TRANSFER PRICING Ros Martin CTA January 2018 INTRODUCTION The - PowerPoint PPT Presentation

TRANSFER PRICING Ros Martin CTA January 2018

INTRODUCTION

The basics ■ Transfer pricing looks at situations where profit is being diverted from one entity to another ■ It is assumed that this is being done to save tax ■ Opportunity will normally exist where connection between companies ■ Main provisions found in TIOPA2010

Example ■ A Ltd (UK) sells goods to its 100% subsidiary B Inc (US) for £100. The goods were purchased by A Ltd for £80 and have a retail price to third parties of £150. ■ Profit for A Ltd if sold to a third party would be £70 (150 - 80), but through the inter-company arrangement profit is only £20 (100 - 80). ■ B Inc then makes the remaining profit of £50 (150-100) so that the overall profit to the group remains the same.

OECD ■ Transfer pricing is often about cross-border transactions ■ Although can apply UK to UK ■ Agenda is set by OECD ■ Extensive guidance issued by them ■ UK legislation is based on OECD model

What does the legislation do? ■ Imposes an arm’s length price on affected transactions ■ But subject to exemptions ■ And provision made for compensation adjustments ■ And balancing payments

THE RULES

Basic transfer pricing rules ■ where associated enterprises are party to a transaction other than on an arm's length basis, and ■ that transaction has the potential to give rise to a UK tax advantage for one of the parties, ■ the taxable profits and losses of that party are to be calculated as if the transaction had been made on an arm's length basis.

Conditions ■ Provision by means of a transaction or series of transactions ■ Participation condition met ■ Actual provision differs from arm’s length provision between independent enterprises ■ Actual provision confers a potential advantage ■ Unless exemption applies

What is arm’s length provision? ■ Provision which would have been made between independent enterprises ■ This is the most difficult aspect of the transfer pricing rules

When is there a potential advantage? ■ Profits reduced ■ Losses increased ■ Profit turned into loss

Participation provision ■ One of the affected persons was directly or indirectly participating in the management, control or capital of the other; or ■ The same person (or persons) was directly or indirectly participating in the management, control or capital of each of the affected persons.

Direct participation in management, control or capital ■ If A is a corporate body ■ And A is controlled by P ■ Control means power of P to secure that the affairs of A are conducted in accordance with their wishes – By means of holding shares or possession of voting rights in A or another corporate body – As a result of any powers conferred by the articles of association or other document regulating A or other corporate body

Indirect participation ■ Where P has the potential to be a direct participant in the management, control or capital of A ■ Where P is a number of major participants in P ■ Where P acts with other persons (Q) to provide financing arrangements to A ■ Where P acts with other persons (Q) to provide financing arrangements to both affected persons and would have control of both affected persons if the rights and powers of Q were attributed to P

Example A Ltd 100% 100% B Ltd C Ltd

Example A Ltd 100% B Ltd 30% 70% C Ltd

Example A Ltd 100% B Ltd C Ltd D Ltd 40% 45% 15% E Ltd

Exemptions ■ Small or medium-sized companies or dormant companies ■ with regard to exchange gains or losses on loan relationship or derivative contracts ■ where the transactions are otherwise than between enterprises (broadly meaning a person with an intention to make a profit or gain or to undertake activity in a businesslike or commercial way). ■ with regard to the calculation of capital allowances ■ with regard to the calculation of any chargeable gain or allowable loss

SMEs ■ SMEs do not normally fall within transfer pricing provisions but – Can elect for exemption not to apply – Where affected person is resident in NQ territory can apply – Where entity is medium sized, HMRC can issue transfer pricing notice

Compensating adjustments ■ Basic provisions did not require an adjustment to be made by disadvantaged person ■ Often provided for in DTT ■ For UK to UK, there is a specific provision allowing this ■ Can also have affected person making tax neutral balancing payment ■ Or for the disadvantaged person to pay advantaged person’s tax

Additional points ■ Adjustments can be made regardless of normal time limits ■ DTR may need to be restricted ■ Some cases where no CA can be made – Disadvantaged person is not a company – Relates to exchange gains or losses from loan relationships or derivatives

Balancing payments ■ This is a payment made between connected persons to restore cash position ■ May be imposed if third party investors ■ Must meet conditions ■ If do, tax neutral

ARM’S LENGTH PRICE

Starting point ■ No right or wrong way to calculate an arm’s length price ■ Guidelines available to assist in the process ■ Issued by OECD

Basic principles ■ Comparability ■ Contractual terms ■ Functional analysis ■ Characteristics of property or service ■ Economic circumstances ■ Business strategies ■ Other points

Comparability ■ There must be a comparison between a controlled transaction and ■ A comparable transaction between independent parties under comparable circumstances ■ Need to – Identify commercial and economical circumstances – Taking account of industry – And factors affecting performance of business operating within that industry

Contractual terms ■ Needs to be examination of contractual terms ■ To determine division of responsibilities, risks and outcomes ■ May include written contracts ■ As well as communications between parties ■ Examination of actual relationship to see if anything is inconsistent with written contract

Functional analysis ■ Looks at activities undertaken in completion of contract ■ Identifies who takes responsibility, provides assets, takes risks ■ Compare these in controlled and independent scenarios

Characteristics of property or services ■ Are we talking about tangibles or intangibles? ■ Are these property or services? ■ What is the form of the transaction (license, sale etc) ■ Duration of transaction ■ Anticipated benefits

Economic circumstances ■ Must compare markets being served and include review of things like – Location – Size – Competition – Availability of substitutes – Supply and demand – Consumer purchasing power – Government regulation – Particular costs

Business strategies ■ What are the strategies of the business? – Innovation – Diversification – Risk aversion – Duration of arrangements – Market penetration schemes

Other points to note ■ Administrations should be disregarding transactions in only exceptional circumstances ■ Losses do not mean there is a problem but recurring losses might ■ Existence of particular workforce must be taken into account ■ Group synergies must be assessed

Transfer pricing methods ■ Five recognised methods – Traditional transaction methods ■ Comparable uncontrolled price ■ Resale minus ■ Cost plus – Transactional profit methods ■ Transactional net margin ■ Profit split

Comparable uncontrolled price ■ Simplest method ■ Compares the price of a controlled transaction ■ With a comparable uncontrolled transaction ■ Looks at difference ■ Need to make sure no material differences between compared transactions ■ Preferred method but it is all about judging comparability

Example of problem ■ A manufacturer sells insulated jackets to a number of companies in different countries, who distribute the goods to the end user. In Ruritania, the climate is unusually mild all year round and therefore the associated distributor has to incur enormous marketing expenditure to shift any units. In Zenda, the climate is freezing all year round; the coats fly off the shelves as soon as the independent distributor can stock them. No marketing is required. The first distributor therefore has a much lower margin than the second. There are prima facie differences between the transactions when the manufacturer sells to each party. Would these change the price the manufacturer would charge? Well they might: the Ruritanian distributor might (if he were independent) negotiate a lower price, in effect a subsidy for his marketing costs. The manufacturer might be willing to subsidise this if the alternative was a lack of sales in Ruritania. Alternatively the distributor might have to live with lower profits. You would have to find evidence of what would happen at arm's length. Differences between the markets in which the two distributors operate might well affect the price which each paid for purchases. This would be true even if both bought exactly the same coats in the same number at the same time.