HMRC now targeting mid-tier firms in its transfer pricing investigations, says expert

Corporate tax expert Heather Self of Pinsent Masons said that HMRC received more transfer pricing yield from its local compliance teams last year than from the Large Business Service (LBS), which deals with the UK's 770 largest businesses. In total, HMRC collected £253 million of extra tax from businesses handled through local compliance teams in 2012/13 - a 68% increase on the £151m it collected in 2011/12 and more than 10 times the £25m collected in 2007/08, according to the figures.

"These numbers should be a warning to mid-tier businesses that their transfer pricing arrangements are now firmly on HMRC's radar," Self said. "Any company of significant size with overseas operations should be aware that HMRC is now actively pursuing businesses below the top tier to reel in additional tax."

"While it has taken a number of years, HMRC is now broadly satisfied that the largest businesses are conforming to transfer pricing relations. The mid-tier are next in line to be investigated, and should make compliance a priority immediately. They should also undertake a 'health check' to make sure they have the formal evidence needed to back up their position," she said.

The transfer pricing regime exists to ensure that transactions made between connected parties are taxed in the same way that they would have been had the connection not existed. The rules permit HMRC to adjust the amount of income earned for tax purposes or expense incurred on transactions between companies in the same corporate group where it appears that the transaction did not take place at 'arm's length', with the same terms as those that would apply if the transaction involved an unrelated company.

Rules on transfer pricing are set at an international level by the Organisation for Economic Co-operation and Development (OECD). The rules allow tax relief on loans between companies in the same group, providing that the company can show that the loan was made available on commercial terms. However, multinational companies including Amazon, Starbucks and Google have all recently been accused of deliberately transferring profits from the UK to lower tax jurisdictions to reduce their UK tax liability.

In July 2013, the OECD presented its recommendations for new global standards to tackle base erosion and profit shifting (BEPS) by multinational companies to the G20. The OECD's work comes as part of an international drive to crack down on transfer pricing arrangements that could be seen as abusive. Tax expert Heather Self said that the authorities in many developing countries, for example, were becoming "much more aggressive in pursuing businesses for additional tax", and that this trend showed "no signs of slowing down".

Businesses with significant overseas operations that pay tax in the UK often choose to apply to HMRC in advance of implementing new transfer pricing arrangements, in order to ensure that the complex transactions involved will not later attract additional tax bills. However, Self said that the average time taken by HMRC to approve these transactions was increasing, creating "huge uncertainty" for businesses forced to put their transfer pricing arrangements into action before approval from the authorities.

"Despite having had several years to apply the correct resources to the problem, HMRC is still falling a long way short of the performance level the biggest businesses need it to reach," she said. "The timescales it is currently working to don't reflect commercial reality, as was the case when the problem was originally identified almost eight years ago. A target of 18 months to resolve a transfer pricing issue is already generous to HMRC: for HMRC to miss even that target by such a distance is disappointing."

"A lot of big businesses are questioning the management of transfer pricing cases within HMRC. While they are undoubtedly complex and challenging cases to settle, reaching a resolution within a reasonable commercial timeframe should be one of HMRC's prime concerns. HMRC, like all Government departments, is under continuing pressure to reduce costs, but has been given additional resources to deal with avoidance and transfer pricing issues. It needs to deploy those resources effectively," she said.

HMRC took an average of 26 months to pre-approve transfer pricing arrangements during the 2012/13 tax year; 54% longer than the 16.9 month average wait a year earlier, according to Pinsent Masons.