SPEED READ This article summarises some of the main transfer pricing (TP) issues that HMRC hears from business and highlights how HMRC can help. For example, early neutral evaluation might help ease business concerns about documentation requirements when there is uncertainty about whether there is a case to answer. Where the economic environment impacts on TP methodologies, HMRC will engage to understand the issues. Collaborative dispute resolution can work very well in the TP environment. New Statements of Practice are being prepared on Advance Pricing Agreements and 'TP, mutual agreement procedure (MAP) & arbitration'. Joint audits may provide a more effective way for tax administrations to monitor and test TP compliance and may also offer significant benefits to enterprises.
Transfer pricing is consistently flagged by big business and their advisers as one of their top tax compliance concerns and it has been discussed at every meeting of the OECD’s Forum on Tax Administration (FTA) over the past 18 months. The reasons for this are clear; transfer pricing is expensive for business when it goes wrong, compliance costs can be great and it is a big risk for tax administrations.
HMRC’s perspective on some current transfer pricing issues and concerns raised by business and their advisers is set out below, as well as some thoughts on future developments.
Governance
Starting closest to home, one frequently raised topic is transfer pricing governance within HMRC, despite it never having been tighter. Enquiries are managed by the Customer Relationship Manager in the Large Business Service, and in Local Compliance with considerable input from transfer pricing specialists.
All this is done within a governance framework aimed to ensure consistency of approach and speedy resolution, including senior level engagement where needed. The effectiveness and efficiency of this governance is kept under constant review and revised where appropriate.
However, HMRC’s internal transfer pricing governance is no more than a means to an end. If it works well it should be invisible and of minimal interest to business and their advisers, who should see only consistency in our approach, early certainty, and a single, seamless HMRC view.
Transfer pricing documentation
Another topic frequently discussed both internationally and with HMRC is transfer pricing documentation. Whilst HMRC’s view is clear and is set out in our published guidance and in Chapter V of the OECD Transfer Pricing guidelines, the big issue for business is consistency between tax administrations, and concerns in this area are rising.
HMRC’s view on its own transfer pricing documentation requirements hasn’t changed and it has no plans to change them. Transfer pricing documentation consists of a mixture of records and evidence in relation to a period covered by a tax return.
As long as a business has primary accounting records, tax adjustment records, records of transactions with associated businesses and sound evidence to demonstrate an ‘arm’s-length’ result, then documentation should not be a problem. What matters is not the length of a transfer pricing report but the quality of the information it contains and whether the facts support the documentation.
One option for addressing concerns about the burden of documentation requirements could be some form of early neutral evaluation – an independent view about whether there is a case to answer. This might take a number of forms, still to be considered, but would, of course, have a cost attached.
Transfer pricing in an uncertain economic environment
Very much on the minds both of advisers and HMRC is how to deal with transfer pricing in a changing economic environment. HMRC’s key message is that, whatever the climate, the way HMRC approaches Transfer Pricing enquiries, working with business to do so, remains unchanged.
It will continue to focus resource to risk and to plan enquiries, in discussion with customers to a clear timetable, with a view to providing early certainty. It will continue to identify risk by listening to its customers, even more important for periods when trading conditions have been different to anything previously experienced.
It will also continue to consider risk by understanding the business, its sector and the economic context in which it operates including the impact of the recession on the business. This approach is even more important when the business cycle exhibits exceptional swings which do not affect businesses uniformly.
The main issues raised with HMRC by business and their advisers can be summarised as follows. First, the time lag of data; if a business is looking for comparables those it has are unlikely to be up to date and reflect the downturn. Second, the inclusion of losses in data sets; traditionally loss makers are not included as comparables and the question posed is whether it is right in a recession now to do so. Third, the impact of difficult conditions on low risk distributors and service providers who have guaranteed rewards.
HMRC’s priority is to ensure that those responsible for reviewing transfer pricing risks and managing enquiries are equipped with the most up to date and informed guidance on these issues, enabling them to provide consistency and early certainty for customers. As ever, active and early engagement with HMRC around problems and questions is the way forward.
Returning to the subject of documentation, what continues to matter the most in considering transfer pricing, whatever the economic conditions, is the importance of the quality of information, documentation, and the evidence base in support of extraordinary adjustments.
