Transfer Pricing - Forum - Freshfields Bruckhaus Deringer

Transfer PricingForum

Vol. 3, No. 1 - February 2012

Transfer PricingForum

TRANSFER PRICING FOR THE INTERNATIONAL PRACTITIONER

Transfer Pricing Guide 2012 — Part One

Issue One — general transfer pricing framework

— recent developments

— documentation requirements

— transfer pricing disputes

Issue Five — the use of transfer pricing methods in practice

Do your tax authorities (at a national and/or regional level) have powers to adjust transfer prices?If so, is this to an arm’s length level or to a pre-ordained level or ratio? Are taxpayers obliged tosatisfy themselves that their transfer prices are at arm’s length? To prepare evidence of this? Arethere penalties for non-compliance? Do the rules extend beyond related parties to parties with astrong business relationship, e.g. major suppliers/ customers/financers?

In what ways have the tax authorities of your jurisdiction been active in transfer pricing over thelast two to three years, whether in terms of carrying out more transfer pricing audits, being moreaggressive, bringing cases to trial or enhancing the capacity of the tax authority with morepeople/more training/more access to expert input/more information resources? Have the taxauthorities improved the transfer pricing compliance burden and outcome for taxpayers, forexample by agreeing more rulings/APAs or making that process easier, or resolving competentauthority issues faster/more constructively?

Do your tax authorities follow the EU Joint Transfer Pricing Forum template of a ‘‘master file’’ and‘‘country files’’? If not, is any other format prescribed?

Do your tax authorities have a specific approach to transfer pricing risk assessment, either writtendown or made apparent through their behaviour?

Is there a favoured method or methods (either in law or in practice) in your jurisdiction? If so,does it favour a Traditional Transactional Method (i.e. the CUP, Resale Price or Cost Plus Method)or a Transactional Profit Method (i.e. the TNMN or Profit Split Method)? Are any other transferpricing methods favoured?

Issue Two

Issue Three

Issue Four

www.bnai.com/tp

United KingdomDanny Beeton, Murray Clayson and Oliver Sangster,Freshfields Bruckhaus Deringer LLP, London

I. Issue One — general transfer pricing framework

A. Do your tax authorities (at a national and/or regionallevel) have powers to adjust transfer prices? If so, is thisto an arm’s length level or to a pre-ordained level orratio? Are taxpayers obliged to satisfy themselves thattheir transfer prices are at arm’s length? To prepareevidence of this? Are there penalties for non-compliance? Do the rules extend beyond related partiesto parties with a strong business relationship, e.g.major suppliers/customers/financers?

The United Kingdom transfer pricing legisla-

tion is set out in Part 4 of the Taxation (Inter-

national and Other Provisions) Act 2010

(‘‘TIOPA’’)1 and stipulates that calculations of corpora-

tion tax and income tax on transactions between re-

lated parties are to be based on the arm’s length

provisions that would have existed between indepen-

dent enterprises rather than the actual provisions.

Very broadly, two parties are related if one directly or

indirectly controls the other; or if a third person di-

rectly or indirectly controls each of them. Save in cer-

tain collaborative contexts, the rules do not govern

unrelated parties linked only by a strong business re-

lationship.

The UK system for corporation and income tax re-

turns operates on a self-assessment basis. When a tax-

payer submits a self-assessment return to Her

Majesty’s Revenue and Customs (’’HMRC’’), it includes

a declaration that the return is, to the best of its

knowledge, correct and complete.2 This declaration

implicitly includes confirmation that transfer pricing

legislation has been complied with, i.e. that all trans-

actions with related parties have either been con-

ducted or recomputed on the basis of arm’s length

terms. There is no requirement on a taxpayer to

submit evidence with his tax return to show that

transactions were conducted on arm’s length terms.

However, HMRC has issued guidance on what records

should be kept in case HMRC decides to conduct an

audit on a taxpayer (see Issue Three, Heading B

below).

The UK does not have a specific transfer pricing

audit system. Instead, enquiries into transfer pricing

issues are made via the mechanism of enquiries into a

company’s self-assessed tax returns under Finance Act

1998, Schedule 18. Following a transfer pricing en-

quiry, HMRC has the power to amend a taxpayer’s tax

return in accordance with the findings of the enquiry,

i.e. to recalculate its tax liability on the basis that any

offending transactions were conducted on arm’s

length terms. The taxpayer may then pay any further

tax due and the applicable interest and penalty (see

below) or appeal against the amendment via the UK’s

tribunal and court system.

