UK extends tax reach on transfer pricing

UK transfer pricing rules look set to become tougher as the government aims to clamp down on companies owned by the same parent entity that sell and buy from one another in low-tax jurisdictions, including private equity firms and their portfolio companies, tax experts are warning.

Under the current rules, companies without a permanent establishment in the UK are protected from certain taxes on sales in the UK by virtue of bilateral double tax agreements. The new Diverted Profits Tax (or DPT) rules provide UK tax authority, HMRC, power to levy tax on the non-resident’s profits where arrangements have been put in place for another person to act as a disguised permanent establishment. This will target the type of arrangement where a contract is negotiated in the UK but formally concluded in another low tax country.

In the past, preliminary deal research and general marketing would have made up the majority of a GP’s extraterritorial activities outside of traditional cross-border M&A activity. But many firms now include deal sourcing and analysis, investment committee representation, deal execution, investor relations, capital raising, fund administration and other back office support functions overseas. For instance, the work of an IR team based abroad should be included in a firm’s transfer pricing policy because intra-group services and intangible property must be priced, caution legal sources.

“The legislation is a game changing shift in policy,” said Chris Bates, tax partner at law firm Norton Rose Fulbright. “The OECD has been seeking to co-ordinate an international response to multi-national tax planning through its Base Erosion of Profits (BEPS) program. The UK has stepped in with a unilateral program of its own which is likely to be highly controversial.”

The draft legislation of the DPT will levy tax on profits diverted from the UK at a rate of 25 percent and the rules are expected to be added to the UK’s Finance Bill in 2015.