View the related Tax Guidance about Transfer pricing
UK transfer pricing in practice
UK transfer pricing in practiceThe UK transfer pricing rules require an adjustment of profits where a transaction between connected parties is not undertaken at arm’s length and has created a potential UK tax advantage. Transfer pricing is a specialist area in tax and relies on an experience of similar businesses and activities. The following therefore only outlines the transfer pricing process in practical terms to allow a non-specialist to understand the methodology of a transfer pricing review. The legislation defines an arm’s length price as the price which might have been expected if the parties to the transaction had been independent persons dealing at arm’s length, based on OECD guidelines. Application of an arm’s length principle under the OECD guidelines is based on a comparison of transactions between associated parties in a multinational enterprise (MNE) with the transactions which would have taken place between independent parties under the same circumstances; this is known as a ‘comparability analysis’. See INTM440000 onwards for details of the types of transaction which could give rise to transfer pricing issues. In order to undertake a comparability analysis, the business must review the commercial and financial relationships between associated parties to establish:•the contractual terms•the functions performed by each party, what assets are used and what risks are taken on•the characteristics of property transferred or services provided•the market in which the parties operate•any business strategies pursued by the parties, eg market penetrationTIOPA 2010, s 164This is known as a functional analysis.
Transfer pricing adjustments and penalties
Transfer pricing adjustments and penaltiesAs explained in the HMRC approach to transfer pricing enquiries guidance note, taxpayers are required to make a transfer pricing adjustment in their UK tax return if an increase in taxable profits or reduction in allowable losses would arise from arm’s length pricing being applied to transactions with connected parties, when compared to the actual pricing that has been applied by the parties. Taxpayers are not permitted to make an adjustment which results in decreased taxable profits or greater allowable losses, unless they believe they are not being taxed in accordance with the terms of a UK double taxation agreement and seek action under the Mutual Agreement Procedures. Compensating adjustmentsIf the adjustment to be made is between UK companies or individuals (a ‘UK-to-UK adjustment’) the 'disadvantaged person' involved in the transaction is able to calculate their tax by making a 'compensating adjustment' to their taxable profits or losses. The following criteria must be met for such an adjustment to be made:•only one of the parties to the actual provision made is an advantaged person in respect of that provision, and•the other affected person is within the charge to income or corporation tax in respect of the relevant profits, and•the advantaged person has made a return on the basis of the arm’s length provisionIf a transfer pricing adjustment is necessary following the conclusion of an enquiry, but the disadvantaged person has already submitted a return for the relevant period, then the disadvantaged party
Transfer pricing and financing arrangements
Transfer pricing and financing arrangementsTransfer pricing rules also apply to financing arrangements. Loans between connected companies where one of those companies controls the other, or where both are under common control, are subject to the regime. The transfer pricing legislation takes precedence over the loan relationships legislation and the rules on the corporate interest restriction. See the Corporate interest restriction ― overview guidance note. The same principles of transfer pricing as set out in the UK transfer pricing in practice guidance note apply to financing transactions. Additional details and examples are provided in the OECD’s Transfer Pricing Guidance on Financial Transactions which have become part of the main OECD Transfer Pricing Guidelines republished in 2022.One important aspect of transfer pricing for loans is thin capitalisation, ie a company does not have enough capital to support the debt. A company will be considered to be thinly capitalised where:•a loan exceeds the amount which the borrower would or could have borrowed from an independent lender, or•the terms of the loan differ from those that would have been agreed with such a lender, eg a higher interest rateTIOPA 2010, s 152; INTM413200Where thin capitalisation occurs, the interest on the excessive part of the loan will be disallowed as a deduction in arriving at the assessable profits or allowable losses of the borrower. This is on the basis that the borrower would not have had a deduction for that amount if the loan had been arranged with a third party. See
Transfer pricing rules ― overview
