intm 431080 - What is transfer pricing all about?
Can transfer pricing be tackled without applying ICTA88/SCH28AA?
There are other ways of challenging the position if it appears that a group may have ordered its affairs to avoid United Kingdom taxation. Compared to ICTA88/SCH28AA these alternatives can sometimes be more straightforward and often less time-consuming.
UK Residence
A company which purports to be resident outside the UK and which is transacting business with a UK resident person, may be vulnerable to a fundamental challenge to its residence status. If it can be proven that the company is in reality resident in the United Kingdom, it can be taxed accordingly. This subject is dealt with in detail elsewhere.
Non-resident companies
Even if it is accepted that subsidiary companies are not resident in the UK, the Controlled Foreign Companies (‘CFC’) legislation may apply. Detailed guidance on the UK’s CFC regime can be found at intm 200000 onwards.
When faced with a non resident company outside the scope of the CFC legislation, it is usually sensible to concentrate on transactions between the non-resident company and its UK affiliates applying all relevant legislation (whether or not it is transfer pricing specific).
ICTA 1988/S74 and other Schedule D computation rules
Before applying ICTA88/SCH28AA consideration must be given to the normal Schedule D computation rules, in particular ICTA88/S74(1)(a) which prohibits the deduction of disbursements or expenses not wholly and exclusively laid out or expended for the purposes of the trade. If there are specific rules denying a deduction for particular expenditure, then these rules take precedence; there is no need to consider the arm's length nature of the particular provision in question.
Broadly for any trade, profession or vocation expenditure is subject to ICTA88/S74(1)(a). Expenditure not incurred wholly and exclusively for business purposes is not allowable. So for example, a company may be recharged the cost of a particular service by another group member. If the company did not actually receive that service, any payment would be disallowed under ICTA88/S74(1)(a). If the company did receive the service then the question of price would be subject to ICTA88/SCH28AA; even if the price turned out to be nil.
Other Schedule D computation rules may also be in point, such as ICTA88/S577. If an affiliate provides entertaining to a company, no deduction could be claimed for any recharge to the company.
Capital Transactions
Characterising transactions as being on capital account is particularly pertinent in the case of companies in start-up mode. ‘Once and for all’ payments can sometimes be properly disallowed on capital/revenue grounds.
Asset Transfers - Capital Gains
The TCGA 1992 legislation on the transfer of assets applies only to transactions on capital account. But, by applying the arm's length standard to non-arm's length transactions, it effectively deals with profit shifts that occur by virtue of the transfer pricing of asset transfers.
For guidance on TCGA92/S18 (Transfers of assets between connected persons) and TCGA92/S173 (Transfers of assets within groups) see CG14480 onwards.
Asset Transfers - Distributions
ICTA88/S209(4) can be useful in certain cases. It deals with the situation where a company transfers an asset (or liability) to one of its members at undervalue (or overvalue). Unless both are companies resident in the UK, ICTA88/S209(4) treats the difference as a distribution. Notwithstanding that transfer pricing principles may be applied to uplift the UK profits, a deemed distribution under ICTA88/S209(4) is a 'qualifying distribution' and, prior to 6 April 1999, attracted an ACT liability.
Inward Financial Transactions - ICTA88/S349
See the guidance on Thin Capitalisation (intm 540000 onwards) and Intra-group funding (intm 500000 onwards) for advice on the use of ICTA88/S349 in circumstances where the terms of a loan would have been different at arm's length but the requisite control test of Sch28AA is not satisfied. It may be possible to establish an income tax charge on the recipient (and deny any request for the interest to flow gross) if the amount of interest can be shown to be excessive by virtue of a special relationship between the parties. But this will depend on the precise terms of any relevant tax treaty.
Financial Avoidance - FA96/SCH9/PARA13
Where financial avoidance is involved, it is worth considering the use of the anti-avoidance provision at FA96/SCH9/PARA13. It operates by disallowing debits where in an accounting period a loan relationship has an unallowable purpose.
Whilst Business Tax (CT: Financial Products) has assumed responsibility for overall policy and domestic operation of the legislation Business International should always be consulted before the section is used in relation to cross-border transactions. See intm 509000.