The penalty regime for transfer pricing is the same

as for other direct tax infringements. There is there-

fore no specific penalty regime for transfer pricing.

HMRC Business International and the Transfer Pric-

ing Board are involved in all cases potentially involv-

ing penalties as part of an overall settlement so as to

ensure consistency in approach. HMRC provides

guidance on how these penalties are applied to trans-

fer pricing in their International Manual

(INTM462120).

For accounting periods ending on or after April 1,

2009, the penalties regime is set out in Finance Act

2007, Schedule 24 as amended by Finance Act 2008,

Schedule 40. The penalty provisions are for inaccura-

cies in a company tax return. A penalty will be charge-

able if the inaccuracy causes a loss of tax or an

increased claim to a loss or repayment and the inaccu-

racy is careless, deliberate, or both deliberate and con-

cealed. All penalties are payable in addition to the

outstanding tax owed.

The level of penalty depends upon the degree of cul-

pability of the company in relation to the underpay-

ment. Where the incorrect return is caused by careless

action (i.e. a failure to take reasonable care) the pen-

alty is 30 percent of the potential lost revenue. Where

it is caused by deliberate but unconcealed action, the

penalty is 70 percent of the potential lost revenue and

when deliberate actions are concealed, this penalty

rises to 100 percent. These penalties can be reduced

by disclosure of the inaccuracy to HMRC. HMRC pro-

vides examples of carelessness in INTM462125.

Where taxpayers can show that they have made ‘‘an

honest and reasonable’’ attempt to comply with the

02/12 Transfer Pricing Forum BNA ISSN 2043-0760 141

legislation, then no penalty is levied even if there

might be an adjustment made.

B. Do your tax authorities follow the OECD TransferPricing Guidelines for Multinational Enterprises and TaxAdministrations in respect of the of the arm’s lengthstandard, the pricing methods which can be used andthe behaviour expected of the taxpayer and the taxauthorities? If not, which variations apply?

Broadly, under TIOPA section 164 the UK’s transfer

pricing rules are to be read in such a manner as to

secure consistency between the application of those

rules and the effect given (in accordance with the

OECD Transfer Pricing Guidelines for Multinational

Enterprises and Tax Administrations) to double taxa-

tion arrangements incorporating Article 9 of the

OECD Model Tax Convention.

C. Do the tax authorities of your jurisdiction accept,whether by practice or as per express transfer pricingregulations, multiple years’ data for the purposes ofcomparability analyses? What is the statistical measureof the arm’s length range generally accepted by thetax authorities of your jurisdiction, whether by practiceor as per express transfer pricing regulations (forexample the inter-quartile range or any other measure ofcentral tendency)?

HMRC accepts multiple years’ data for the purpose of

comparability analyses in the same way that this is

recommended by the OECD Transfer Pricing Guide-

lines as a way of sometimes improving comparability.

HMRC does not prescribe a statistical measure of the

arm’s length range, but accepts the recognition in the

OECD Transfer Pricing Guidelines that a measure of

central tendency can be helpful, and are usually pre-

pared to discuss the inter-quartile range.

D. Do tax authorities of your jurisdiction refer tocomparables while conducting a transfer pricing auditwhich the taxpayer could not have access to whilepreparing its documentation?

HMRC does not refer to ‘‘secret comparables’’. How-

ever, it has indicated informally and separately from

its written guidance that it believes that it may be per-

tinent to refer to information which was available at

the time that the taxpayer filed its return, even where

this became available after the taxpayer carried out its

formal transfer pricing benchmarking exercise, and

possibly after the transaction took place during the

tax year. It is not clear whether such a position would

be accepted by a court.

II. Issue Two — recent developments

A. In what ways have the tax authorities of yourjurisdiction been active in transfer pricing over the lasttwo to three years, whether in terms of carrying out moretransfer pricing audits, being more aggressive, bringingcases to trial or enhancing the capacity of the taxauthority with more people/more training/more access toexpert input/more information resources? Have the taxauthorities improved the transfer pricing complianceburden and outcome for taxpayers, for example byagreeing more rulings/APAs or making that processeasier, or resolving competent authority issuesfaster/more constructively?

Transfer pricing is currently regarded as a very high

priority international tax issue by HMRC. Significant

resources have been dedicated in recent years to the

formation of the Transfer Pricing Group, the recruit-

ment of specialist economists, and generally there has

been a heightened focus on case selection. A number

of high profile and high value settlements have been

reached (Astra Zeneca in 2010 and Diageo in 2008

being recent examples). HMRC has been prepared to

litigate (the DSG Retail case3 being the prominent

modern reported case — see further discussion of this

case below) and have engaged external counsel to pre-

pare cases for trial. HMRC pursues vigorously and

with resolve those cases where it considers significant

amounts of tax have been underpaid.

