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Tax experts flag transfer pricing risk

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HMRC’s large business service (LBS) has increased its compliance activity to target businesses that it suspects of using transfer pricing to avoid UK corporation tax, according to the law firm Pinsent Masons. However, the figures cited by the firm represent a working estimate of ‘tax under consideration’ in enquiries, some of which cover a number of years. HMRC has said that in many cases it finds that there is no additional tax to pay.

The LBS is investigating £1bn of tax linked to transfer pricing issues, 47% up from last year's figure of £680m, the firm said in its press release. The figures did not necessarily mean that more avoidance or evasion was taking place but suggested that HMRC was being ‘more thorough’ with its investigations, said Heather Self, a partner at the firm.

HMRC said in a statement: ‘We are bringing in more people and additional legal support to speed up our work identifying and challenging multinationals’ transfer pricing arrangements and to further strengthen our risk assessment capability across the large business sector.

‘This in turn will help to ensure that multinationals do not shift profits out of the UK and pay the tax due in line with UK tax law.’

The figures were released by HMRC last October in response to a freedom of information request. HMRC set out the ‘tax under consideration’ in LBS enquiries and emphasised that the figures represented a snapshot at 31 July 2012 of the ‘open operational risks’ under consideration.

‘These are not annual figures and include enquiries which may have been open for several years,’ HMRC said.

The total ‘tax under consideration’ at that date was more than £21bn, including transfer pricing and ‘thin cap’ issues amounting to £1bn, but HMRC stressed that these amounts were not ‘tax owed or unpaid’. The estimates helped LBS managers to deploy resources to produce the ‘best results’, it said. ‘In many cases, when HMRC has looked at the full facts it has become clear that there is no further liability at all.’

Media reports have suggested, nonetheless, that the figures reflected an increase in tax avoidance by multinationals. The headline at Reuters was ‘Taxman sees increased avoidance by big business’, and the International Business Times reported that 'tax under consideration' was ‘the amount of tax HMRC estimates is owed by big firms’.

Pinsent Masons said transfer pricing ‘concerns the charges made between the different parts of an international business for goods, services, or intangible assets such as intellectual property, which can affect the profits reported in different markets’.

The firm noted that multinationals including Amazon, Starbucks, and Google had been accused of ‘deliberately transferring profits from the UK to lower tax jurisdictions to reduce their UK tax liability’.  But it pointed out that work to strengthen transfer pricing guidelines were already under way, and said calls for more radical reform to prevent abusive transfer pricing were ‘a knee-jerk reaction’.

Campaigners argue that the current international tax system enables groups of companies to structure their affairs to minimise tax without breaching current transfer pricing guidelines. Some argue that a managed transition to a system of ‘unitary taxation’ is the only effective way to tackle profit-shifting to tax havens.

James Bullock, head of litigation and compliance at Pinsent Masons, told Sky News today that the ‘ethos’ behind transfer pricing was that there should be a proper arm’s length allocation of prices between group companies, as there would be between unrelated parties. In the global economy there had to be a mechanism for allocating value, but the question of what represents an arm’s length value was ‘a moot and debatable point’.

Bullock is a member of Tax Journal’s editorial board. He said there was a particular issue in relation to the transfer of value, particularly value represented by intellectual property, into low-tax jurisdictions and so-called tax havens, but ‘that doesn’t mean to say that [such a transfer is] not valid or can’t be justified’. Anyone setting up a franchise operation for an outlet having substantial brand value would expect pay some money for the use of the brand.

Heather Self said: ‘It is often cheaper for multinational businesses to borrow on a group basis and make inter-company loans to trading subsidiaries. Tax relief will have been claimed on these loans, but HMRC will have suspicions that similar financing would not have been available on the open market, given the current lending drought.’