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Review and adjustments

Review and audit

What rules, standards and procedures govern the tax authorities’ review of companies’ compliance with transfer pricing rules? Where does the burden of proof lie in terms of compliance?

Her Majesty’s Revenue and Customs (HMRC) has established an overarching transfer pricing group with specialist knowledge and skill, which is overseen by a transfer pricing board. The board monitors the work of HMRC in relation to transfer pricing.

The taxpayer’s charter, published by HMRC, sets out the rights taxpayers should enjoy, and HMRC’s expectations of the taxpayer. In addition, HMRC is guided by its internal manual in dealing with potential controversies, HMRC International Manual at INTM482040-482160. Additionally, the Code of governance for resolving tax disputes is in place to ensure that HMRC deals with all cases fairly.

Audits into transfer pricing issues, referred to as ‘enquiries’, involve the following three-stage process:

  • At the selection stage, a risk assessment will be carried out in order to determine whether an enquiry is necessary – the relevant officers must have a business case to support an enquiry.   
  • The progress stage involves opening an enquiry by issuing a formal corporation tax self-assessment enquiry notice under the rules in Schedule 18 of the Finance Act 1998 (which generally require an enquiry to be opened within 12 months following the date on which a corporation tax return is filed).
  • At the resolution stage, after sufficient information is made available and an analysis has been carried out, HMRC will form a view on the transfer pricing subject to the enquiry. If adjustments are required, HMRC may either proceed toward settlement or litigation against the taxpayer. It should be noted that the transfer pricing board is the only body with the power to decide whether to litigate.

HMRC endeavours to settle transfer pricing enquiries within 18 months; however, particularly complex cases may take up to 36 months. The average completion time for 2016-2017 was just under 30 months.

Most transfer pricing cases involve taxpayers seeking to show that a decision by HMRC is incorrect. Therefore, the formal question of where the burden of proof lies need not be addressed, as the court may accept either the taxpayer's or HMRC’s position, or arrive at a different conclusion as to the application of the arm's-length test. It is normally the taxpayer that presents a case first at an appeal hearing, and therefore the burden of proof theoretically lies with them; however, where the taxpayer has purportedly failed to submit a return or comply with a notice, HMRC must prove that this failure took place.

Do any rules or procedures govern the conduct of transfer pricing audits by the tax authorities?

HMRC International Manual at INTM482040-482160, the taxpayer charter and the code of governance for resolving tax disputes (see above).

Penalties

What penalties may be imposed for non-compliance with transfer pricing rules?

The transfer pricing penalty regime is the same as for other direct tax infringements. HMRC provides guidance on how these penalties are applied to transfer pricing in its International Manual. The penalty depends on how serious the non-compliance is considered to be and the degree of culpability of the taxpayer in any underpayment of tax.

A penalty may be due in the following circumstances:

  • If an incorrect return is made and a business has been careless or negligent in establishing the arm’s-length basis for the return. The following standard maximum penalties will apply, based on the potential lost revenue, depending on the particular circumstances involved.

Reason for penalty

Type of inaccuracy

Maximum penalty payable

Giving an inaccurate return or other document

 Careless

 30% of potential lost revenue

Giving an inaccurate return or other document

Deliberate, not concealed

70% of potential lost revenue

Giving an inaccurate return or other document

 Deliberate and concealed

100% of potential lost revenue

Inaccuracy discovered later but no reasonable steps taken to inform the relevant body 

Treated as careless

30% of potential lost revenue

Understated assessment not notified

N/A

30% of potential lost revenue

Inaccuracy due to the deliberate behaviour of another person

N/A

100% of potential lost revenue

 

  • If a business does not maintain the appropriate documentation necessary to demonstrate that it has made its returns on the basis that the terms of connected party transactions were considered to be on arm’s-length terms. The penalty for failure to keep or preserve records can be up to £3,000.

Penalties for non-compliance with country-by-country reporting range from £300 to £3,000. There is also a penalty of £60 for each day a taxpayer fails to provide information.

Adjustments

What rules and restrictions govern transfer pricing adjustments by the tax authorities?

Under UK transfer pricing legislation, HMRC may make primary adjustments, and in the case of UK-to-UK transactions, compensations or corresponding adjustments.

HMRC requires that the taxpayer make available all information and records it considers relevant to the tax in question. This power extends to information including electronically stored communications or other data, and HMRC is entitled to use this information when reaching its decision, making adjustments or during any formal litigation proceedings (subject to any legal or professional privileges that might prevent certain information being admitted as evidence).

HMRC does not use secret comparables when determining the arm’s-length price in an enquiry.

Challenge

How can parties challenge adjustment decisions by the tax authorities?

Taxpayers may appeal decisions made by HMRC to the First-tier Tax Tribunal. The dispute may also be resolved through alternative dispute resolution or settlement. While this approach is encouraged by HMRC, the practice is still rare in the United Kingdom. If permission is granted, further appeals may be brought in the Upper Tribunal, Court of Appeal and Supreme Court.

Mutual agreement procedures

What mutual agreement procedures are available to avoid double taxation arising from transfer pricing adjustments? What rules and restrictions apply?

While not all tax treaties of which the United Kingdom is signatory contain the mutual agreement procedure provision, in practice this has not prevented HMRC from attempting to resolve a dispute with its tax treaty partner if an exchange of information article exists which allows for information to be provided as part of a discussion.

The only condition for requesting a mutual agreement procedure is that an action giving rise to double taxation has (or is likely to) occurred in the territory concerned, either within six years from the end of the relevant accounting period or the period as specified in the relevant treaty, whichever period happens to be longer. HMRC’s description of how it would normally expect a claim to proceed is set out in Statement of Practice 1 (2011).

The United Kingdom has also begun to include arbitration clauses in its tax treaties. These exist under the UK-France tax treaty, as well as tax treaties with Germany, the Netherlands and Switzerland. Further, it has opted to apply Part IV of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) to its tax treaties, providing arbitration measures which will apply with respect to tax treaties where both contracting jurisdictions have chosen to apply Part VI of the MLI.

The EU convention on the elimination of double taxation in connection with the adjustment of profits of associated enterprises (90/463/EEC) may provide an alternative to the mutual agreement procedure under UK tax treaties, where residents of EU member states are potentially subject to double taxation. A mutual agreement procedure may be invoked under one of the United Kingdom’s tax treaties, under the European Arbitration Convention or both simultaneously.

Further, the EU Tax Dispute Resolution Mechanism Directive, adopted on October 10 2017, provides measures that aim to ensure taxpayers are able to resolve all disputes related to the interpretation and application of tax treaties. While this directive will become applicable in the European Union from July 2019, it is unclear whether UK taxpayers will have access to its benefits, due to the uncertainty surrounding the United Kingdom leaving the European Union.

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