Dispute resolution
Collaborative Dispute Resolution (CDR) is very much on the agenda with work on this across HMRC led by Geoff Lloyd. CDR is an approach which can work very well in the transfer pricing environment, with recent experiences having demonstrated, for example, the benefits of joint modelling. In addition, feedback from business reinforces the importance of getting the basics right at the beginning of an enquiry, agreeing what the problems are and how much they really matter, before engaging in detailed discussion of transfer pricing methodology.
International dispute resolution: APA and MAP
Disputes between HMRC and business and their advisers, are of course, only part of the transfer pricing picture. Feedback from business is that it is concerned about growing international pressures and worries that other tax administrations are gearing up for greater transfer pricing activity and will be looking to change their approach. As a result, HMRC is often asked about its ability to resource the growth of competent authority work that business anticipate will arise as a result of growing international demands.
An invaluable way of bringing certainty in an uncertain environment is the use of bilateral and multilateral Advance Pricing Agreements (APAs). These ensure that a business and one or more tax administrations have a shared understanding of pricing going forward. At the moment HMRC is not seeing a huge increase in demand for APAs, although the resource allocated to this important activity is continually reviewed and it will remain an HMRC priority for the future.
HMRC will be publishing a revised APA Statement of Practice (SP) by the end of the year, following discussion with business and advisers. This updated SP will, in particular, emphasise the importance of initial informal dialogue with HMRC when a business is considering making an application, as well as providing more clarity on the criteria for admission to the APA programme and transparency about the process. It reflects lessons learned by HMRC as the programme has developed and an expectation that APAs will become more widely used.
Mutual agreement procedures (MAP) under tax treaties or the European Arbitration Convention aim to eliminate double taxation that might result from a transfer pricing adjustment. HMRC is seeing an increase, not yet in the number of requests to invoke MAP (around 50 last year), but in their size and complexity and this work also remains a priority. HMRC will also be publishing by the end of the year a Statement of Practice on ‘Transfer Pricing, MAP and Arbitration’ to replace previous Tax Bulletin articles, again following discussion with business and advisers.
Joint audits
Feedback from business is that MAP and APAs cannot and do not always provide the solution to their needs. HMRC has therefore been considering future developments and whether there is there a different way to tackle transfer pricing issues to avoid the need for MAP and to speed up APAs.
The OECD, through FTA Commissioners, is exploring whether tax compliance of multinationals can be monitored and tested more effectively through, what it is calling ‘joint audit’ rather than simply by means of the traditional national models. HMRC is pro-actively engaged with its treaty partners in developing these joint audit proposals, through a small number of willing multinational pilots.
There are a number of different models which might be used. One could be a joint team made up of the different tax administrations to jointly identify issues, including cross-border avoidance, on the basis of the same facts. Another could be two tax authorities collaborating in assessing cross border risks, not through a joint team, but by three way engagement with the business.
Although these proposals are badged as ’joint audit’ they are potentially far more wide reaching. The ability to jointly assess the level of cross-border risk by mutual risk identification and analysis would enhance the ability of tax administrations to identify risks and therefore compliance activity on the one hand, whilst, on the other, reducing compliance burdens for businesses by more quickly concluding where enquiries were not necessary.
A joint team would be able to tackle those risks, once identified, far more effectively – for example, on the basis of all interested tax administrations listening to the same facts at the same time. The benefits to tax administrations, including the transparency it offers, are clear. This approach would also reduce the compliance burden on the multinational, by providing earlier certainty and allowing a single audit rather than multiple audits or enquiries.
As globalisation speeds up year on year and new issues continue to appear on the horizon, transfer pricing will remain a challenge for HMRC and for business. New ways of working, whether more real time working, joint audits, CDR, early neutral evaluation or other approaches yet to be considered, will need to be part of the answer. By working together across tax administrations as well as with business and advisers HMRC will be able to learn to resolve issues faster and more effectively.
Melissa Tatton is Deputy Director, Business International with responsibility for transfer pricing and for JITSIC (Joint International Tax Shelter Information Centre). She chairs HMRC’s Transfer Pricing Board which sets HMRC’s strategic direction on transfer pricing. Melissa has a wide range of corporate tax policy experience within HMRC.