Transfer pricing rules ― overviewWhat is transfer pricing?Transfer pricing is the price at which an enterprise transfers either physical goods, intangible property or services, including financing arrangements, to associated enterprises. Generally, enterprises are associated if there is direct or indirect control by one of the enterprises of the other, or they are under common control. For these purposes, direct control means the ability to determine how the affairs of the company are conducted by virtue of the shareholding, voting rights or any powers within the articles of association or other document regulating the company or any other company. Determining whether indirect control exists depends on including rights and powers which are available in the future or which are held by other persons. Transfer prices are important because, in large part, they determine the taxable profits of associated enterprises in different tax jurisdictions. Different tax authorities seek to ensure that the amount of taxable profit of an enterprise in their jurisdiction represents the appropriate amount of profit and that multinational enterprises do not transfer profits to low tax territories to minimise their tax liability. Most tax authorities therefore require transfer prices between associated enterprises to be agreed on an arm’s length basis, that is equivalent to the price that would have been charged and terms agreed between independent parties in the same circumstances.Transfer pricing risks mainly arise in cross-border transactions; however, UK transfer pricing legislation also applies to transactions where both associated parties are within the UK, given the risk
Foreign profits ― loss relief
Foreign profits ― loss reliefThe treatment of losses of UK companies from foreign operations depends on the nature and extent of the foreign operations.Trade carried on wholly overseasLosses of a UK company from a trade carried on wholly overseas by that company cannot be set against any profits from other sources, including other overseas businesses. The losses can only be carried forward and set against future profits of the same trade. This rule was not relaxed by the changes in the utilisation of losses carried forward arising from 1 April 2017 which apply for UK trading losses. These amendments allow other trade losses carried forward to be offset against future profits or surrendered as group relief. For details of the rules on carried-forward trade losses from 1 April 2017, see the Trading losses carried forward and Group relief for carried-forward losses guidance notes. The carried-forward loss relief changes also introduced a restriction such that only 50% of profits in excess of £5m can be offset by losses brought forward. This
HMRC’s powers to open an enquiry into a return
HMRC’s powers to open an enquiry into a returnIntroductionAn important clarification needs to be made to help in the understanding of this note. Whilst the legislation refers to an ‘enquiry’, HMRC now refers to enquiries as ‘compliance checks’.As this note specifically covers HMRC’s powers, the term enquiry has been used to match up with the language used in the legislation. However, some of the other material referred to, such as factsheets, includes the term compliance checks rather than enquiry.For the purpose of this note, an enquiry and a compliance check have the same meaning.An HMRC Officer has the power to either correct a return or open an enquiry, and each of these processes is discussed below.For more details about compliance checks, see the Types of checks on returns guidance note. For details of what to do when a compliance check is opened, see the Opening letter to a compliance check guidance note and other guidance notes in that subtopic.Correcting a returnAn Officer can, within nine months of receiving a self assessment tax return or a corporation tax return, amend it without opening an enquiry in order to correct:•an obvious error or omission. ‘Obvious’ means that there can be no doubt what the correct entry should be. This could include correcting arithmetical errors, transposition of incorrect figures and errors of principle•anything else that the Officer has reason to believe is incorrect based on information already held and where no more information is neededTMA 1970, s 9ZB; FA 1998,
Corporate debt ― overview
Corporate debt ― overviewThis guidance note provides an introduction to the provisions governing the taxation of debt for UK companies and also provides links to more detailed guidance notes dealing with those provisions.The taxation of corporate debt in the UK is complex. There are several different sets of rules governing the amount and timing of tax deductions available for interest and other amounts relating to corporate debt. These include:•the loan relationships regime•the corporate interest restriction (CIR) rules•transfer pricing and thin capitalisation requirements•a range of associated anti-avoidance measures ― it should be noted that there are regime anti-avoidance rules (RAARs) in CTA 2009, ss 455B–455D and related sections for loan relationships and in TIOPA 2010, s 461 applicable to the CIRIt should also be remembered that payments of interest by a UK company on all liabilities capable of remaining outstanding for more than one year are subject to withholding tax, unless they are expressly exempt or qualify for relief.Loan relationshipsIn most instances, a company’s financing costs and income are taxed or relieved under the loan relationships regime. Relief is only available where the cost attaches to the company’s own loan relationships or a balance which is deemed to be a loan relationship for tax purposes. See the What is a loan relationship? guidance note.A loan relationship exists where a company stands in the position of debtor or creditor in respect of a money debt that arises from a transaction for the lending of money. Although, it
