This article is accompanied by a slide presentation on YouTube. Feel free to use my material for your own in-house purposes, all I ask is that you acknowledge the source.
HMRC’s approach to transfer pricing has become more rigorous. Recent evidence of this change was the renaming of HMRC’s Large Business Customer Relationship Managers (CRMs) to Customer Compliance Managers (CCMs), suggesting a shift of emphasis from building relationships with businesses back to “good old-fashioned compliance”.
HMRC’s International Manual states that whilst case teams can accept information from a group about its business and its transfer pricing to inform their annual risk review processes, they cannot engage in any discussions on TP issues except under the Advanced Pricing Agreement (APA) process or when those issues are under enquiry through HMRC’s TP governance process.
HMRC’s reluctance to enter into informal discussions with multinationals on TP matters is likely to increase both taxpayer uncertainty and the number of TP enquiries. Therefore, the value of clear and comprehensive TP policies and documentation is greater than ever.
This article looks at HMRC’s TP enquiry process. It draws on HMRC’s International Manual, INTM 480500 onwards, and concludes with my thoughts on actions that can be taken by multinationals to minimise the risk of an HMRC TP enquiry. It follows the structure of the guidance, looking at the sections on “governance”, “working an enquiry” and “evidence gathering”. I look at the section on examining transfer pricing reports in a separate article. Original wording has been retained in places for clarity and the avoidance of doubt.
As HMRC’s International Manual is freely available online, it can give groups and their advisors an insight into HMRC processes and policies and into how HMRC specialists are trained to deal with a transfer pricing enquiry.
This is an extremely useful insight to have as it should help you to better manage your relationship with HMRC and design TP policies and documentation that are more likely to successfully pass HMRC’s risk assessment tests.
HMRC Transfer Pricing Governance
“A transfer pricing enquiry must not in any circumstances be opened (or any approach made to a customer that might be construed as a transfer pricing enquiry) or settled unless approval to do so has been obtained from the Transfer Pricing Panels or Transfer Pricing Board under the appropriate governance procedure.” INTM481010
The three mandatory stages of TP Governance that case teams must follow are:
- Making sure the selection of a case is appropriate,
- Ensuring there is effective progress in a case, and
- Reaching the appropriate conclusion in a case
So, if the case team decides that a TP enquiry is required they must prepare a business case for consideration by the TP Governance Panel. This is a narrative document which sets out the case background, the risk assessment work undertaken, the reasons for and against enquiry and any special features.
If an enquiry is authorised by the governance panel the case team will issue a formal CTSA enquiry notice.
The TP governance panel is required to review progress on a six-monthly basis. It is mandatory for each HMRC transfer pricing enquiry to have an Action Plan tailored to the complexity of the case, prepared in collaboration with the business if possible, setting out the timeline for fact-finding, analysis, exchange of views, the resolution review and the expected settlement date.
When the case team has formed a view on how the enquiry should be settled, their proposals must be authorised through the governance process. TP governance will decide whether to settle the enquiry without adjustment, settle by negotiation or proceed to litigation.
If the decision is to negotiate, the case team will be given clearly defined parameters within which to settle.
Guidance for HMRC case teams on working a transfer pricing enquiry
Opening the case
HMRC case teams are reminded that the aim of their enquiry is to test the business’s controlled transactions against the arm’s length principle, where the risk is greatest. They are also told to establish a cooperative relationship with the business where possible.
Working the case
Every transfer pricing enquiry should feature an action plan prepared in collaboration with the business setting out the timeline from initial fact-finding through to resolution and closure, there should be meetings with the business to identify, understand and agree all the relevant facts and issues, followed by a prompt assessment of the evidence by HMRC and finally closure, either without adjustment or with settlement negotiations leading to resolution by agreement.
Transfer pricing documentation
There are four classes of evidence that HMRC may want to analyse; primary accounting records; tax adjustment records; records of controlled transactions; and ”arm’s length” records.
Initial information request
An initial information request should be comprehensive and aim to understand how the business trades; to identify who carries out what functions; to understand the nature, scope and volume of relevant inter-company transactions; how they were priced; and to see what profit accrues. Early discussions will establish if a transfer pricing report is available. If so, this may provide much of the factual information required by the case team and allow any subsequent information requests to be more precisely targeted.
HMRC’s Process for Examining a TP Report
Case teams will carefully scrutinise your TP report to determine whether the business’s transfer pricing is actually on an arm’s length basis. They will not be fooled by the bulk or apparent sophistication of a report, but will drill down to the substance to determine whether its assertions are supported by credible evidence.
See my article “HMRC’s Process for Examining TP Reports” for more detail.
Exchange of information
HMRC may seek to obtain information from another jurisdiction if what’s required can’t or won’t be provided by the UK business.
Reaching a settlement
The settlement of a transfer pricing case needs governance approval from the Transfer Pricing Panel or Transfer Pricing Board, following a resolution report from the case team.
HMRC recognises that there is rarely a single ‘right’ answer as to what is the arm’s length price and a case team’s recommendations will often identify a framework for establishing the arm’s length price, rather than a single figure.
