Corporation Tax

10 questions answering everything you want to know about transfer pricing

1. What is it? Transfer pricing is the charges made by one enterprise to another within the same group, (they don’t need to be legal entities)

2. Why is it important?

It is often used by businesses (enterprises) to move profits to low tax jurisdictions

3. What does it cover?

Sale of goods

Provision of services, including management fees

License of intangibles, patents

Use of money, interest rates and thin capitalised businesses

Use of tangible property

Or the non-charge for these

4. How does HMRC confirm the pricing is correct?

By using an “at arms lengths” test know as Comparable Uncontrolled Price (CUP). Of course this isn’t always available so the HMRC can also use

Resale price

Cost plus

Profit split

Residual profit split

Transactional net margin

5. Burden of proof

Is with HMRC, although governed by the OECD. Article 9 of the Model Tax Convention

forms the basis of bilateral tax treaties involving OECD member countries

Taxpayers are only expected to provide documentation which would be reasonable for them to have in their possession.

From the taxpayer’s point of view, the OECD guidance only requires documentation to be kept which would be consistent with the evaluation of any other business decision.

6. What records need to be kept?

Only the records that would normally be expected to be kept by a business. HMRC can’t ask for anything else.

Documentation must exist at latest by the time the Corporation Tax return is filed.

7.  What can be done to mitigate?

Entering into an Advance Pricing Agreement (APA) with HMRC, it’s preferable to a retrospective examination of the enterprise’s transfer pricing policies

It is binding on HMRC and the company over an agreed period, usually 3 to 5 years

8. Who needs to be worried?

Obviously all large organisations, medium enterprises are subject to power of direction, which means they don’t have to self-assess. The HM Revenue and Customs would only make a power of direction against one of these companies in exceptional circumstances.

A small enterprise is completely exempt from the transfer pricing rules, unless the other party is a related party in a country without a non-discrimination clause typically, a tax haven.

9.  So what’s the definition?

Enterprise Category

Headcount

Turnover

Balance Sheet Value

Medium

<250

Not to exceeding €50m

Not exceeding €43m

Small

<50

Not to exceeding €10m

Not exceeding €10m

Macro

<50

Not to exceeding €2m

Not exceeding €2m

10. To encourage UK businesses to not park their patents overseas HMRC introduced the Patent Box 10% CT rule.

The Patent Box enables companies to apply a lower rate of Corporation Tax to profits earned after 1 April 2013 from its patented inventions and certain other innovations. The relief will be phased in from 1 April 2013 and the lower rate of Corporation Tax to be applied will be 10 per cent.

Patent Box

The Patent Box enables companies to apply a lower rate of Corporation Tax to profits earned after 1 April 2013 from its patented inventions and certain other innovations. The relief will be phased in from 1 April 2013 and the lower rate of Corporation Tax to be applied will be 10 per cent. The company can only benefit from the Patent Box if the company is liable for Corporation Tax and makes a profit from exploiting patented inventions.

The company must also own or exclusively license-in the patents and must have undertaken qualifying development on them.

An enterprise can benefit from the Patent Box if the company owns or exclusively licenses-in patents granted by:

  • UK Intellectual Property Office
  • European Patent Office

The company or another group company must have also undertaken qualifying development for the patent by making a significant contribution to either:

  • the creation or development of the patented invention
  • a product incorporating the patented invention

Watch out for transfer pricing issues, see my blog on this.

Patent holders may wish to license their inventions for further development. If the company holds licenses to use others' technology it may still be able to benefit from the Patent Box. But to do so it must meet all of the following conditions:

  • Rights to develop, exploit and defend rights in the patented invention
  • One or more rights to the exclusion of all other persons (including the licensor)
  • Exclusivity throughout at least an entire national territory - rights to manufacture or sell within part of a country, for example, would not qualify as exclusive
  • The licensee must either be able to bring infringement proceedings to defend its rights or be entitled to most of the damages awarded in successful proceedings relating to its rights.

The exclusive licensing conditions are relaxed for groups of companies. This recognises that one company in the group may own a portfolio of patents while another exploits them.

