Thought leadership from our experts

Recent UK Transfer Pricing Developments – A Continued Focus on Base Erosion and Profit Shifting

Transfer pricing rules have been part of UK tax legislation since 1997, and most multinationals operating in the UK are required to self-assess compliance with the arm's length principle when completing their tax returns. The UK tax authorities have long seen transfer pricing as a key issue. In recent years, the UK government has devoted more resources to heightened scrutiny of companies' transfer pricing arrangements, which has led to a higher volume of transfer pricing inquiries.

The UK tax authorities' focus on a number of key areas (such as pricing intangibles and contractual allocations of risk) are also concerns the G20, the Organization for Economic Cooperation and Development (OECD) and other participating governments are seeking to address through the work on transfer pricing under the base erosion and profit shifting (BEPS) project.

UK government's approach to BEPS and introduction of diverted profits tax

In early 2014, the UK government released a policy paper on the priorities for taking forward the G20/OECD's BEPS action plan entitled Tackling aggressive tax planning in the global economy: UK priorities for the G20-OECD project for countering Base Erosion and Profit Shifting. The paper stated that "The UK has led the way in this international action, driving the international tax, transparency and trade agenda and fully backs the OECD's Base Erosion and Profit Shifting project." In October 2014, the UK government observed that the UK will "continue to work collaboratively with our international partners to take forward the recommendations from the 2014 reports and tackle the 2015 Action Plans."

The UK government formally committed to implementing country-by-country reporting in a statement published in September 2014, with legislation allowing regulations to make the OECD's country-by-country reporting a requirement in the UK passed in March 2015. It is anticipated that regulations enabled by this measure will be issued once the OECD has completed further work. The start date is expected to be accounting periods beginning on or after 1 January 2016, with the first reports filed by 31 December 2017 (in accordance with the G20/OECD's timetable for implementation).

The UK government introduced a new measure in the form of a "diverted profits tax" with effect from 1 April 2015 and in advance of the completion of the BEPS project. This new tax addresses some of the concerns being discussed under the BEPS project in relation to the creation of a (UK) taxable presence, and also pricing arrangements where there is a lack of economic substance. The diverted profits tax is intended to encourage multinationals to adjust their UK corporate tax position, and applies at a rate of 25% of the 'diverted' profit. This means, for example, that when a transfer pricing adjustment is not made for UK corporation tax purposes (currently charged at 20%) a higher rate of tax would apply to a diverted profits tax assessment.

The new tax applies in two distinct situations. The first is when a non-UK company has artificially avoided having a taxable presence (permanent establishment) in the UK. The second is when a group has a UK company (or UK permanent establishment of a non-UK company) and there is a tax advantage as a result of an entity or transactions that lack economic substance. There is an exemption from diverted profits tax for small and medium-sized businesses (based on the existing European Union thresholds that apply in UK transfer pricing legislation). Additional exemptions apply to avoidance of UK permanent establishment cases when there are either low UK sales or low UK expenses of the group. It remains to be seen how the diverted profits tax applies in practice, and whether future UK implementation of the permanent establishment and transfer pricing outcomes under the BEPS project (Actions 7-10) renders it less applicable or relevant.

Other UK transfer pricing developments

The UK government recently introduced a measure that relates to restrictions on bareboat charter fees paid by oil and gas companies operating in the North Sea. The new rules cap the tax-deductible amount of intragroup lease payments for drilling rigs and floating accommodation vessels under a bareboat charter (or similar) arrangement. In addition, the cap applies to third-party payments when a composite service is provided under separate contracts, one of which is a bareboat charter agreement. The cap applies from 1 April 2014 and is calculated by reference to the historical capital cost of the asset that is subject to the lease.

To date, there have been very few transfer pricing cases before the UK courts. As a result, any case that provides information on the UK courts' views on the interpretation of transfer pricing legislation is helpful. One such recent case is Abbey National Treasury Services Plc v HMRC [[2015] UKFTT 0341 (TC)] in which the UK's First-tier Tribunal decided in the tax authorities' favour. The case concerned broader points on the taxation of derivatives (and involved a scheme subject to the UK's disclosure regime), but also considered whether the issue of shares between two UK companies in the same group was within the scope of the UK transfer pricing legislation.

The First-tier Tribunal held that the UK transfer pricing rules applied to the issue of shares in this case. This suggests that other transactions involving shares, or potentially a wide variety of investment instruments, are likely to be considered within the scope of UK transfer pricing legislation. The tribunal accepted that the share issue in this case was not comparable, for pricing purposes, with a bonus issue. The arrangements therefore met the requirements in the OECD's transfer pricing guidelines for recharacterisation of the transactions actually undertaken.

UK transfer pricing legislation and OECD developments

The UK transfer pricing legislation is set out at Part 4 of the Tax (International and Other Provisions) Act 2010. The legislation is framed in a way that explicitly requires interpretation in a manner that "best secures consistency" with Article 9 (Associated Enterprises) of the OECD Model Tax Convention, including the arm's length principle, and also the OECD's transfer pricing guidelines. Reference is to the latest OECD material – currently the 2010 OECD guidelines. Future changes to the OECD guidelines will take effect in UK law following the issuance of a treasury instrument. The next consolidated version of the OECD guidelines is not expected before late 2016 or early 2017, to reflect the outcome of all the changes arising from the transfer pricing work under the BEPS project, and it is anticipated that UK legislation will make reference to this version shortly thereafter.