If settlement cannot be reached on HMRC’s proposals, the case must be referred back to the governance process with further facts if any have emerged or with further recommendations. Any settlement will be considered in the context of HMRC’s Litigation and Settlement Strategy.
Case teams also have to bear in mind that any settlement must be defensible at competent authority.
How many years
Earlier or later years will be included in the settlement if appropriate.
Assessments and enquiry closure notices
Strict procedures must be followed by HMRC to formally close the enquiry and ensure its validity.
Interest is a statutory imposition and so cannot be waived.
A penalty may be due, although this is very unusual in TP cases.
After the settlement
HMRC case teams are advised that they must not enter into any arrangement that amounts to a forward agreement and they cannot give any guarantee that a future return will not be the subject of another transfer pricing enquiry.
The only way in which the business may be able to gain certainty in relation to future years is through the formal Advance Pricing Agreement process.
If the HMRC case team concludes that the business’s transfer pricing is not at arm’s length, they will have to find with good evidence the alternative price that would have existed between independent parties transacting under the same circumstances. Note that if the business has followed the rules and taken a reasonable stance, the the burden of proof lies with HMRC, not just to demonstrate that the business’s pricing is wrong, but that their alternative is more appropriate.
In some situations the case team may be able to demonstrate their view on the arm’s length price during the course of testing the price used by the business. However, in other cases the team may need to build up a case from scratch, possibly by using a different methodology.
This is not a straightforward exercise. The case team must leave a clear audit trail or explanation as to how their transfer pricing was calculated because it will be carefully and critically scrutinised by the business and, if HMRC’s alternative is agreed, the business may decide to make a claim through the MAP process.
Therefore the case team must carry out a detailed review to find and test the relevant facts and assumptions. The business should ensure that HMRC’s understanding of the relevant facts and circumstances is correct, otherwise unnecessary difficulties and misunderstandings may arise and resolution may take longer.
The case team may carry out its own comparability analysis. This can be a complex process and I shall be doing separate articles on the various elements of a comparability analysis. In the meantime please refer to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Authorities for detailed guidance or the HMRC International Manual, which gives a helpful summary.
So, what can we take from all of the above?
There is substantial guidance material available to HMRC case teams on how they should conduct a transfer pricing enquiry. An awareness of this material will help businesses tailor their relationship with HMRC and may give them a tactical advantage during a transfer pricing enquiry.
If HMRC disagrees with the business’s transfer pricing then the burden of proof is on the HMRC case team to demonstrate that, not only is the business’s pricing inconsistent with the arm’s length standard, but that their alternative is more appropriate to the facts and circumstances of the case.
If HMRC case teams do not invest time and resources in correctly and comprehensively establishing the facts regarding the business’s controlled transactions, unnecessary difficulties and misunderstandings may be created. The onus is on the business to ensure that the case team is basing its analyses and conclusions on accurate facts and information.
Prior knowledge of what might trigger HMRC scrutiny will enable you to lessen that risk and there are steps you can take to reduce the risk of a lengthy enquiry. There are no guarantees but here are some suggestions.
- Present your evidence clearly and concisely. Unfortunately, in my experience, many transfer pricing reports are padded out with lengthy but vague and distracting material of little value so, even where the pricing is perfectly reasonable, HMRC can’t easily tell that from the report, resulting in an unnecessary enquiry. Consider hiring an independent transfer pricing specialist with HMRC experience to sense-check your documentation before releasing it.
- In the event of a transfer pricing enquiry, you should be open and cooperative with HMRC. Do your best to ensure that the case team fully understands your business and the evidence you’ve gathered to demonstrate that your transfer pricing is on an arm’s length basis. It’s not unusual for HMRC enquiries to be opened or prolonged because case teams have reached erroneous conclusions due to a misunderstanding of basic facts & circumstances. So, early, regular and open communication with HMRC will benefit you.
- You must ensure that you fully understand HMRC’s concerns. What was the outcome of their risk assessment? What is the basis of their conclusion that your transfer pricing presents a risk? Specifically, what risks are they seeking to address? Follow up a written request from HMRC for information by calling the case-worker to ensure that you fully understand that request and their underlying concerns. Don’t assume that you know! You should then respond promptly and completely.
- If appropriate, you should probably, at an early stage, advise the case team that you will be seeking to resolve any double-taxation that arises as a result of their enquiry through the MAP process.
- If a transfer pricing enquiry becomes hostile and confrontational it is likely to take longer than necessary and the risk of an upwards adjustment is increased. So confrontation should be avoided.
I try to make the contents of this website as useful, reliable and factual as possible but any opinions that slip through are solely my own.
The purpose of the site is to inform and educate readers with guidance and useful tips. It provides only an overview of the regulations and guidance in force at the date of publication and is not a substitute for professional advice. The contents are not designed to provide professional advice or financial advice and should not be relied on as such.
You should not base any action on the contents of this website without first obtaining specific professional advice, tailored to the facts and circumstances of your situation, from an appropriately qualified Transfer Pricing expert.
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