The company has to make an election to benefit from the reduced rate of Corporation Tax that applies to the Patent Box.

The election must be made within two years after the end of the accounting period in which the relevant profits and income arose.

The full benefit of the regime will be phased in from 1 April 2013. You will need to apply an appropriate percentage to the profits your company earns from its patented inventions.

The appropriate percentages for each financial year are:

  • 1 April 2013 to 31 March 2014: 60 per cent
  • 1 April 2014 to 31 March 2015: 70 per cent
  • 1 April 2015 to 31 March 2016: 80 per cent
  • 1 April 2016 to 31 March 2017: 90 per cent
  • from 1 April 2017: 100 per cent

Just for the nerds, there is no box on the Company Tax Return for making the election. Instead apply the reduced 10 per cent rate by subtracting an additional trading deduction from your Corporation Tax profits.

Examples

 

If a company has trade Corporation Tax profits of £1,000 in the financial year from 1 April 2015 which qualify in full for the Patent Box, and the main rate of tax is 22 per cent, then instead of arriving at a tax charge of £100 by multiplying £1000 by 10 per cent, the calculation is:

 

Calculation Amount
Profits chargeable to Corporation Tax £1,000
Patent Box deduction = £1000 × 80% x ((22 - 10) ÷ 22) £436
Profits chargeable to Corporation Tax £564
Tax payable = £564 × 22% £124

Depreciation for tax purposes

In the language of the taxman, depreciation is called “Capital Allowances” or sometimes ”wear and tear allowances”  and how we accountants report it differs in the management reports of businesses be they internal management accounts or for statutory reporting. So what purchases are covered by Capital Allowances? Not always an easy question to answer, but if you buy or make something either physical or intangible (for example software, although not internally generated intellectual property “IP” ), and it is used to produce economic benefit to the business or, put simply, kept long term for the benefit of the business then that will be considered an applicable purchase.

In accountants’ terms, we define Fixed Assets using various headings, for example Buildings, Motor Vehicles, Computers, Plant & Machinery and Fixtures and Fittings. Depending on the type of asset, the business may apply different rates of depreciation.

The taxman’s treatment of Fixed Assets is totally different. There is not a relationship at all, giving rise to a heading in a business’ statutory accounts as “Deferred Tax” being a timing difference between the accountant and the tax treatment.

HMRC starts with two headings, the main pool where most assets are classified and the special rate pool.

Once the purchase or construction has passed the test of being suitable to claim Capital Allowances, the asset is placed in the general pool, unless it qualifies as being classified elsewhere.

The special rate pool covers all assets that are integral to the business’ properties, (not the building itself though, that rule was phased out in 2006).

The assets which are now classed as integral features are:

* Electrical systems (including lighting systems)

* Cold water systems

* Space or water heating systems, powered systems of ventilation, air cooling or air purification, and any floor or ceiling comprised in such systems

* Lifts, escalators and moving walkways

* External solar shading

Over the years a number of exceptional pools were created, ostensibly to make the system more user friendly:

Small Pool Allowance

Two considerations.  If capital expenditure in either the general pool or special rate pool is less than £1,000 then it can be written off in the current year.

New expenditure of £1,000 or less, recorded separately in its own pool and written off in full in the current year.  Just in case you were thing of it, you can’t write off the first £1,000 of expenditure in this manner

 Annual investment allowance (AIA)

This was introduced in 2008 and covers plant and machinery, but not cars. The allowance has been a bit of a yoyo. When it was introduced in 2008, the allowance was £50,000, in 2010 this was increased to £100,000, then in April 2012 reduced to £25,000. It was announced in the Autumn statement that from the 1 January 2013 for two year only this allowance has been increased to £250,000

The AIA replaced the first year allowances which ceased to be allowable from 2008. Although there was a special first year allowance which was applied temporarily in 2009 to energy-saving and water-efficient equipment, cars with very low carbon dioxide emissions and goods vehicles with zero carbon emissions.

