The below provides an initial take on some of the changes proposed. The rules are draft and each person’s circumstances are different. You should always undertake your own analysis or take your own advice before making any tax filing decisions.
PE – proposed new UK rules
What they do: The proposals better align with OECD principles meaning that statute can be removed in favour of reference to OECD material. Other changes are for specific industries.
Why this matters: The 2017 OECD model treaty had a broader definition of PE than UK statute. The concept of “habitually playing the principal role leading to the conclusion of contracts” is capable of generating debilitating enquiries on a subjective and evidence heavy question.
We think it would be wrong to assume that HMRC will always accept that a separate UK entity charging an arm’s length price will always account for the same profits that could be attributed to a PE.
TP – proposed new UK rules
What they do:
- Allow HMRC to direct that the participation condition is met with the threshold including “indirectly participating in the management”. Also expand those instances where common control is deemed to exist. This includes a ‘main purpose’ test for arrangements seeking to secure the participation condition is not met.
- Remove the concept of ‘market value’ for intangible assets transferred (or where a licence is granted) where TP rules apply, thereby removing the perceived problem of whether ‘market value’ always gives the same answer as ‘arm’s length price’. (Also, include transfers at nominal value in those situations where intangible asset computational difficulties are relieved.)
- Contain new rules on when loan guarantees are disregarded (when they allow what would otherwise be ‘excessive’ borrowing) and when loan guarantees can be deemed to exist (when they allow a UK borrower to reflect overall UK borrowing capacity).
- Confirm that implicit parental support is not a guarantee.
- There are other complex rules which deal with reallocating financing costs where a guarantee was given. There are further complex and subjective rules on when one person can be said to have a qualifying interest in another for financing cases.
- Rewrite the parts of the loan relationships and derivatives code which deal with the interaction between those codes and transfer pricing. In some cases these help companies who were previously penalised by the TP rules being a ‘one way street’. Also resolve difficulties with the interaction between FX matching and TP.
- Exempt UK to UK transactions (albeit in a complex way with exceptions). One exception is if one UK company has made a patent box election. There are 15 other special regimes where the exemption is disapplied.
Why they matter:
These proposed amending rules are especially hard to read without a deep understanding of the underlying legislation. Even apparent simplifications (eg exemption for UK to UK transactions) are complex to digest.
The main concern is the expansive and subjective way in which participation is now measured. It will take time to discern whether highly intertwined commercial relationships (such as franchisor/franchisee or principal/contract manufacturer) could lead to the participation condition being “treated as met”, per the new s.148A. Equally, joint ventures may, for the first time, have transactions with their members which are now caught.
When phrases like “having regard to all the circumstances” are used, the scope for invasive and evidence heavy enquires is very high. The guidance suggests this is a mechanism for HMRC to apply the TP rules to situations where OECD measures of participation would be met.
We question whether the actual rules could be broader whether unintentionally or not. If the OECD measure is what matters, why not just replace all statute on participation with a reference to the OECD provisions? This is the approach taken for PE.
The rules on indirect participation in financing cases are especially concerning, with three references to “reasonable to suppose”. What if something is reasonable to suppose but not true?
The broadening of participation matters because it might conceivably cover situations where it is clear from the surrounding commercial circumstances that an arm’s length deal has been reached. However, if that is the tested transaction, must it now be disregarded and replaced with someone else’s notion of what could or should have been agreed?
A fundamental reality is that no businessperson uses the transfer pricing guidelines to guide them in actual commercial negotiations. That is why they sensibly place primacy on adopting a comparable uncontrolled price where possible. Commercial situations are often bespoke and unique; it would be a severely retrograde step if commercial deals were supplanted for tax purposes by an authority’s fantasy about what should have been negotiated instead.
Unassessed Transfer Pricing Profits
What they do:
- Repeal the Diverted Profits Tax rules.
- Replace DPT with a concept of profits that were not assessed under transfer pricing principles but should have been assessed.
- Subject such profits to an additional tax rate of 6% where certain gating conditions are met. Presumably, penalties would apply in the same way as before.
- Impose gating conditions that cause the UTPP rules to trigger where there is a combination of an ”effective tax mismatch outcome” and “the tax design condition”.
- Measure a tax mismatch outcome as anything where the counterparty taxes at less than 80% of the corporation tax amount (generally less than 20% at present). This is subject to various conditions which will be broadly familiar to those with knowledge of the anti-hyrbid rules.
- The tax design test is a “reasonable to assume” test. It must be reasonable to assume that the arrangements are designed to have the effect of reducing, eliminating or delaying the liability of anyperson to pay any tax.
- The proposed procedural rules appear to introduce an element of jeopardy for the taxpayer if they are still in time to amend their return. On receipt of a notice, they can amend their return (thereby avoiding the extra 6% tax) but then lose the ability to contest the notice.
- As with the DPT rules, there is a ‘pay to play’ element where the tax assessed must be paid in order for an appeal to be possible.
Why they matter:
On an initial review, there appear to be many unsatisfactory elements to these proposals.
It appears profoundly unfair to apply a motive test such as this with a “reasonable to assume” threshold. The burden of proof is on the taxpayer to prove it is not reasonable to assume, which might be impossible even when there is clear evidence of other intentions. Just because something is not true, it does not mean it was not reasonable for an officer of HMRC to assume it.
The ’design’ condition also appears an unreasonable constraint on the freedom of choice as to where to locate operations. If a multi-national chose to locate operations in a jurisdiction with a lower tax corporate tax or employment tax rate, could they be taken to trigger the design condition if it was reasonable to assume that, but for the rate differential, the functions would be located in the UK?
The relationship between UTPP and access to MAP is also unclear. The guidance notes refer to “providing clearer access to treaty benefits” yet the word “treaty” (or equivalents) do not appear in the draft legislation. It appears that access to MAP would rely upon the taxpayer amending their self assessment and then making a MAP claim in the other territory (effectively asking the other territory to adopt a position they might not agree with themselves).
If HMRC’s position is that the transfer price self assessed is correct but reflects an unacceptable design element which must be countered, a MAP process would appear to involve HMRC talking about an imagined transaction whilst their counter-party would be talking about the actual transaction.
Overall
There are some sensible reforms proposed, such as partly eliminating UK to UK transfer pricing and instances where the ‘one way’ nature of transfer pricing gives unfair results.
Overall, these changes appear to be both complex and far reaching. They have clear capacity to increase the instances of dispute and the evidential burden involved in resolving these disputes.
It is hoped that thoughtful representations from a large body of taxpayers and professionals will lead to the final rules being an improvement.
