INTM435010 - Transfer pricing: tax cases - Watson Brothers v Hornby (24TC506)

It is interesting to note that on the domestic front the Courts had no problem embracing the main tenet of any transfer pricing code, namely the arm's length principle.

The first modern instance was the 1942 case of Watson Brothers v Hornby. The brothers were poultry farmers and under the then rules were taxed on their farming profits under Schedule B, which only charged a portion of the annual value of the land. They also, however, ran a hatchery, which was a trade within Case I Schedule D because the activities were outside the definition of` 'husbandry'. The brothers used the hatchery as their source of hens for the poultry business, so that it became necessary to consider at what value the chicks should be transferred from the Schedule D trade to the Schedule B farming business.

Relying on the mutuality principle, the Inland Revenue contended that a man cannot make a profit by trading with himself and therefore that the chicks should be transferred at the cost of rearing them. Market conditions, however, dictated that the chicks could have been sold only for something less than cost: some of the chicks sold at auction had fetched four pence each whereas the cost of rearing had been seven pence each. The Watson Brothers wrote off the difference between cost and market price and claimed it as a Schedule D loss.

The Courts upheld the claim that the arm's length principle should apply and allowed the market value, in this case lower than cost, as the transfer price.