intm 431070 - What is transfer pricing all about?
How did the UK’s transfer pricing rule evolve?
By the start of the 20th century the United Kingdom had one of the world's most developed economies and possibly the most comprehensive tax system. Quite a few UK companies had overseas operations (both subsidiaries and branches). Rates of tax tended to be slightly higher in the UK and additional levies had to be imposed during wartime. Manipulation of transfer prices had started to cause a few problems before the First World War and remedial legislation was first attempted in 1915.
1915 legislation
In 1908 the Revenue had been obliged to accept (Stanley v The Gramophone and Typewriter Ltd) that not all of the profits made by a UK based group could be taxed here. So, with the knowledge that the profits of certain group companies were outside the scope of the UK’s taxing jurisdiction, the existence of cross-border tax opportunities began to emerge. But at that time many companies with overseas operations, particularly the 'plantation-type' companies, tended to be managed and controlled from the UK, and so were resident here. It is therefore unlikely that much scope existed for the manipulation of import prices in such cases. However, the Revenue was also worried about non-resident companies which, instead of selling through branches in the United Kingdom, set up subsidiaries to do the selling and charged them inflated prices.
Problems concerning taxation of trades carried on by non-residents through UK agents influenced the form of FA15/S31(3) and thus the way in which profits were adjusted when a non-UK resident carried on business with, and controlled, a UK resident. If it appeared that the conduct of the business had been arranged to leave the resident company with less than the ordinary profit which might have been expected to arise from that business, then the non-resident would be chargeable to tax in the name of the resident as if the resident had been their agent. It is interesting to note that although this pragmatic approach was confined to cases of transfer pricing abuse, the principle - that of charging the profits of a non-resident - re-emerges in the controlled foreign companies legislation. In the event, Section 31(3) was of little value, since later court decisions cast doubt on the suitability of what was seen as a machinery provision for the purpose of imposing a charge.
1951 legislation - ICTA88/S770
The evolution of the arm's length principle and its relevance to the computation of trading profits marched in step with developments on the international front when the United Kingdom began to negotiate double taxation agreements following the Second World War.
The impetus for the enactment of what became ICTA88/S770 came from a problem which arose in 1950 concerning sales at undervalue to the UK subsidiary of an overseas company. Although there was in existence a double taxation agreement with an `associated enterprises' article doubts were expressed whether, in the absence of any specific transfer pricing legislation, the Revenue could invoke the arm's length principle to substitute the open market value of the property sold for the price included in the company's books.
The idea was to make use of the Associated Enterprises Article in the relevant treaty. The argument was that treaties are incorporated into our law by virtue of what is now ICTA88/S788 and therefore they could be used exactly as if they were part of our domestic code. But there were doubts and in 1951 the provisions of what became ICTA88/S770 were enacted. ICTA88/S770 (detail at intm 436000 onwards) included a relatively unusual feature: the 'Board's Direction'. This provided that the legislation applied only if the Board so directed. The intention of this feature was to provide an element of taxpayer protection by means of Head Office oversight and prevent ICTA88/S770 from being applied in inappropriate cases. In effect, the application of the legislation's was at the discretion of the Inland Revenue. One of the effects of this feature is that the usual penalty consequences of making an incorrect return did not apply to transfer pricing.
In 1975 some deficiencies in the provisions concerning control were remedied and information powers were introduced.
1998 legislation - ICTA88/SCH28AA
In 1997 the legislation was given a thorough overhaul. The huge growth in intra-group trading across national boundaries and the increasing diversity and complexity of multinationals' trading arrangements gave rise to concerns that the transactional approach of ICTA88/S770 might not offer adequate exchequer protection in the modern business environment. And, with the arrival of CTSA it was necessary to make transfer pricing compatible with Self Assessment. So in 1998 the legislation was completely changed to a code much more closely aligned with OECD Model Treaty Article 9 than was ICTA88/S770.
Furthermore, it is expressly stated that the new code is to be construed in accordance with the 1995 OECD Transfer Pricing Guidelines. In many respects, this formalises the situation already in place under S770 as it has always been Revenue policy to administer the transfer pricing regime in accordance with the OECD guidelines.
However, the wording of the basic rule in ICTA88/SCH28AA is significantly wider in scope that that at ICTA88/S770 which is phrased in terms of 'the transaction'. Transactions are now to be analysed in the light of all relevant terms, conditions, and arrangements.
It is worth noting that the new code at ICTA88/SCH28AA does not include the Board's direction requirement seen in ICTA88/S770. Indeed, it was the scrapping of this feature that brought the regime within self assessment. However, fears were raised by taxpayers during consultations on the new code that abandoning the direction could weaken the taxpayer protection afforded by direction requirement. In response to this, the code incorporates the `Board's Approval` which ensures a level of Head Office oversight in enquiry cases.
2004 legislation
UK-UK transactions were exempt from transfer pricing rules for the purposes of calculating profits arising prior to 1 April 2004. However, to address uncertainty that arose concerning this exemption following a legal judgment by the European Court of Justice, the Finance Act 2004 ended this exemption and made various other changes that apply for the purposes of calculating profits arising on or after 1 April 2004. The Act also made new exemptions available to Small and Medium Sized Enterprises in most circumstances, and to pre-existing dormant companies.
