UK and International Tax news
HMRC Consults On TP And Secondary Adjustment Rule
Monday 20th June 2016
HMRC has recently issued a consultative document on the introduction of secondary adjustments into the UK’s transfer pricing legislation.
The UK’s transfer pricing rules seek to ensure a correct allocation of taxable profit linked to activities undertaken in the UK from transactions between connected parties, typically two companies belonging to the same group. The rules require the terms of the transaction, and thereby the profits arising from it, to be calculated by reference to those which would have been agreed if the companies were independent [the ‘arm’s length principle’] and it is applied whether a UK resident company is transacting with another UK company or one that is based overseas.
The arm’s length principle has been adopted internationally for transfer pricing [see the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations and Article 9 of the OECD Model Tax Convention on Income and on Capital] and provides an agreed basis for the fair allocation of profit on cross border transactions between connected parties and also avoids double taxation.
The UK’s transfer pricing rules require the calculation of taxable profits on the price that would have been charged at arm’s length. This is achieved via an adjustment – the primary adjustment – to the price that is effective for tax purposes. As the primary adjustment is only effective for tax purposes, any cash benefit from non arm’s length pricing can accumulate say in an overseas company, often located in a low tax country. This cash benefit can be reversed by a secondary adjustment rule which applies a tax charge on the excess cash arising on non arm’s length pricing.
These rules are an internationally recognised approach and are already part of the transfer pricing rules applied in the US, Canada, France and certain other EU member states.
The UK’s rules require a ‘primary adjustment’ to be made to the original price, which is effective for tax purposes, but do not currently require a secondary adjustment to be made.
The Commentary on paragraph 2 of Article 9 of the OECD Model Tax Convention notes that the Article does not deal with secondary adjustments, and thus it neither prevents nor requires tax administrations to make them.
The government is now consulting on whether a secondary adjustment rule should be introduced into the UK’s transfer pricing legislation and how that rule would be designed. In particular, it is seeking views on the introduction of a constructive loan rule, when it should apply, how the loan should be recognised for accounting purposes, what interest rate should apply, for how long the secondary adjustment should apply, the tax treatment of the repatriated loan balance, interaction with APAs, and the requirement for an anti avoidance test.
The consultation runs until 18 August 2016.
For more detail on the above contact Keith Rushen on 0207 486 2378.
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