INTM432090 - Schedule 28AA - how it works

The affected persons: enterprises

ICTA88/SCH28AA/PARA1(1)refers to provision made or imposed between any two (connected) persons, suggesting a broad scope for the schedule, as the term persons includes bodies corporate, partnerships and individuals. However, paragraph 1(2) and (3) require the actual provision to be compared with the arm’s length provision that would have been made between independent enterprises.

Paragraph 2 requires the schedule to be construed in accordance with the OECD model convention, as interpreted by the OECD transfer pricing guidelines. Article 9 of the convention sets out the arm’s length principle by reference to conditions made or imposed between enterprises. Article 3 defines enterprise as “the carrying on of any business”.

This suggests that Schedule 28AA should be applied only where both parties are enterprises, but that this term should be interpreted broadly. The term encompasses more than trading activity, but a natural interpretation implies an intention to make profit or gain, or to undertake activity in a businesslike or commercial way.

In most situations where Schedule 28AA potentially applies there is likely to be little doubt that both the parties to a provision are enterprises. Situations where this may be less clear include the potential application of the schedule to individuals and to charities. It is clear that both individuals and charities can act in a way that would cause them to be regarded as enterprises. This conclusion will follow whenever a trade is being carried on or in other cases where activity is carried on in an organised way with a view to profit or gain. The nature of the activity and whether it carries a commercial flavour will also be relevant.

It is necessary to consider whether a particular provision to which Schedule 28AA potentially applies is one made between two enterprises. Hence it is possible that different conclusions will follow for different provisions made by the same person – some transactions may be made in a capacity unrelated to an enterprise that is being carried on while others may be made in the context of the enterprise.

Examples – Individuals:

• Participation in the management or control of a company does not in itself constitute the carrying on an enterprise. It follows that the office of director, or other employment by a controlled company would not normally constitute a provision made between two enterprises.
• And if a company provides residential accommodation rent free to a participant who just makes personal use of it as their home, transfer pricing rules would not generally apply (though other tax rules, eg relating to employee benefit or distributions, might well be relevant).
• Similarly, holding investments in a close investment holding company would not constitute an enterprise for the purpose of considering provisions made between the company and the individual.
• Holding properties for rent in general does constitute an enterprise. However, if an individual holds property principally for private purposes, incidental letting activity that is intended to offset costs rather than to generate income is not likely to constitute an enterprise.
• Lending to connected companies may or may not constitute an enterprise. If the activity is undertaken in a businesslike way with a view to generating gains on shares in the company, this is like to be represent a form of enterprise. On the other hand, isolated loans where the intention is to provide long term funding for a family business may well not be made in the context of an enterprise.
• Where an individual is carrying on an enterprise, it follows that the SME exemption will potentially apply, provided the employment and financial limits are met. These limits will apply on an aggregate basis, including the individual and all connected businesses, including those carried on by controlled companies.

Examples – Charities

• If a charity enters into a cost sharing arrangement with a connected person, and the costs being shared are incidental to the charity’s primary charitable purpose, this is unlikely to represent an enterprise being carried on by the charity.
• An example of the above is the case where a charity allows a connected company to use property owned by the charity. If the property is held principally for the purpose of the charity’s charitable activities, this is likely to represent no more than a means of offsetting costs, and so would not be an enterprise.
• However, arrangements conducted in a commercial way, for the purpose of generating income may well represent an enterprise. As noted above, any form of trade represents an enterprise, but the term also encompasses activity that falls short of a trade if it is undertaken with a view to financial gain.

Companies

Companies other than charities are generally established in order to undertake commercial activity and so, barring exceptional circumstances, companies will always be enterprises and their transactions with other enterprises will be within the scope of Schedule 28AA.

Companies set up on a not for profit basis will nonetheless carry on an enterprise if they undertake commercial activity in a businesslike way. In particular, a not for profit organisation whose principal role is to support the activity of other enterprises (whether or not they are related enterprises) is likely to be carrying on an enterprise itself. Another indication of enterprise is a company that carries on activity with the aim of providing remuneration to directors or employees.

Self assessment

The legislation is mandatory for transactions within its scope and refers to the computation of tax. As taxpayers are required to self assess their liability to tax, this means that if they are affected and are potentially advantaged in respect of UK tax by the actual provision, then their tax returns must calculate their tax liability on the basis that their provisions with connected persons were priced in accordance with the arm’s length principle.

Companies resident in the UK and non-resident companies trading in the UK calculate their tax liability under the CTSA regime.

Individuals and non-resident companies liable to income tax in respect of Schedule A profits calculate their tax liability under the ITSA regime.