- Could the new TP participation condition be used to attack transactions genuinely made at arm’s length?
s.148 TIOPA 2010 contains a broad test of whether one party is “directly or indirectly participating in the management control or capital of the other”. The added emphasis in bold highlights the broadest part of this test. As things stand, this breadth is tempered by the need to interpret this test in line with ss.157-163, which have the effect of applying this rule by reference to specific measures.
The new s.148A effectively allows HMRC to, by notice, test a taxpayer without reference to ss.157-163. It repeats the test shown in bold above and states that it shall be determined “having regard to all the circumstances”.
Many commercial contracts contain provisions which place considerable restrictions on how one or both counterparties must operate and mechanisms for consulting on key management decisions. For example, third party contract manufacturing arrangements might contain provisions which broadly give the principal a considerable degree of control over the way in which the contractor performs that contract. In a franchise arrangement, the level of control can be very high.
Could such arrangements between unrelated parties constitute “indirect participation in the management …. having regard to all the circumstances”?
This question matters. The best way to estimate the arm’s length price of a transaction is to look for a comparable transaction. If a commercial arrangement, arrived at through commercial negotiations, is regarded as a controlled transaction, does that mean that the actual commercial price is set aside in favour of less perfect comparables or other transfer pricing methods?
- How do you deal with royalty free licenses, for example in distribution or contract manufacturing arrangements?
As highlighted in the Australian PepsiCo case, many commercial arrangements necessarily involve the licence of intangibles in order to enable the service provider to perform their service (eg distribution or contract manufacture). Very often, the necessary licence is provided royalty free. In PepsiCo, the majority dismissed the idea that this meant the licence was provided for nothing, broadly on the basis that licencing intangibles to allow a service provider to perform their functions can benefit both parties and it was not, per [para 36] the ‘central bargain’.
The proposed new TP rules now contain a specific instruction at s.151(3) which applies when pricing a transfer or licence of intangibles. It requires an assumption that “the transfer or grant at arm’s length would be for consideration of a sum of money”.
To many, zero consideration would not be seen as “consideration of a sum of money”. It therefore appears that this cannot be the transfer pricing answer even if it is the arm’s length answer.
Less clear is whether this provision is intended to force taxpayers to consider the licence of intangibles separately from other contractual provisions. Do the rules require a monetary value be placed on what might, in commercial reality, be something given in exchange for entering into the arrangements which are central to the contract?
These amendments are said by the explanatory notes to be “made in connection with the amendments to Part 8 CTA 2009”. Those changes remove reference to the market value test which currently applies to transfers of intangibles even where the transfer pricing rules also apply.
It is unclear whether the changes were considered necessary as a relieving provision, for example to ensure an arm’s length value basis where intangibles were acquired as part of a business transfer accounted for using merger accounting.
At present, the explanatory notes are too light on detail to discern why the addition of s.151(3) was felt to be necessary and the effect, if any, it is intended to have on situations like that in the PepsiCo case.
- Do revisions to the PE definition resolve ambiguity about what does and does not constitute a dependent agent?
Some have taken heart from the slight change of the language of the PE definition when compared with the earlier consultation draft. The proposed test will read as follows (emphasis added):
“a person acting on behalf of the company habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts, that are routinely concluded without material modification by the company [outside the UK]”.
The word “material” is new when compared with earlier consultation drafts. It appears designed to relieve situations where contracts are sufficiently bespoke that a UK sales person cannot reasonably be said to have ‘done the deal’.
However, that still leaves ambiguity over what is or is not material. Further, the question of who plays the principal is an inherently subjective question. What if a business relationship was built over months by one salesperson but a more senior sales person steps in to get the sale over the line? In sales language, does the opener play the principal role or is it the closer? If sales are made pursuant to a framework agreement, what is the relevant contract?As ever, application of the dependent agent test to real life situations gives rise to an inherent risk of subjectivity and dispute.
- Given that the new UTPP rule attacks a perceived difference between the actual and correct result under the actual provisions entered into, what place does the ‘design’ hallmark have?
There appears to be no direct replacement of the “relevant alternative provision” found in the DPT rules (see FA 2015 s.82(5)). This was the concept which sought to establish the controlled transactions one might expect had tax on income not been a consideration. The self assessed result was compared with this imagined result.
Instead, the UTPP at s.217B compares the self assessed result with what HMRC consider should have been the self assessed result, based on applying the transfer pricing rules to the actual transaction.
It is therefore odd that one of the gating provisions for a UTPP assessment is that the s.217E ‘design condition’ is met. This is met when the provision which triggers the transfer pricing requirement is designed in response to any tax. Yet, if a multi-national overtly designed its actual arrangements with tax in mind, there could only be an assessment if those arrangements were priced incorrectly. There is no provision to assess them by reference to what arrangements might have existed but for that design.
It appears that both the s.217D effective mismatch and s.217E design condition are there because it is intended that those who design their inter-company trading arrangements with tax in mind should be subject to greater jeopardy should they price those arrangements wrong.
However, there is good reason to be concerned that the design condition might not afford much protection. Firstly, it is necessary to factor tax into commercial decision making to make it commercial. Secondly, the design condition is met where it is “reasonable [for HMRC] to assume”. This threshold might be met whatever the actual circumstances.
- The replacement of DPT with UTPP is said to afford access to MAP. How is this intended to work in practice and how does this interact with the ‘pay to play’ element of UTPP dispute resolution?
In essence, the complex procedural rules give the recipient the choice of a taxpayer amending their return (where still possible) to align with the notice or protesting it. A protest has a ‘pay to play’ element.
At the very least, this seems to compromise the ability of a taxpayer to avail themselves of the MAP procedure.
A taxpayer who believes their self assessment was correct, and does not therefore wish to amend it, can only appeal the preliminary notice on certain narrow grounds. If that notice results in an assessment, they must pay tax on the difference (however large) at the premium (31%) rate, in order to appeal. Accordingly, a MAP procedure would take place against a background of the company being out of pocket.
The taxpayer’s alternative is to revise their self assessment return so as to eliminate the allegedly underassessed amount. This would result in tax becoming payable at the regular rate (so they would still be out of pocket). Furthermore, taking this position would appear to shift any opportunity to initiate the MAP procedure to the other territory. The possibility of achieving this could be complicated by the double taxation now resulting from the company’s own assessment and not the assessment of HMRC.
HMRC’s draft guidance does state that this regime is intended to be subservient to the UK’s treaty and MAP obligations. However, clarification on how HMRC believe this is achieved would be welcome.
- What evidential burden will be required to dislodge even speculative HMRC assertions?
As ever, the burden of proof is on the taxpayer. Phrases like “indirectly participating in the management … having regard to all the circumstances”, “the principal role”, and “reasonable to assume” invite a subjective judgment where it is easy to imagine how different decision makers with different objectives might take opposing positions.
There is a difference for taxpayers between proving their position is justified and proving that HMRC’s position is not. Proving a negative could be highly burdensome, especially in tests which demand that regard be paid to “all” the circumstances.
- In light of the above, will the draft rules meet their stated objectives: improve fairness, equalise treatment between domestic and multinational corporations and support growth by improving tax certainty and access to treaty benefits?
There are some welcome changes in the new legislation. Aligning PE profit attribution with OECD rules and limiting the instances where TP rules apply to UK to UK transactions are two examples.
Nevertheless, the above questions and commentary suggest that further work is required before the new legislation can be said to meet its stated objectives.
