The UK Tax Authority (HMRC) recently published a statistical study on transfer pricing (TP) trends in relation to the audit process, Advanced Pricing Agreements (APAs), Advanced Thin Cap Agreements (ATCAs) and Mutual Agreement Procedures (MAPs). A look at the results provides a good indication of where HMRC is focusing efforts and what UK businesses need to know about TP audits.
Noteworthy statistics include:
- The total yield from TP adjustments is now over £1 billion per year.
- The average time taken to resolve audits has dropped to 24.4 months at the end of 2011 (from 38 months in 2007). Of course, this is a welcome change for businesses operating in the UK; however, it also indicates that HMRC is becoming more efficient with its TP resources, opening the way for increased audit activity and intensity.
- The number of APAs in force has increased to 70 from 56, and there are some 231 ATCAs in force to support TP on intra-group debt.
Recent TP statistics show a reduction in the average time taken to resolve a TP audit. However, what does this really mean for UK businesses? There are two main reasons for the shorter resolution time in TP audits:
- HMRC has been focusing more and more on TP audits and assembling a specialist team to deal with the inquiries (e.g., experienced economists and risk assessment models). The specialist team resolves audits more expeditiously; however, the number of audits has also increased.
- UK companies have been paying more attention to transfer pricing and complying with documentation requirements by either using outsourced expertise or building a TP team in house.
The increased number of APAs and ATCAs fits in with the considerations above and HMRC is keen to agree on TP a priori to avoid the risk of long and costly TP audits. At the same time, we have seen a boom in tax-efficient supply chain projects, which has also motivated businesses to obtain certainty on the TP prior to implementing costly restructuring projects. An important consideration is the quality of TP documentation; HMRC's newly enhanced TP expertise and dedicated team takes a more sophisticated look at the detail behind TP studies.
Comparability studies - probably the most commonly used method for testing TP policies (irrespective of the most appropriate method) - are increasingly being challenged on the basis of comparability and functionality. "Cookie cutter" TP reports are being met with harsh scrutiny. In our experience, when advising clients on dispute resolution, there is likely to be a significant drain on resources in the longer term, if attention is not given to building an accurate functional profile, selecting an appropriate pricing method and executing that method with accuracy and credibility.
It is no surprise that the number of MAPs has declined, as it is now less likely that businesses and HMRC cannot agree on the TP position either a priori (through certainty agreements) or following a TP audit. It should be noted that two years may be a reduction, but it is still a long time frame for resolving a TP audit, which means businesses are still required to allocate resources to resolving issues. As discussed above, a multilateral APA that brings in the relevant tax administrations can be one of the most effective TP risk management tools a multinational can employ.
For those companies where TP risk is reasonably higher than average (i.e., large intragroup transactions, complex structures / transactions, TESCM planning, etc.), the risk of being audited increases. Therefore, it remains critical to produce robust TP documentation and ensure that implementation is carried out correctly.
Businesses should try to adopt a risk-based approach to TP studies (e.g., using more than one method to test the policy, seeking an APA or ATCA, etc.). This may require an allocation of resources in the short term, but is still far less costly and time consuming than a two-year TP audit.
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