Under Corporation Tax Self Assessment, companies are required to price their transactions with overseas affiliates on an arm’s length basis - without being challenged by the Revenue. Incorrect pricing may result in arrears of tax, interest and penalties. So transfer pricing is a prime area of tax risk.
The Finance Act 1999 created a new procedure to enable businesses to gain tax certainty and to reduce administrative costs for Revenue and taxpayer alike: Advance Pricing Agreements (APAs). The Revenue has just issued Statement of Practice 2/99, setting out in detail (19 pages) how it will operate the new procedure. On complex transfer pricing issues, multinational groups can negotiate an APA with Inland Revenue Head Office, setting a methodology to determine the transfer price for tax purposes. To avoid double taxation, the UK Revenue would also prefer to enter into bilateral or multilateral APAs involving foreign tax authorities as well as the multinational group.
When might an APA be worth seeking?
An APA might be advantageous if, for example, the company is already undergoing a transfer pricing investigation, or the risk of a future transfer pricing enquiry is high: much of the compliance costs will probably have to be incurred anyway, and an APA negotiation is likely to be less adversarial than a Revenue enquiry after the event.
However, negotiating and monitoring an APA is a considerable undertaking, and may not be appropriate where there is only a moderate risk of the Revenue challenging the taxpayer’s transfer prices. Also, the APA process is designed to offer taxpayers assistance in resolving complex transfer pricing issues. The Revenue has emphasised that advance clearance will not be available on less complex matters; the inherent tax risk will need to be managed in other ways.
When might a group be interested in APAs?
- If the group’s business process is both multinational and complex - for example, an investment banking group engaged in global financial trading.
Briefly, what does an APA involve?
The business makes an ‘expression of interest’ to the Revenue, so that both sides can consider in outline what the APA might cover. The business then makes a ‘formal submission of application for clarification’ to the Revenue, setting out its proposals. The Revenue then considers the application; it may ask for further information, and will discuss the issues with the business. The two sides will, for example, have to agree on the key assumptions underlying the transfer pricing method. If the APA is to be bilateral, the Revenue will liaise with the foreign tax authority. The APA will typically last for three to five years; if appropriate, it may be used as a basis for agreeing transfer-pricing issues on earlier years. The business will have to make annual reports to the Revenue on its compliance with the APA.
For further information on APAs and other methods of managing the tax risks inherent in transfer pricing, speak to your usual KPMG tax contact.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.