intm 467020 - Establishing the arm's length price: gathering your own evidence
Establish the facts
The first step in establishing the arm’s length price is to ensure that the facts are correct. This is crucial.
A common sense approach is necessary but it is only possible to make a sustainable judgement based on a full understanding of all facts. Once the facts are available, you can begin to compare what has happened between the connected parties with what would have happened at arm’s length.
Check the facts from your risk assessment
In your risk assessment you will have summarised what you know about the group and the cross-border transactions. This information will have come from a range of sources, some of which may be from the group’s website or press releases. Remember that these forms of media are there to promote the group. While the group will not present information that is untrue, the information may be incomplete. As with all information presented during the enquiry, you should examine it critically.
In other parts of the risk assessment you will probably have had to make informed assumptions when building up a picture of the group’s transfer pricing. At the other end of the spectrum, where the facts are not in dispute, you may still need to ask questions to establish information, e.g. the CT computation may provide details of royalties paid in a year, but you may not know how these are split between different products or product types.
Ask the group to confirm what you think you know and provide answers where your knowledge is incomplete.
Functional analysis
The functional analysis is the group’s description of its intra group transactions. It will usually be found as a separate section in any transfer pricing report prepared by the group (See intm 466040 Transfer pricing reports - functional analysis). The analysis should state who does what and who bears what risk. Scrutinise the functional analysis carefully to establish a complete picture of the group’s operations and in particular what functions take place where. The taxpayer knows his own business the best; however, your understanding of the facts will allow you to consider whether the terms of trade and prices adopted between parts of the group are those which would have existed between independents.
There may be significant omissions in any information provided. You need to review carefully all information presented to decide if you have a complete understanding of the activities of each part of the group.
You may find on occasion that the group’s functional analysis will have overlooked some intra-group transactions (see below). A less common problem is that the facts are wrong. While you would expect a functional analysis to have been built up from questioning the group’s employees, sometimes this will have been carried out at a high level by someone halfway around the world. Misunderstandings occur and facts may be over looked. You should consider how a functional analysis has been compiled and whether this would lead to a partial not a complete picture.
For example: a detailed transfer pricing report had been prepared to support the payment of a royalty in respect of the world brand name of one of the group’s most popular products, which was sold by a subsidiary. An examination of the facts revealed that the product in question was sold by the subsidiary under a different brand name - which was actually owned by the subsidiary.
Has anything been missed?
As part of the risk assessment process you should have thought about the scope of likely intra-group transactions. There may be such transactions that you have thought about, but the company has missed, or dismissed as being insignificant.
What actually happens?
Where the multinational enterprise ('MNE') has adopted tax minimisation strategies such as a commissionaire sales structure, then the transfer pricing report prepared for the group may be based on what is supposed to happen. Where such structures are introduced, they are usually accompanied by new operating instructions and procedures for staff, showing how functions are to be carried out. Other functions are carried out by other parts of the MNE. You must establish what actually happens once the new structure has been put into operation. This may well involve looking at prime documents and working papers of key personnel within the MNE. You may need to ask to meet with key members of staff.
Consider a case where the new tax minimisation structure introduced by the MNE relies on contracts being concluded outside the UK. When you look at prime documentation, you may find that virtually all the work done in concluding the contracts was carried out in the UK, despite what the new operating manuals say is supposed to happen. Once all the terms had been agreed, the contracts were signed in another country. In such a case you would want to consider if the contracts were in fact concluded in the UK. This will depend on the facts of the particular case.
Strategies for dealing with arrangements that seek to move profits out of the UK by way of organisational structures are discussed in more detail in the chapter on Transfer pricing: tax-planning structures at intm 465000.
Obtaining information from third parties
In some significant cases, you may need to obtain information from third parties, in order to test how a transfer pricing structure works. The group should be given every opportunity to provide this information, but you may need to approach third parties to obtain information.
TMA70/S20(3) provides an avenue to formally obtain such information from third parties in the UK. It may also be possible to obtain such information under Exchange of Information (See intm 462090).
Approaching third parties for information is often contentious and may well provoke objections from the taxpayer. If you consider that you do need to obtain such information, please contact a member of Business International.