(i) Recent statistics

In March 2011 an HMRC spokesperson announced at

a public event that interest in Advance Pricing Agree-

ments (‘‘APAs’’) had increased rapidly in the prior few

months. It appeared that HMRC had turned down

only one of 36 applications for an APA in the previous

12 months (on the basis that the transaction involved

was too simple to merit an APA). It is possible that

other potential applications could have been deterred

at the pre-filing stage and would not appear in these

statistics — there had been initial discussions on a no-

names basis. HMRC indicated that it did not intend to

publish statistics on the type of transaction or the

transfer pricing method used because there are so few

APAs each year that the confidentiality of taxpayers

could be put at risk.

The same spokesperson added that, in addition to

the general APAs, HMRC had agreed a large number

of Advance Thin Capitalisation Agreements

(‘‘ATCAs’’), which other administrations might include

in their general APA statistics. This should be remem-

bered when forming a view on the relative willingness

of HMRC to agree a future transfer pricing arrange-

ment compared with other tax administrations.

In December 2011, HMRC published transfer pric-

ing statistics for the first time (http://

142 02/12 Copyright = 2012 by The Bureau of National Affairs, Inc. TP FORUM ISSN 2043-0760

www.hmrc.gov.uk/international/transfer-pricing-

stats.pdf). The press release noted that the position at

the end of the first quarter of 2008 was that the aver-

age time taken to settle an enquiry was 38 months,

and the average age of open enquiries was 32 months.

‘‘Significant progress has been made since that date’’,

according to the press release. As at March 31, 2011,

90 percent of cases open as at April 1, 2008 had been

settled. The following tables appear in the press

release:

Age of open enquiries

31/03/10 30/06/10 30/09/10 31/12/10 31/03/11 30/06/11 30/09/11

Average age of open enquiries (months) 24.82 23.37 22.62 20.15 19.20 21.17 21.3

50% open less than (months) 16.22 15.42 12.40 12.49 12.43 12.46 12.40

Age of settled enquiries

12 months to 31/03/10 30/06/10 30/9/10 31/12/10 31/3/11 30/6/11 30/9/11

Average (months) 33.3 34.6 33.7 33.6 29.4 24.8 24.4

50% settled within (months) 31.0 32.4 32.5 32.4 25.7 20.7 19.3

The age of settled enquiries reflects settlement of

those taken up before April 1, 2008 and those taken up

after that date.

HMRC commented that there has been significant

progress in settling older cases and in reducing the

time to settle enquiries generally; this is reflected in

the ages of both open and settled enquiries. In the

three months to June 30, 2011 HMRC resources were

focused on settling existing enquiries and while this

helped to drive down the age of settled enquiries fewer

new enquiries were opened in the period leading to an

increase in the average age of open enquiries.

The following table also appears in the press re-

lease:

Transfer Pricing yieldYear 2007/8 2008/9 2009/10 2010/11

Total Amount £519

million

£1,595

million

£1,139

million

£436

million

Large Business Service £494

million

£1,564

million

£973

million

£273

million

Local Compliance £25

million

£31

million

£66

million

£163

million

The press release noted that fluctuations in the yield

from year to year are principally due to the effects of a

small number of very large cases. At the mid-year

point the yield for 2011/12 had already significantly

exceeded the total yield for 2010/2011.

APA statistics – year ended March 31, 20112009/10 2010/11

Applications made during year 32 49

Applications turned down 3 1

APAs agreed during year 20 35

Applications on hand at year end 56 69

Average time to reach agreement: 20.3 months 22.7 months

50% agreed within: 16.5 months 14.0 months

HMRC commented that significant progress was

made in settling some very old cases during 2010/11,

hence an increase in average time to reach settlement;

at the same time, the reduced median age of settle-

ments reflects the progress made in resolving cases. A

small number of applications were not accepted into

the APA programme. The ATCA process is administra-

tively separate and the following separate ATCA fig-

ures appear in the press release:

ATCA statistics – year ended March 31, 2011

ATCAs agreed during year 127

Applications on hand at 31/3/11 173

Agreements in force during 2010/11 231

Average time to reach agreement: 9.8 months

50% agreed within: 6.9 months

Finally, the press release contains the following fig-

ures on Mutual Agreement Process (‘‘MAP’’) negotia-

tions, with the comment that the time taken to reach

agreement is partly dependent on the responsiveness

of the other tax administration involved:

MAP statistics for 2010-112009/10 2010/11

Cases resolved during the year 45 40

Cases admitted during the year 51 39

Cases on hand 31/3/11 93 92

Average time to resolve cases 24.3 months 27 months

50% resolved within 21.3 months 19 months

At the end of 2011 the OECD released MAP statistics

for 2010 which showed that the number of new UK

MAP cases rose from 56 in 2009 to 68 in 2010 and that

the inventory of UK MAP cases rose from 120 at the

end of 2009 to 131 at the end of 2010. These cases of

course were for calendar years and as such would not

completely match up with the figures in the table

above (however, the OECD figures appear to be gener-

ally higher in terms of new cases and inventory of

cases than the HMRC figures for some reason).

(ii) Alternative dispute resolution (ADR)

Towards the end of May 2011 an HMRC spokesperson

gave a public update on the ADR pilot. This had in-


volved the use of external mediators to help to resolve

ten disputes before they could proceed to the First-

Tier Tax Tribunal (‘‘FTT’’). As a result of the success of

these pilots, HMRC proposed to encourage new ways

to reach agreement without giving in on points of

principle, the appointment of HMRC and taxpayer

‘‘facilitators’’ to help reach agreement in meetings,

and reports from experts to help to resolve the non-tax

aspects of disputes.

HMRC published draft guidance on ADR in June

2011, explaining how it was a third route to settling

tax disputes in addition to the two existing routes

(namely bilateral agreement between the HMRC case-

worker and the taxpayer or at a tribunal). Three alter-

native methods were announced, comprising:

s facilitative mediation, where the mediator offersno opinion but brings the two parties together;

s evaluative mediation, where the mediator may offera view on the merits of the respective parties; and

s expert determination.On November 30, 2011 Anthony Inglese, HMRC’s

general counsel, announced publicly that the ADR

pilot scheme was working well but that a number of

problems had to be ironed out before it could be fully

implemented, that HMRC had still not ‘‘arrived at the

best model’’. He noted that of the 14 cases that had en-

tered the ADR pilot, five had been resolved. Two of

these five cases required third party mediation and the

other three required intense mediation using the fa-

cilitative and evaluative methods. Of the 14 cases, ten

involved VAT (of which it is known separately that one

was resolved by reference to a transfer pricing expert

report on the open market price) and the other four

involve direct tax matters. Inglese asked taxpayers to

continue to work collaboratively with HMRC even

though a case may be heading for the FTT (and it is in-

teresting in this respect that ADR was rechristened

‘‘collaborative dispute resolution’’ for a spell earlier in

the year).

ADR is welcome as an appropriate way of dealing

with transfer pricing disputes, with their wide range

of possible arm’s length outcomes, but as Inglese ex-

plained in November 2011, ADR is quite costly and

will only be used in long-running disputes where posi-

tions have become entrenched or where progress has

stalled.

B. Are there any recent disputes or cases that haveimpacted on the transfer pricing landscape and if so inwhat way? Are there any in the pipeline that areexpected to have a significant impact on the transferpricing landscape?

Major transfer pricing disputes that proceed all the

way to a final court decision have been rare in the UK.

Indeed, in recent years there has only been one case

that has been litigated to a conclusion and a judgment

handed down. This landmark case, DSG Retail, was

released on March 31, 2009 and reported on April 23,

2009. Before that case, there had only been two re-

ported decisions on substantive issues relating to the

interpretation of ICTA 1988, section 7704 being the

Ametalco case,5 where interest-free loans were found

to be ‘‘business facilities’’ within the scope of the then

transfer pricing legislation; and the Waterloo case,6 in

which it was decided that, in a case where loans were

made to trustees to place them in a position to grant

employee share options, the business facilities were

made directly to certain offshore employer subsidiary

companies, even though there was no direct contract

with those companies.

Two further transfer pricing cases are worth men-

tioning for the sake of completeness. While the facts

in both Meditor Capital Management v. Feighan7

(‘‘Meditor’’) and Glaxo Group Ltd v. Inland Revenue

Commissioners8 (‘‘Glaxo’’) concerned transfer pricing,

these cases did not consider pricing methodology or

the substantive interpretation of section the transfer

pricing legislation. Meditor concerned the scope of

HMRC’s powers to request information with focus on

the procedural requirements within a tax audit,

whereas Glaxo considered the powers of HMRC to

make a tax adjustment (in that case a transfer pricing

adjustment) to an assessment which remained ‘‘open’’

beyond the then usual six-year statutory limitation

period.

