UK and International Tax news
Transfer Pricing And Compensating Adjustments
Tuesday 24th September 2013
HMRC has published a technical note for comment following the Chief Secretary’s recent announcement concerning proposals to tackle avoidance involving ‘compensating adjustments’ in the transfer pricing code.
Tax rate arbitrage advantages can arise where such adjustments are claimed by individuals for transactions entered into with connected companies subject to a lower corporate tax rate. HMRC has become aware of two arrangements that exploit the rules where interest receipts arise to individuals from debt in excessively leveraged companies and/or excessive rates of interest, and where companies are under remunerated by partnerships for the services that they provide.
The UK transfer pricing rules apply in particular where companies are overly indebted with levels of borrowing that would not have occurred at arm’s length but for the relationship that exists between the lender and borrower. The rules restrict interest deductions arising from non arm’s length debt by recalculating the taxable profit as if arm’s length arrangements had been entered into rather than the actual arrangements. A compensating adjustment may be claimed by the lender so that its position mirrors that of the borrower. This effectively removes an amount of interest equal to the excess over the arm’s length amount from the charge to income tax of the lender and correspondingly from the deductible amount for the borrower.
HMRC is concerned that this can have the effect of enabling lenders to extract money from the borrowing company without paying income tax. The lenders’ connection with the company means that they are often taking a return on loans in place of a profit distribution.
HMRC is proposing that the compensating adjustment mechanism will be removed for taxpayers within the charge to income tax where the counter party to the transaction is a company. This will apply to amounts arising on or after the date the legislation takes effect.
Whilst HMRC has indicated that there is no intention for these changes to adversely affect commercial arrangements, there will be a short opportunity for discussion on the policy proposals before the legislation comes into effect.Contact Us