Type

Capital Allowance

Includes

1

Main Pool 18%  per annum since 6 April 2012 Until 2008 this was 25%, was previously 20% All assets not included elsewhere

2

Special Rate Pool 8% per annum Until 2008 this was 10% Long life assets

3

Annual Investment Allowance (AIA) £250,000 per annum since 1 January 2013 for 2 years When introduced in 2008 was £50K increased to £100K in in 2010. Down to £25,000 in April 2012 On plant and machinery only

4

First year allowance SME 50%, Medium sized businesses 40% Not  long life assets or leased equipment On plant and machinery only

Capital Allowances on motor vehicles rules are more complicated and are on a separate blog

Life after submitting a tax return

You’ve completed your tax returns, you think you can now breathe a sigh of relief, but can you? HMRC can inspect any taxpayer’s records under Schedule 36 by FA08, FA09 and FA10. They can check the tax records for:-

Pay as You Earn (PAYE)

Value Added Tax (VAT)

Income Tax (IT)

Capital Gains Tax (CGT)

Corporation Tax (CT)

Insurance Premium Tax (IPT)

Inheritance Tax (IHT)

Stamp Duty Land Tax (SDLT)

Stamp Duty Reserve Tax (SDRT)

Petroleum Revenue Tax (PRT)

Aggregates Levy (AGL)

Climate Change Levy (CCL)

Landfill Tax (LFT) and

Bank Payroll Tax (BPT)

 

The technical term for the inspection is a Compliance Check. They will check that the tax payer has:-

  1. Complied with their obligations
  2. Paid the correct amount of tax and at the right time
  3. Claimed the correct reliefs and allowances

 

 

 

The inspection

This can be completed by anything from a short telephone call to confirm a single fact, to a detailed investigation of a person's entire financial affairs over a period of years.

HMRC may undertake checks by either asking for information or documents or by arranging a meeting or visit.

They may:

  • Require taxpayers by notice in writing to provide information and produce documents (a “taxpayer notice”)
  • Require third parties by notice in writing (for example a supplier or bank) to provide information and produce documents (a “third party notice”)

 

The caveat being that these requirements are reasonable for the purpose of checking a tax position. The generic term for these types of notice is information notice.

 

The recipient has the protection of a right of appeal to, or prior approval by, an independent tribunal. There is no right of appeal however where the notice only refers to information or documents that form part of a taxpayer's statutory records, or any person's records that relate to:

  • The supply of goods and services
  • The acquisition of goods from another member state, or
  • The importation of goods from outside the European Union (EU) by a business

 

If the taxpayer is not forthcoming with the information, HMRC may invoke their statutory powers to obtain them.

 

They may also request assistance with aspects of a tax check from other government departments.

 

This could include a situation where there is reason to believe that a taxpayer:

  1. did not notify chargeability to tax
  2. did not register for VAT if required, or
  3. is operating in the informal economy

Restrictions on Information Powers

The taxman is not all-powerful; some safeguards have been installed, set out in the law and with guidance so that in carrying out compliance checks

  • HMRC's powers are used reasonably and proportionately
  • Taxpayers are clear about when a compliance check begins and ends
  • Officers have no right to enter any parts of premises that are used solely as a dwelling, whether to carry out an inspection or to examine documents produced under an information notice. They can, however, enter if invited
  • FA09 adds to Sch 36 FA08 a power to inspect all property for the purpose of valuation (for direct taxes purposes). This requires either the taxpayer's agreement or Tribunal approval
  • Unannounced visits will only be made where agreement has been given by an authorised officer

Other safeguards include the fact that officers can’t require certain things to be provided:

  1. Information relating to the conduct of appeals against HMRC decisions
  2. Legally privileged information
  3. Auditors or tax advisers advice to a client about their tax affairs
  4. Information about a person's medical or spiritual welfare
  5. Journalistic material

Time constraints

  • Information over six years old can only be included in a notice issued by or with the approval of an authorised officer
  • HMRC cannot give a notice in respect of the tax position of a dead person more than four years after the person's death

 

The Power to Visit Business Premises and Check Assets and Records

Inspection powers allow an officer of HMRC to enter business premises and inspect the premises, business assets and statutory records.