Since these cases did not deal with pricing method-

ology as such, it was not until DSG Retail that the UK

transfer pricing legislation received in-depth judicial

consideration. This was the first UK case concerned

with transfer pricing methodologies and ICTA 1988,

Schedule 28AA, applicable for corporation tax pur-

poses for accounting periods ending after June 30,

1999. The Special Commissioners (the first level of tax

appellate body prior to the establishment of the FTT)

found in favour of HMRC, in concluding that the ar-

rangements put in place by DSG Retail were not at

arm’s length and the Special Commissioners rejected

DSG Retail’s assertions that there were arm’s length

comparables that justified its transfer pricing ap-

proach. Instead, the Special Commissioners favoured

the application of a formulaic profit-split, which they

believed to be in accordance with the OECD Transfer

Pricing Guidelines (which were also considered to be

relevant to the previously applicable legislation at

ICTA 1988, section 770 as they were expressly so in re-

lation to section 770A and Schedule 28AA, on the

basis that the OECD Guidelines were ‘‘the best evi-

dence of international thinking on the topic’’).

In light of the relative dearth of transfer pricing case

law, it is highly likely that a UK court or tribunal

would look to any relevant authorities emerging out of

Commonwealth countries or other jurisdictions with

a common law tradition in order to inform its deci-

sion. For example, recent Canadian cases such as Gen-


eral Electric Capital Canada Inc. v. Her Majesty The

Queen and GlaxoSmithKline Inc. v. Her Majesty The

Queen might well be persuasive in arriving at conclu-

sions in the UK.

III. Issue Three — documentation requirements

A. Do your tax authorities follow the EU Joint TransferPricing Forum template of a ‘‘master file’’ and ‘‘countryfiles’’? If not, is any other format prescribed?

HMRC does not prescribe any particular transfer pric-

ing documentation format. The EU Joint Transfer

Pricing Forum published a report on June 8, 2010 re-

cording various member states’ responses to a survey

on the implementation of the Code of Conduct on EU

Transfer Pricing Documentation.9 The UK response

referred to a survey of UK business in 2007 which

found that:

‘‘most said that in its current form it had little practi-cal use. . .The UK decided that the implementation ofthe Code of Conduct was not its highest priority due tolack of support from business’’.

The UK also commented that ‘‘Chapter 5 of the

[OECD Transfer Pricing] Guidelines (Documentation)

underpins the UK’s documentation requirements.’’

B. Must documentation be filed, and if so, when? Arethere special contemporaneous documentationrequirements, for example in the context of‘‘extraordinary’’ situations such as restructurings? Whatmust be available if requested by the tax authorityeven if it need not be filed? Is there other informationthat the taxpayer will be expected to have referred to insetting transfer prices even if this does not have to berecorded?

Under Part III of Schedule 18 to the Finance Act 1998,

the only explicit transfer pricing documentation re-

quirements are that a company keeps such records as

to enable it to deliver a correct and complete company

tax return. HMRC provides guidance in its Interna-

tional Manual (INTM433030) regarding what docu-

mentation should be kept by the taxpayer to evidence

and support its arm’s length approach.

The documentation can be created at various times

as set out below:

s ‘‘Primary accounting records’’ (e.g. records of trans-actions occurring in the course of a business) wouldgenerally be created at the time the information en-tered the business accounting system, i.e. before atax return was made for the period in question.

s ‘‘Records of transactions with associated busi-nesses’’ (i.e. transactions subject to the transferpricing rules) and ‘‘tax adjustment records’’ (i.e. anyadjustments of tax on taxable profits) would need tobe created before a tax return was made for theperiod in question.

s ‘‘Evidence to demonstrate an arm’s length result’’(i.e. essentially company background, functionaland economic analysis type of evidence) wouldneed to be made available to HMRC in response toa ‘‘legitimate’’ and ‘‘reasonable’’ request in relationto a tax return that has been made.There is no requirement in the UK to submit the

arm’s length documentation when the tax return is

filed every year. However, a UK taxpayer needs to

ensure that the evidence supporting the figures in-

cluded in the tax return is available, albeit not neces-

sarily in a form that could be immediately made

available to HMRC. The documentation needs to be

submitted in response to a legitimate and reasonable

request from HMRC. For enquiries made under the

general information powers for self-assessment, the

taxpayer is formally expected to reply to a request

within 30 days, although in practice reasonable re-

quests for an extension of time will commonly be

granted.

