision is consistent with the arm’s length provision. It’s not enough to look only at the final outcome, i.e. the interest deduction.
Ultimately, the burden of proving that a provision has been made or imposed on an arm’s length basis falls on the taxpayer, although it is up to HMRC to prove careless or deliberate behaviour where a penalty is considered to be appropriate.
So, in answer to the question posed by this note, “what is the provision in UK transfer pricing”, the answer must be that any interaction between connected parties could be a provision.
Finally, I’ll leave you with a question.
Suppose the provision is a connected party loan, UK borrower and Luxco lender, say £100m at 6% interest (cash paid) for a term of 5 years. What if the best comparable data available suggested that the most the UK company could borrow at arm’s length was £50m with a rate of 8%, otherwise terms the same.
On the basis of these figures and the UK transfer pricing rules above (taking account of all factors), what should their allowable annual interest deduction be; £6m, £4m, £3m or something else? What would you do and why? (Replies below)
If you want more detail on the rules please refer to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations and/or the HMRC International Manual.
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