HMRC figures show that significant progress has been made in resolving transfer pricing issues with companies since a new approach was adopted in 2008, the department announced.
The average age of open enquiries at 30 September 2011 was 21 months, compared to 32 months at 31 March 2008. The average time taken to settle an enquiry fell from 38 months to 24 months over the same period. Of the enquiries settled in the year to 30 September 2011, half were settled within 19 months of being opened.
The yield from transfer pricing enquiries in 2010/11 was £436m, down from just over £1bn the previous year. ‘Fluctuations in the level of yield from year to year are principally due to the effects of a small number of very large cases,’ HMRC said. ‘At the mid-year point the yield for 2011/12 has already significantly exceeded the total yield for 2010/11.’
Andrew Hickman, Partner in KPMG’s transfer pricing practice, said HMRC had cleared some ‘very large’ older cases.
‘We can now expect more cases to be taken up to close the tax gap, and the statistics already show a focus on smaller taxpayers in addition to the largest multinationals,’ he said. ‘Hard data about HMRC’s transfer pricing efforts has not been readily available, and so publication is welcomed.’
Thirty-five Advance Pricing Agreements were reached during 2010/11, HMRC said. The average time taken to reach agreement was almost 23 months.
Fixing a transfer price is ‘not, in itself, illegal or abusive’
Transfer pricing is something that ‘unscrupulous companies abuse in order to evade tax’, Christian Aid said in a submission to the G20 last year. Such abuse is considered to be a key element in what the charity has called ‘massive tax dodging by multinationals’.
In a report for the European Commission last year, PwC Belgium estimated that about two-thirds of business transactions worldwide take place within a group of companies, and that many developing countries capture only 40% of their tax potential.
Campaigners accept that transfer pricing itself is not, as some critics have suggested, a form of tax evasion or avoidance. The transfer price is the price fixed when related parties trade with each other.
The global Tax Justice Network says on its website: ‘Transfer pricing is not, in itself, illegal or abusive. What is illegal or abusive is transfer mispricing, also known as transfer pricing manipulation or abusive transfer pricing.’
KPMG’s Andrew Hickman and Sarah Norton co-authored the transfer pricing division of Simon’s Taxes – published by LexisNexis, which also publishes Tax Journal. They observed that a ‘general assumption’ is often made that because of the special relationship between two related parties, the transfer price that results from negotiations could be affected by that relationship.
‘Tax authorities are therefore concerned to eliminate two things,’ they wrote. ‘Firstly, the deliberate manipulation by [multinational enterprises or MNEs] of their transfer prices to recognise lower profits in states with higher corporate tax rates, and vice versa. This can reduce the aggregate tax payable by the multinational group, so minimising the global tax rate and increasing after-tax returns available for distribution to shareholders. Secondly (and more commonly), the inadvertent use of transfer pricing that does not meet the arm's length principle.’
UK tax law requires a company to make an adjustment in its tax return to the profits shown in the accounts, so that the tax liability is based on the price that would have been agreed in an ‘arm’s length’ transaction.
Relative indifference
Hickman and Norton added: ‘There are a number of reasons why an MNE may use pricing that inadvertently does not meet the arm's length principle. For instance, the MNE may adopt transfer pricing designed to incentivise certain behaviour by group members. Alternatively, the MNE may simply be relatively indifferent about where they recognise profit.
‘One explanation for this may be that senior management is often not primarily concerned with the profitability of a particular legal entity. The focus instead is on whether a particular product or product line is profitable and contributing to the group's overall level of profitability. Many MNEs analyse the final selling price of their product to the end user and the cost of producing that product including distribution. The location in which the profit occurs is of secondary importance.
‘However, for tax authorities, the location in which profits are recognised is of crucial importance. The friction between the tax legislator's focus on national boundaries and taxable entities and the multinational's view of transnational product lines and organisation causes much of the heat in both complying with and policing transfer pricing rules.’
HMRC’s view
The authors’ assessment is reflected in HMRC’s published guidance. The department’s International Manual says:
‘A transfer price is the price charged in a transaction. And where connected parties transact with each other there is not always the need or the incentive to charge prices that precisely replicate what would have happened had they been dealing at arm's length. As a result the level of their commercial profits may differ – sometimes by accident and, on occasions, by design – from what would have arisen if they had done the same transactions with unconnected parties.’
