by Gareth Green of Transfer Pricing Solutions Ltd, a member of the Quantera Global Network
The UK has enacted new rules requiring disclosure of tax treatments where the correctness of the position is uncertain. The rules are effectively a requirement that taxpayers must provide HMRC with a list of tax treatments that HMRC might wish to challenge.
The rules are not specifically targeted at transfer pricing, but it seems likely that some transfer pricing arrangements and branch profit attributions will fall within their scope.
Businesses in scope
The rules will only apply to large companies and partnerships that are resident in the UK or have a taxable presence there. The measure of large is turnover greater than £200 million or gross assets exceeding £2 billion.
This is largely measured on an entity basis, but in the case of companies it is also necessary to include turnover and assets of any other group companies that are taxable in the UK. If the entity is not UK resident, only the turnover and assets attributable to their UK taxable presence will count.
Criteria for notification
The basic rule is that the taxpayer must notify HMRC if their UK tax return relies of any tax treatment that is ‘uncertain’. There is a size threshold, which means that notification is not required if the tax at stake is no higher than £5 million. The tax at stake is the additional UK tax that would have been payable under an alternative tax treatment that HMRC might consider to be more appropriate.
When will transfer pricing treatment be uncertain?
There are two alternative definitions of uncertainty, whose broad effect is that a transfer pricing treatment will be uncertain if either of these tests apply:
1. There was sufficient uncertainty that the taxpayer booked a provision for the potential tax understatement in the accounts.
This test is relatively straightforward.
2. The treatment is contrary to HMRC’s known position.
HMRC has published guidance on the new rules, including in relation to potential sources of what is a known HMRC position. The source that is most likely to be relevant for transfer pricing is HMRC’s ‘Manuals’, which represent guidance for tax inspectors, published under Freedom of Information principles. In particular, the International Manual (IM) includes lengthy coverage of transfer pricing and PE profit attribution and is likely to be be main source of ‘known positions’ on these topics.
This is problematic, because the IM is often discursive, rather than prescriptive. There is no system of labelling which statements in the IM are a ‘position’ for these purposes and unfortunately the guidance does not make clear how to determine whether specific content in the manuals should be regarded as setting out a ‘position’. For instance, some of the content could be read as being intended merely to signal to inspectors that they should be sceptical about certain arguments, but without clearly stating that HMRC regards such arguments as always being wrong. In the absence of clear guidance, many taxpayers are likely to feel it is safest to err on the side of assuming that any statement that expresses any sort of preference or doubt is a ‘position’.
Known positions may also be those set out by HMRC in correspondence with the taxpayer.
There is a possibility that a third trigger for uncertainty will be added to the legislation at some future point. This is that there is a ‘substantial possibility’ a tribunal or court would find the treatment to be incorrect in one or more material respects.
Notification and penalties
If a notification is required it must be made by the due date for the tax return in question. The legislation applies to all tax returns whose due date for filing is after 31 March 2022, so for December year-end companies this will first apply to the tax return for the year ended 31 December 2021. There will be an online form to be completed. The required information will include the nature of the uncertainty and the quantum of tax at stake.
Failure to notify will give rise to penalties.
Implications
These new rules represent quite a shift in the UK transfer pricing compliance environment, which currently only obliges UK taxpayers to self-assess whether their transfer pricing meets the arm’s length test, but not to identify and notify potential counter-arguments to it.
The thresholds for size of company and tax at stake will exclude many transfer pricing analyses, but a considerable number will not be excluded.
This may lead to a dramatic increase in the importance of the IM. Although it will remain the case that taxpayers are free to adopt a position contrary to the IM if they feel the IM is wrong, they will surely now hesitate to do so, given that they will have to highlight the matter to HMRC, almost certainly leading to an enquiry. Furthermore, businesses who have, up until now, been far more concerned about the OECD transfer pricing guidelines than the IM may now have to refer to the IM as an essential part of every transfer pricing analysis, to determine whether anything in the IM might constitute a known position that is contrary to their proposed transfer pricing position.
There is no grandfathering. Uncertain tax treatments must be notified, even if they originated in earlier years.
Gareth Green
Transfer Pricing Solutions Ltd
44 1582764726
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