 

If an information notice has been issued earlier, the documents required in that notice could be inspected at the same time.

 

FA09 incorporates into Schedule 36 inspection powers in respect of the:

  • business premises of Involved third parties
  • valuation of premises for Income Tax or Corporation Tax

These inspections:

  • must only be undertaken where it is reasonably required to establish the tax position and
  • will normally be by prior arrangement, the date and time being convenient to the taxpayer

The Power to Visit Business Premises and Check Assets and Records

Inspection powers also allow any officer to enter any premises when they believe the premises are to be used in connection with taxable supplies of goods or taxable acquisition of goods from Member States, and such goods or documents relating to such goods are on the premises.

There is no right of appeal against an inspection but the occupier can refuse entry and prevent the inspection from being completed.

The occupier can be penalised for such obstruction, where the inspection has been approved by a Tribunal.

There may be occasions when a pre-arranged visit will be inappropriate, for example where there is a strong risk that the taxpayer would move the business or remove stock or other assets. In such cases, an unannounced visit may be undertaken subject to prior agreement by an authorised officer.

If a formal statutory approach is needed, and it has not been possible to agree the time of inspection and give written confirmation, the inspection must be approved by a Tribunal and 7 days written notice of the time of the inspection given. The application for approval must be made by, or with the approval of, an authorised officer.

When a Penalty can be charged where a person:

  • Fails to comply with an information notice
  • Conceals, destroys or otherwise disposes of documents required by an information notice
  • Conceals, destroys or otherwise disposes of documents that they have been notified are, or are likely to be, required by an information notice
  • Deliberately obstructs an inspection that has been approved by the Tribunal.
  • In complying with an information notice provides inaccurate information or produces a document that contains an inaccuracy,
  • Fails to comply with a notice requiring contact details of a tax/duty debtor to HMRC.

These rights are covered in sections 38 FA 08 and 09

 

Types of Penalties

There are four types and amounts of penalty:

  • An initial penalty of £300
  • A daily penalty of up to £60 for every day that the failure or obstruction continues after the date the initial penalty is assessed
  • A tax-related penalty
  • A penalty not exceeding £3000 for providing inaccurate information or documents in response to an information notice

A tax-related penalty is in addition to the initial penalty and any daily penalties. The amount of the penalty is decided by the Upper Tribunal having regard to the amount of tax which either has not, or is unlikely to be, paid by that person.

 

A person is not liable to a penalty if they have a reasonable excuse for:

  • Failing to comply with an information notice, or
  • Providing inaccurate details or documents, or
  • Deliberately obstructing a tribunal approved inspection

If they correct their failure as soon as the excuse ends, the excuse will then be treated as continuing until the correction is made.

Normally, daily penalties will not be assessed after the failure has been remedied.

Record Keeping

Schedule 37 of FA08 amended existing record keeping legislation in respect of PAYE, VAT, IT, CGT and CT, whilst Schedule 50 to FA2009 extends this approach to IPT, SDLT, AGL, CCL, and LFT with BPT being included from 8 April 2010. Following consultation it was accepted that SDRT and PRT did not require separate statutory provisions, whilst IHT will be addressed through guidance.

These provisions are aimed at alignment and clarification.

This approach is designed to be flexible across a range of business and non-business taxpayers.

There are penalties for failure to keep adequate records.

The basic requirements in relation to record keeping have not changed but rules have been aligned on how long records are kept.

 

How long to keep your records

As a general rule, you should keep your records for a minimum of six years. However, if you are:

• an employer, you need to keep Pay As You Earn (PAYE) records for 3 years

(in addition to your current year)

• a contractor in the Construction Industry Scheme (CIS), you need to keep your CIS

records for 3 years (in addition to your current year)

• keeping records to complete a personal (non business) tax return, you only need to

keep them for 22 months from the end of the tax year to which they relate.

If you need to keep records for other reasons, for example the Companies’ Act

requires limited companies to keep specific records and you also use those records

for tax purposes, you need to be aware that there may be different time limits for

retaining them. Be careful not to destroy any records you also use for tax purposes

too soon.