The UK has proposed deemed loan treatment for any advantage arising from a transfer pricing adjustment in excess of GBP1 million. 

Businesses need to take immediate action to review structures where transfer pricing adjustments might be made to identify whether those adjustments are at risk of being treated as deemed loans, with imputed interest.

What is proposed?

The UK is consulting  on the introduction of a "secondary adjustment rule" to cancel out any advantage that arises as a result of any transfer pricing adjustments made.

A transfer pricing "primary" adjustment occurs when the price paid in a transaction between related entities does not meet the arm's length test, resulting in a UK tax advantage. The tax advantage is cancelled by the adjustment, which only takes effect for tax purposes.

Example: UKCo pays its overseas subsidiary a royalty of GBP10 million for a licence to use IP. The arm's length price would have been GBP8 million so, following a primary adjustment, the tax deduction claimed by UKCo is reduced to GBP8 million, and its taxable profits increased by GBP2 million. However the overseas subsidiary retains the GBP2 million, which stays outside the UK tax net.

The secondary adjustment, if introduced, would treat the GBP2 million as a deemed loan from UKCo to its subsidiary, with the imputed interest (most likely at well above market rates) on that loan being taxable in UKCo's hands.  The deemed loan starts at the end of the accounting period in which the correct primary adjustment is made and ceases when the funds are repatriated to the UK as this would be seen as a repayment of the deemed loan.

Retrospective effect

Although the secondary adjustment rules are unlikely to be introduced until 2017 or 2018, it is likely that the change will have retrospective effect, that is, it will apply the rule to deemed loans "arising" in all accounting periods for which the enquiry window has not yet closed or where there is an open enquiry, such that the transfer pricing position has not yet become final.

This means that large deemed loans, and interest associated with those loans, could arise going back many years.

What should businesses be doing now?

Businesses with a risk of a transfer pricing adjustment in excess of GBP1 million being made could be affected by the new rules. This would significantly increase the cost of a disallowance of excess interest or outbound royalty under the UK transfer pricing rules. Groups should urgently review structures where this is likely to be an issue.

Given the rule's potential retrospective application, businesses have a real incentive to accelerate APA/ATCA discussions with HM Revenue & Customs, or, where practical, to settle disputes, in order to reach agreement as soon as possible.

The proposals are outlined in the Consultation Document, which can be accessed here and comments are invited until 18 August 2016.