HMRC figures show that significant progress has been made in resolving transfer pricing issues with companies since a new approach was adopted in 2008, the department announced.
The average age of open enquiries at 30 September 2011 was 21 months, compared to 32 months at 31 March 2008. The average time taken to settle an enquiry fell from 38 months to 24 months over the same period. Of the enquiries settled in the year to 30 September 2011, half were settled within 19 months of being opened.
The yield from transfer pricing enquiries in 2010/11 was £436m, down from just over £1bn the previous year. ‘Fluctuations in the level of yield from year to year are principally due to the effects of a small number of very large cases,’ HMRC said. ‘At the mid-year point the yield for 2011/12 has already significantly exceeded the total yield for 2010/11.’
Andrew Hickman, Partner in KPMG’s transfer pricing practice, said HMRC had cleared some ‘very large’ older cases.
‘We can now expect more cases to be taken up to close the tax gap, and the statistics already show a focus on smaller taxpayers in addition to the largest multinationals,’ he said. ‘Hard data about HMRC’s transfer pricing efforts has not been readily available, and so publication is welcomed.’
Thirty-five Advance Pricing Agreements were reached during 2010/11, HMRC said. The average time taken to reach agreement was almost 23 months.
Fixing a transfer price is ‘not, in itself, illegal or abusive’
Transfer pricing is something that ‘unscrupulous companies abuse in order to evade tax’, Christian Aid said in a submission to the G20 last year. Such abuse is considered to be a key element in what the charity has called ‘massive tax dodging by multinationals’.
In a report for the European Commission last year, PwC Belgium estimated that about two-thirds of business transactions worldwide take place within a group of companies, and that many developing countries capture only 40% of their tax potential.
Campaigners accept that transfer pricing itself is not, as some critics have suggested, a form of tax evasion or avoidance. The transfer price is the price fixed when related parties trade with each other.
The global Tax Justice Network says on its website: ‘Transfer pricing is not, in itself, illegal or abusive. What is illegal or abusive is transfer mispricing, also known as transfer pricing manipulation or abusive transfer pricing.’
KPMG’s Andrew Hickman and Sarah Norton co-authored the transfer pricing division of Simon’s Taxes – published by LexisNexis, which also publishes Tax Journal. They observed that a ‘general assumption’ is often made that because of the special relationship between two related parties, the transfer price that results from negotiations could be affected by that relationship.
‘Tax authorities are therefore concerned to eliminate two things,’ they wrote. ‘Firstly, the deliberate manipulation by [multinational enterprises or MNEs] of their transfer prices to recognise lower profits in states with higher corporate tax rates, and vice versa. This can reduce the aggregate tax payable by the multinational group, so minimising the global tax rate and increasing after-tax returns available for distribution to shareholders. Secondly (and more commonly), the inadvertent use of transfer pricing that does not meet the arm's length principle.’
UK tax law requires a company to make an adjustment in its tax return to the profits shown in the accounts, so that the tax liability is based on the price that would have been agreed in an ‘arm’s length’ transaction.
Relative indifference
Hickman and Norton added: ‘There are a number of reasons why an MNE may use pricing that inadvertently does not meet the arm's length principle. For instance, the MNE may adopt transfer pricing designed to incentivise certain behaviour by group members. Alternatively, the MNE may simply be relatively indifferent about where they recognise profit.
‘One explanation for this may be that senior management is often not primarily concerned with the profitability of a particular legal entity. The focus instead is on whether a particular product or product line is profitable and contributing to the group's overall level of profitability. Many MNEs analyse the final selling price of their product to the end user and the cost of producing that product including distribution. The location in which the profit occurs is of secondary importance.
‘However, for tax authorities, the location in which profits are recognised is of crucial importance. The friction between the tax legislator's focus on national boundaries and taxable entities and the multinational's view of transnational product lines and organisation causes much of the heat in both complying with and policing transfer pricing rules.’
HMRC’s view
The authors’ assessment is reflected in HMRC’s published guidance. The department’s International Manual says:
‘A transfer price is the price charged in a transaction. And where connected parties transact with each other there is not always the need or the incentive to charge prices that precisely replicate what would have happened had they been dealing at arm's length. As a result the level of their commercial profits may differ – sometimes by accident and, on occasions, by design – from what would have arisen if they had done the same transactions with unconnected parties.’
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