C. Are there reduced compliance obligations for smallertaxpayers and/or transactions, or for simplertransactions?

Many small and medium sized enterprises are ex-

cluded from the scope of the transfer pricing legisla-

tion altogether. For the purposes of calculating profits

arising on or after April 1, 2004, TIOPA, section 166

onwards exempts small and medium sized enterprises

(defined as per INTM432112 using the European rec-

ommendation (2003/361/EC) which broadly applies

an employee headcount ceiling and a financial ceiling

to an enterprise or, where the enterprise is part of a

group or association, to that group) from the basic

transfer pricing rule in TIOPA, section 147. The opera-

tion of these criteria is as shown in the table below:

SME exemption criteria

Maximum

number of staff

And less than one of the

following limits:

Annual

turnover

Balance sheet

total

Small

Enterprise

50 a10 million a10 million

Medium

Enterprise

250 a50 million a43 million

This exemption will apply except:

s in relation to transactions with a resident of a terri-tory with which the UK does not have a tax treatycontaining a suitable non-discrimination clause; or

s where the taxpayer elects to disapply the exemptionfor a particular chargeable period; or

s if the Commissioners of Revenue & Customs give amedium-sized enterprise a transfer pricing noticerequiring the basic transfer pricing rule to be ap-plied in the computation of their profits and lossesfor that chargeable period.There are no exemptions for smaller and/or simpler

transactions between sufficiently sized enterprises al-


though HMRC will follow the guidance in paragraph

1.13 of the OECD Transfer Pricing Guidelines where it

is stated that in practice there is difficulty in obtaining

adequate information to apply the arm’s length prin-

ciple and that:

‘‘[I]t is important not to lose sight of the objective tofind a reasonable estimate of an arm’s length outcomebased on reliable information.’’ (Emphasis added).

The UK response to the EU survey on the imple-

mentation of the EU Code of Conduct on Transfer

Pricing Documentation (see above) included the com-

ment that:

‘‘The UK applies the OECD TPG at 5.4 which says thatthe demonstration of an ‘‘arm’s length’’ result shouldbe ‘‘in accordance with the same prudent businessmanagement principles that would govern the processof evaluating a business decision of a similar level ofcomplexity and importance’’. We would expect thedocumentation to reflect this.’’

IV. Issue Four — transfer pricing disputes

A. Do your tax authorities have a specific approach totransfer pricing risk assessment, either written down ormade apparent through their behaviour?

HMRC tends not to focus on particular industries or

geographic locations for its enquiries; the approach

adopted by HMRC is risk-based. During a risk assess-

ment, HMRC analyses all types of transactions and

will categorise some transactions to have a higher risk

than others, depending on the facts and circum-

stances.

The geographic location of counterparties to a

transaction (e.g. in tax havens) may be a factor that

feeds into the risk assessment (amongst many other

factors). However, this factor would not necessarily

trigger a transfer pricing enquiry by itself. Addition-

ally, some industries (such as pharmaceuticals, con-

sumer goods and technology) may be more prone to

enquiries as a result of the accumulation of knowl-

edge and experience by individual tax inspectors, and

perhaps their tendency to exploit high value intan-

gibles, but this is not due to a policy to focus on par-

ticular industries.

HMRC has also highlighted other areas of concern

that are likely to lead to enquiries, including where a

taxpayer has recently made structural changes to its

business or the way in which its business, or a part of

it, is characterised in its tax return. Following HMRC’s

increased investment in transfer pricing investigation

resources since early 2008, it is likely that the level of

scrutiny will continue to grow.

More generally, HMRC’s Anti-Avoidance Group has

stated that, under the risk-based approach, various

‘‘signposts’’ would generally tend to indicate that a

transaction or arrangement might potentially merit

investigation, including the following:10

s transactions or arrangements bearing little or nopre-tax profit which rely wholly or substantially onan anticipated tax reduction for significant post-taxprofit;

s transactions or arrangements that result in a mis-match. Examples would be mismatches betweenthe legal form or accounting treatment and the eco-nomic substance; or between the tax treatment fordifferent parties or entities; or between the taxtreatment in different jurisdictions;

s transactions or arrangements exhibiting little or nobusiness, commercial or non-tax rationale;

s transactions or arrangements involving contrived,artificial, transitory, preordained or commerciallyunnecessary steps or transactions; or

s transactions or arrangements where the income,gains, expenditure or losses falling within the UKtax net are not proportionate to the economic activ-ity taking place or the value added in the UK — es-pecially where the transactions or arrangementsare between associates within the same economicentity and would not have occurred between partiesacting at arm’s length and/or add no value to theeconomic entity as a whole.