Transfers of goodwill and other IP
Transfers of goodwill and other IPSales or acquisitions of businesses are likely to include the transfer of intangible fixed assets (IFAs) such as goodwill and / or other intellectual property (IP).This guidance considers some of the relevant tax issues arising on a transaction structured either as a transfer of trade and assets, or as the sale of shares in a company which owns goodwill or other IFAs. For a discussion of the tax implications generally of a share sale or an asset sale, see the Tax implications of share sale and the Tax implications of trade and asset sale guidance notes respectively.For details of the intangibles regime generally, see the Corporate intangibles tax regime - overview guidance note.What is goodwill?The accounting definition of IFAs (other than goodwill) is set out in FRS 102, s 18.2 and is ‘an identifiable non-monetary asset without physical substance’. IFAs have a continuing use in the company’s trade.Goodwill is covered by FRS 102, s 19.22. It is measured at cost and is defined as the excess of the cost of the business over the acquirer’s interest in the net amount of identifiable assets, liabilities and contingent liabilities, measured in accordance with the rules within that section.Goodwill may be personal, connected with the premises (for example a hotel), or associated with the brand or trade name. There are many other types of intellectual property such as patents, know-how, designs, processes and customer lists.See the What is an intangible fixed asset? guidance note.IFAs in trade and
Setting up overseas ― branch or subsidiary
Setting up overseas ― branch or subsidiaryAlthough a UK company can do a reasonable amount of business in another country without a taxable presence in that country, eventually the company may need to consider whether to establish a more formal presence in such a country, generally by way of a branch or subsidiary.The decision will often usually depend on commercial factors, particularly where there are regulatory requirements which demand, for example, a particular level of capital which is more easily satisfied through a branch structure where the parent company capital is taken into account.Where there is no particular commercial pressure for one legal form over another, tax issues may influence the decision by taking into account the local country’s tax position for branches and subsidiaries. For example, the parent company should consider:•is there any difference in tax rates between a branch and a subsidiary?•can profits be remitted back from the country to the UK in the same way? For example, the US has a branch profits withholding tax which is reduced to 5% in the UK / US tax treaty, but dividends paid from a US subsidiary to a UK parent company owning more than 80% of the share capital in the subsidiary for more than a year before the dividend is paid would not suffer any US withholding tax on the profits distributed by the subsidiary (see DT19867A)•can start-up losses in the entity be easily relieved against group profits?It is important to consider the classification
IFRS 16 leases ― the tax implications
IFRS 16 leases ― the tax implicationsOverview of IFRS 16International Financial Reporting Standard 16 (IFRS 16) came into force for accounting periods beginning on or after 1 January 2019, replacing International Accounting Standard 17 (IAS 17). The adoption of IFRS 16 applies to all entities which apply International Financial Reporting Standards or Financial Reporting Standard 101 Reduced Disclosure Framework (FRS 101). Entities applying FRS 102 are excluded from the changes.Prior to IFRS 16, lessees and lessors were required to make a distinction between finance and operating leases. Where the lessee had substantially all the risks and rewards incidental to the ownership of an asset, it had to recognise a finance lease asset and liability on its balance sheet. Where the lessee did not have substantially all the risks and rewards incidental to the ownership of the asset, it recognised lease payments as an expense over the lease term and was considered to have an operating lease. This treatment will continue under FRS 102. However, IFRS 16 removes the distinction between finance leases and operating leases for a lessee. Under IFRS 16, a lessee will recognise all leases, subject to some limited exceptions for short-term leases or those of low value (see below), on its balance sheet leading to a ‘right-of-use’ (ROU) asset and a lease liability for all leases. The treatment for lessors under IFRS 16 is broadly unchanged.For tax purposes, changes in accounting standards for leases would normally have been ignored as a result of the provisions in
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