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HMRC have published an amended technical note on compensating adjustment rules, following a recent consultation.
The transfer pricing rules are designed to mainly avoid double taxation between individuals and connected companies on international transactions, but they also apply to transactions within the UK. An increase in the taxable profits of one party gives rise to a right of the counterparty to claim a corresponding tax reduction known as the compensating adjustment.
HMRC have published an amended technical note on compensating adjustment rules, following a recent consultation.
The transfer pricing rules are designed to mainly avoid double taxation between individuals and connected companies on international transactions, but they also apply to transactions within the UK. An increase in the taxable profits of one party gives rise to a right of the counterparty to claim a corresponding tax reduction known as the compensating adjustment.
The current adjustment rules can reduce the overall tax payable where the increased profits are taxable at corporation tax rates but the compensating adjustment is relieved at a higher income tax band.
Under the new regime, persons other than companies within the change to income tax will be prevented from claiming a compensating adjustment where the counterparty is a person within the charge to corporation tax.
When the compensating adjustment claim is denied but the claim would have related to excess interest paid by the counterparty, the excess interest – over an arm’s length amount – will be treated for income tax purposes as a dividend rather than interest, meaning the excess will be taxed at dividend rates rather than at rates applicable to interest.
Legislation giving effect to the changes to the transfer pricing code takes effect from 25 October 2013. Amounts of fee income or interest accruing before the date are outside the scope of the measure.
Nigel May, tax partner at MacIntyre Hudson, warned that the change means large partnerships and limited liability partnerships must consider carefully the pricing methodology for transactions with any connected companies
“The legislation is not limited to the service companies that are targeted and could as easily impact upon arrangements that had been put in place for commercial purposes, where a transfer price has not been maintained,” he said.
“Where a tax driven service company structure has been put in place, consideration needs to be given to the particular circumstances: are there commercial reasons for maintaining the structure, with necessary adjustments to reflect the new environment?
“If you are not a large enterprise, saving exceptional circumstances, you will in due course fall outside of the transfer pricing regime as you fall out of the period for which you have elected in to transfer pricing,” added May.
He noted that it may be clear in some instances that there is no reason to continue with the service company arrangement. Particular regard has to be given to the practicalities of abandoning the service company.
“This is not going to happen overnight. Proper consideration needs to be given to the contractual arrangements as between the service company and the partnership where there is a wish to dispense with the service company to allow the orderly transfer of the various obligations.”
May said the new rules will not in most circumstances affect anything other than large partnership/LLP structures.
“They have brought an end to what has been styled ‘playing the transfer pricing game’ for those who have operated a service company structure to benefit from these rules, while immediate consideration of the consequences is a must, there are options open ranging from an orderly withdrawal from the arrangement through to reconsideration of the raison d’être of the structure given the financial needs of your practice.”