B. How easy and effective is it to use APAs and the MAPto avoid or help to resolve transfer pricing controversyin your jurisdiction?

(i) MAP

The UK has a large network of tax treaties, covering

well in excess of 100 countries. Where the other coun-

try agrees, the UK generally includes a MAP article in

its international treaties. The European Union ‘‘Con-

vention on the elimination of double taxation in con-

nection with the adjustment of profits of associated

enterprises’’ 90/463/EEC (‘‘the Arbitration Conven-

tion’’) provides an alternative to the MAP procedure

under the UK’s tax treaties where residents of EU

member states are potentially subject to double taxa-

tion. MAP may be invoked under one of the UK’s tax

treaties, under the Arbitration Convention or under

both simultaneously.

In order to request a MAP, an enterprise must

present a case that it is subject to taxation otherwise

than in accordance with the tax treaty or the arm’s

length principles of the Arbitration Convention to

HMRC. Once HMRC has considered the application,

it may conclude that in fact the taxation of the rel-

evant transaction in the other state is in accordance

with the treaty and may grant relief on a unilateral

basis. Alternatively, it may conclude that the adjust-

ment is not in line with the treaty and will take up this

matter with its counterpart in the treaty partner state.

If negotiations between the competent authorities

provide adequate evidence to satisfy HMRC that the

adjustment made by a tax treaty partner is in accor-


dance with the tax treaty, a corresponding adjustment

will usually be granted. However, if the UK remains

dissatisfied, it is not obliged to grant relief. Where the

treaty party is an EU Member State or (though this is

currently the exception rather than the rule) the

double tax treaty contains an arbitration provision, at

the taxpayer’s request the matter may progress to arbi-

tration.

Although the Arbitration Convention is regularly in-

voked, it has generally been possible for states to

arrive at agreement under MAP without proceeding to

the secondary stage of the proceedings stipulated

thereby. As a result, the Arbitration Convention, and

arbitration clauses in double tax treaties, must be re-

garded as a powerful tool for the taxpayer to use to

achieve resolution of double taxation.

(ii) APAs

The APA rules are set out in Part 5 of TIOPA. These

rules are fairly skeletal; the process is substantially

fleshed out in HMRC’s published guidance, Statement

of Practice 2/10, which explains how HMRC applies

the rules.

Generally, taxpayers in the UK report positive expe-

riences with the APA programme and find the process

cooperative, transparent and flexible. However, tax-

payers commonly remark upon the time taken to

agree APAs. HMRC statistics for 2010–11 show that it

took an average of 22.7 months to agree the APAs

agreed during the year, with 50 percent agreed within

14 months (see Issue Two, Heading A above). These

timing considerations, and the high level of work and

expertise required for the application, can impose

high costs on enterprises that enter into the process.

Other common taxpayer complaints include that the

process is too focused on bilateral APAs and too vague

about what sorts of issues will meet HMRC’s ‘‘com-

plexity’’ threshold (carrying the risk that one invests in

the early stages of the process only to be rejected

later).

However, in practice HMRC has seemed open to

early, informal discussions. This can go some way to

helping taxpayers gauge whether their issues are suf-

ficiently complex from HMRC’s point of view to justify

putting more effort and resources into the application

process. Those early discussions can be anonymous,

fronted by the taxpayer’s advisers. HMRC is also pre-

pared to address pre-existing issues in APA applica-

tions. In suitable cases, an APA might help a taxpayer

resolve open issues with HMRC in an informal way.

This could become a more attractive secondary objec-

tive as HMRC continues to toughen up on transfer

pricing disputes.

HMRC has updated their international manual to

include a new section on real-time working of transfer

pricing issues and APAs (see INTM471010). The guid-

ance makes clear that the appropriate course of action

will be influenced by what the customer is hoping to

get out of the real-time review. If the customer is after

legal certainty about the tax treatment of future trans-

actions, the only way this can be obtained is via the

APA process. Where legal certainty is not being

sought, HMRC may be able to give a general opinion

on methodology or risk status. HMRC may also give

an indication, expressed in terms of the level of risk, of

how HMRC might see the transfer pricing risk posed

in the corporation tax return, once it is made (without

leaving any inference that any particular price for

goods or services used in calculating profits in a tax

return will automatically be considered by HMRC to

satisfy the requirements of the transfer pricing rules

in the absence of an APA).

