What UK changes can we expect?
In January 2024, HMRC released a summary of consultation responses on the proposed reform of transfer pricing rules (along with permanent establishment/PE and Diverted Profits Tax/DPT rules). The Government is aiming to produce draft simplified legislation for consultation during 2024 with the aim of improving tax certainty and achieving better alignment with Double Tax Treaties.
What might we expect?
Changes to UK:UK Transfer Pricing Rules
This will create an unnecessary compliance burden with limited risk of tax loss to the Government. Could these rules be removed in all circumstances except where there is a UK tax advantage, e.g., though taking advantage of small CT rate?
Definition Changes
Definition changes relating to (for example) the use of the term “provision” for identifying impacted transactions, the “participation condition” and the “acting together” rules. It would of course be extremely helpful if the definition of “control” was unified across all areas of tax legislation.
Simplification of rules
Simplification of rules regarding the valuation of intangible assets and the loan relationship rules and their interaction with transfer pricing rules; and
More guidance from HMRC
More guidance from HMRC on the application of any new legislation including the operation of the “one way street” provisions whereby TP adjustments can only increase UK taxable income.
What USA changes can we expect?
In October 2023, the IRS announced new enforcement initiatives including a “large foreign-owned corporations transfer pricing initiative.” This appears to be specifically targeting US distributors that report losses or low profits on a consistent basis. The IRS has been sending letters to US distribution subsidiaries highlighting their US tax obligations.
The letters essentially state that where the company has reported losses or low margins, the pricing of intercompany transactions may not comply with US transfer pricing rules. The letters suggest that if the company has not complied fully with the rules, the company should file amended tax returns to increase its US taxable income for the years in question. Asking the company to self-correct their transfer pricing position acts as a warning that the company is on the IRS radar for reflecting too little profit in the US. Companies should ensure that their transfer pricing documentation and benchmarking is up to date and supports that their transfer pricing is arm’s length.
Who should be concerned by these developments?
A “distributor company” is potentially an easy target for any Tax Authority since it is not usually a complex entity. It has limited functions and limited risks and should not be making consistent losses year after year. If there are losses or low profits over an extended period of time, this could indicate that transfer pricing below market rates is the reason unless there are other factors such as a start-up/market penetration phase or lack of appetite for the product in the local market (but these reasons can only be short term as an “independent business” would soon go out of business or exit the market).
Do you operate a target operating margin approach with sustained low profitability or losses?
If yes, now is the time to revisit your transfer pricing model and ensure the policies are supportable with up-to-date documentation and benchmarking data. This should ensure your TP model will stand up to Tax Authority scrutiny and will offer protection against and costly penalties in the event of enquiries.
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