There are various changes being made to the TP legislation and other parts of the legislation which interact with the TP rules. In general these are positive because they should reduce ambiguity for taxpayers and support the application of tax treaties to improve tax certainty.
One of the main areas where there is no international consensus is on a definition of when two enterprises are associated. In the UK, we have the participation condition, which defines when two enterprises are treated as associated for the purposes of the UK TP rules. HMRC intend to make some targeted changes that will widen the net:
- A new form of direct participation where two persons are subject to an agreement for common management;
- An anti-avoidance provision ensuring the participation condition is met when a person enters into arrangements with a main purpose of not meeting the participation condition; and
- A power allowing HMRC to issue a transfer pricing notice requiring a taxpayer who is under enquiry to file on the basis that the participation condition is met.
On a more positive note, HMRC have listened to feedback that the 鈥�acting together鈥� rule is overly broad and ambiguous. Amendments will focus on aggregating equity holding lenders鈥� interests for the purposes of determining indirect participation for financing transactions involving persons acting within the same arrangement.
As expected, some transactions between UK resident companies will be made exempt from the application of UK TP rules. Whilst the exemption is a welcome development, it is narrowly defined so as to protect the UK tax base and, as a result, there are various qualification and disqualification criteria that, on first impressions, do not look like much of a simplification but do at least provide greater clarity on when TP should be considered for domestic transactions. The taxpayer may elect, or HMRC may direct, that the exemption should be disapplied. We do still see some cases where taxpayers would wish to elect to apply the TP rules so that they can claim compensating adjustments and those compensating adjustment provisions will be retained with some helpful changes relating to financial transactions.
One of the most significant areas of tension between the current UK TP rules and OECD principles relates to financial transactions, where the OECD published specific guidance found in Chapter X of the OECD Transfer Pricing Guidelines in 2020. Here the UK TP rules聽(initially for new or substantially amended debt only) will be better aligned with the Chapter X guidelines. In particular:
- The legislation will make it unambiguous that implicit support to a borrower鈥檚 credit quality from its group should be taken into account; and
- Explicit guarantees will also be taken into account, to the extent they would lower the rate of interest at arm鈥檚 length, but not to the extent they increase the quantum borrowed.
The compensating adjustment rules for domestic lenders or guarantors are retained with helpful amendments relating to distinguishing guarantees from implicit support that should reduce ambiguity.聽There is also a helpful change that will make section 192 claims clearer and more certain. Broadly, this will allow a UK company outside the borrowing unit of a thinly capitalised UK borrower to elect to be taxed as if it provided a guarantee over all or part of the non-arm鈥檚 length element of the borrowing, enabling excess borrowing capacity in other UK companies (e.g. a UK sister company) to be accessed. This claim is helpful for inbound groups, for example where they have a divisional structure and do not hold all their UK operations under a single UK holding company.
Valuations for transfers of intangible fixed assets that fall within the scope of the UK TP rules will be performed under the arm鈥檚 length principle. This will help improve tax certainty through Advance Pricing Agreements and treaty negotiations. The limited derogation from the one-way street principle will be retained for transfers (but not licences) of intangible fixed assets.
The draft legislation also includes clauses that bring exchange gains and losses on loan relationships and derivative contracts into scope of the UK TP rules, but without disturbing existing hedging arrangements. The one-way street will also be relaxed so as to not disallow debits that represent a reversal of a foreign exchange or fair value credit that was previously brought into account. There will be a consultation on a limited documentation requirement to accompany the FX rule changes.
It is good to see that there are circumstances where HMRC are willing to relax the one-way street, but not going further with this as part of the first major reform of the TP rules in the last 20 years is also arguably a missed opportunity as the one-way street approach is increasingly problematic in practice as explained in our previous article published in Tax Notes International which makes the case for wider relaxation.