C. How easy to use and effective is the CompetentAuthority process in your jurisdiction?

HMRC’s guidance in Statement of Practice 1/11 pro-

vides at paragraph 21 that ‘‘MAP does not provide a

parallel avenue to the domestic appeals process’’. The

UK follows the approach set out in the OECD Com-

mentary on Article 25 of the OECD Model Tax Con-

vention at paragraph 76 which emphasises that a

person cannot simultaneously pursue the MAP and

domestic legal remedies. Where UK domestic legal

remedies are still available, HMRC will generally re-

quire that the taxpayer agrees to the suspension of

these remedies or, if the taxpayer does not agree, will

delay MAP until the remedies are exhausted.

HMRC’s MAP statistics for 2010–11 (see Issue Two,

Heading A above) show that the mean time taken to

resolve cases in 2010–11 was 27 months, but the

median time was 19 months. The figures also show

that HMRC is currently managing to resolve a similar

number of cases each to the number admitted each

year.

V. Issue Five — the use of transfer pricing methodsin practice

A. Is there a favoured method or methods (either in lawor in practice) in your jurisdiction? If so, does it favour aTraditional Transactional Method (i.e. the CUP, ResalePrice or Cost Plus Method) or a Transactional ProfitMethod (i.e. the TNMM or Profit Split Method)? Are anyother transfer pricing methods favoured?

There is no favoured method, although HMRC is pre-

pared to apply the profit split method in order to test

the outcome of the taxpayer’s use of another method,

or where they believe that the data used in the appli-

cation of another method is not reliable, possibly be-

cause the comparability adjustments which would be


required are too great. HMRC is very familiar with

and prepared to accept the use of all transfer pricing

methods.

B. In which circumstances do particular methods tend tobe applied by your tax authorities, for example to audittransfer pricing arrangements, in litigation, or in APAs?

There is little experience of transfer pricing litigation

in the UK, and the methods agreed to in APAs are not

disclosed. In DSG Retail, as discussed above, the profit

split method was applied. HMRC may challenge the

use of the CUP or resale price methods where these

are associated with a prolonged period of losses for

the taxpayer.

C. Are taxpayers allowed or expected to use the ‘‘mostappropriate method’’ in the sense that it is the one whichbest fits the transactions involved, or can be used mostreadily with the information available, or can be appliedwith the fewest adjustments?

HMRC is flexible on the transfer pricing which has

been used, as long as it allows robust benchmark data

to be used with reliable comparability adjustments. As

noted above, HMRC reserves the right to look beyond

the results of the benchmarking of a ‘‘tested party’’ to

rationality of the profit outcome for both parties and

the split of profit between them.

Ultimately, it should always be borne in mind that

HMRC’s stated view is that the arm’s length provision

is that which would have been made between inde-

pendent enterprises. If no provision would have been

made or imposed between independent persons then

the legislation allows the advantaged person’s profits

to be computed accordingly — thus reflecting the

arm’s length position.Danny Beeton is head of transfer pricing economics atFreshfields Bruckhaus Deringer LLP in London and may becontacted by email at [email protected] Clayson is a partner in Freshfields Bruckhaus DeringerLLP’s tax practice group in London and may be contacted byemail at [email protected] Sangster is a trainee solicitor at Freshfields BruckhausDeringer LLP in London and may be contacted by email [email protected].

NOTES1 This legislation applies for accounting periods endingon or after April 1, 2010. For accounting periods endingprior to this date the relevant legislation can be found insection 770A of the Income and Corporation Taxes Act1988 (‘‘ICTA 1988’’) and Schedule 28AA to the same Act.2 For corporation tax, Schedule 18 paragraph 3(3) of theFinance Act 1998 (FA 1998).3 DSG Retail Ltd and Ors v. Revenue and Customs Com-missioners [2009] STC (SCD) 397.4 Section 770 was the forerunner to the modern transferpricing code. It was replaced by ICTA 1988, section 770Aand Schedule 28AA which were rewritten as Part 4 TIOPAwith effect from April 2010.5 Ametalco UK v. Inland Revenue Commissioners [1996]STC (SCD) 399.6 Waterloo plc and Ors v. Inland Revenue Commissioners[2002] STC (SCD) 95.7 [2004] STC (SCD) 273.8 [1996] STC 191.9 http://ec.europa.eu/taxation_customs/resources/documents/taxation/company_tax/transfer_pricing/forum/jtpf/2010/jtpf_2010_06_08_replies_implementation_en.pdf10 Guidance from HMRC Anti-Avoidance Group on avoid-ance indicators.


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