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Transfer pricing rules: HMRC briefing sets out limitations

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The ability of multinational groups to exploit differences between national tax systems to reduce their tax bills without breaching transfer pricing rules is explained in a new HMRC briefing.

“The rules require multinationals to calculate their taxable profit as if transactions between companies within the group were carried out at the prices that would be charged between two entirely independent companies (known as the ‘arm’s-length price’),” HMRC said in Taxing multinationals: transfer pricing rules published on 2 May.

A “significant proportion” of global trade is made up of intra-group transactions, HMRC noted, adding that the UK has “a leading role” in the OECD’s current review of the rules.

The issue briefing acknowledged that multinationals have “considerable freedom” to establish business operations wherever they choose and “will take a number of factors into account when deciding where to locate, including the local tax regime”.

It added: “The transfer pricing rules are complex and can be difficult to apply to transactions that only take place within a multinational group. In some cases, they are exploited by business in an attempt to reduce the amount of tax that has to be paid.

“By choosing where business processes, assets and risks are located, a multinational can reduce the amount of tax it pays by locating some activities in countries with low tax rates. The transfer pricing rules will determine the profits that should be allocated to those countries, which are then taxed at a low rate.

“While moving some parts of the business could make it less efficient and less profitable, moving other parts – in particular intellectual property, financial assets and some risks – is less likely to affect how the business runs, and so these elements are easier to relocate to low tax countries.

“Where assets or risks are held by a company based in a low-tax country, the current transfer pricing rules will not prevent some profits being attributed to that company, even if it only has a few employees and does not take an active part in the business.”

HMRC pointed out that it challenges arrangements that do not allocate enough profit to the UK, and that since it formed a dedicated transfer pricing group in 2008 it has secured £4.1bn of additional tax by challenging transfer pricing arrangements.

Deloitte has noted that the issue briefing explains “some of the limitations” of the current rules. But OECD tax officials have indicated the arm’s length principle remains “an essential element” of a fair allocation of taxing rights between countries.