Borrowing trends and the overall economic environment have undergone notable changes, prompting the UK tax authority (HMRC) to set out guidance for Tax Inspectors when selecting cases for audit.
Groups with intra-group funding arrangements in the UK should be aware of key changes that have been made to thin capitalisation.
Beneficial Ownership and Tax Treaties
New thin capitalisation guidance requires Tax Inspectors to consider beneficial ownership and substance in certain locations, if there are instances in which:
- A reduced withholding tax rate is being claimed or is relevant under a particular treaty;
- A company is relying on a "conduit company" argument for thin capitalisation purposes (i.e., the argument that a lower margin of interest should be appropriate or that the netting of intra-group debts and credits is relevant).
How do the changes impact business?
The new guidance has been introduced to counteract aggressive structures that are obtaining both a withholding tax benefit and a thin capitalisation benefit. In the above instances (which are commonplace with international structuring involving special purpose vehicles), it will be important to be prepared for a beneficial ownership review alongside thin capitalisation. Readers may recall that this was the case prior to April 2004, whereby a review of thin capitalisation was often accompanied by a withholding tax review on the associated interest. The new guidance is soon to be published on the HMRC website at INTM504000 and it involves some useful examples (and a list of "do's and don't's") in the context of commercial substance and the new finance company regime.
Working in Real-Time
HMRC will seek to work transfer pricing issues in real-time with all of its customers. Dealing with thin capitalisation issues close to the date of the relevant transactions provides early certainty for the customer and allows HMRC to examine the issues when information and, in some cases, relevant business personnel are more easily available. Discussions with a customer will, therefore, often take place in advance of a return being submitted. Such communication may be initiated by the customer or as a result of HMRC's risk management approach.
HMRC have advised that: "The only way that a customer can be given advance certainty about the transfer pricing treatment of interest payable under debt is through a formal application for an Advance Thin Capitalisation Agreement (ATCA)." It is essential that any real-time discussion of thin capitalisation issues involve the Transfer Pricing Group (TPG). When potential transfer pricing issues of this nature unexpectedly arise during discussions with a customer, the Customer Relationship Manager (CRM) and case team should point out that this is an area where TPG input will be needed and that it may be sensible to postpone discussing the issue until a member of the TPG can be present.
However, if the customer still wishes to proceed, the HMRC team should:
- Ascertain if the customer is seeking legal certainty about the treatment of the arrangements and, if so, advise the customer about the ATCA process and the related Statement of Practice and INTM guidance;
- Listen to whatever the customer has to say without giving an opinion on the tax treatment of the arrangements and let the customer know that they will contact them again after they have discussed the issue with the relevant Transfer Pricing specialist; and
- Approach the TPG for specialist advice, decide the next steps and advise the customer as to what will transpire.
How do the changes impact business?
Whilst the language is formal, HMRC have also specified that: "When legal certainty through the ATCA process is not being sought, case teams may, with TPG input, give an indication, expressed in terms of the level of risk, of how HMRC might see the transfer pricing risk posed in the corporation tax return, once it is made. They should do this without entering into discussion on pricing, thereby, leaving no inference that any particular level of interest payable used in calculating profits in a tax return will be considered by HMRC to satisfy the requirements of the arm's length standard in the absence of an ATCA."
The reasons for the above changes are twofold:
Limited resource at HMRC has necessitated a focused approach. It may, for example, be the case that, following a risk assessment, HMRC decides that the transfer pricing issues raised by a customer do not warrant detailed enquiries at that time. Whilst this has been the intention of the legislation for a number of years, the recent guidance confirms that HMRC International is not satisfied with the approach being taken by all Inspectors.
HMRC International is attempting to improve consistency across thin capitalisation and certainty rulings.
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