HMRC crack down on transfer pricing avoidance
The government has announced new proposals to restrict the use of the compensating adjustments mechanism contained within the transfer pricing legislation where it generates Income Tax advantages.
The announcement by the Chief Secretary to the Treasury was made in response to two schemes that HMRC has become aware of that appear to generate Income Tax advantages.
The first scheme relates to large partnerships which employ their staff through a separate service company that the partnership owns. By choosing not to pay an appropriate fee to the company for providing this service, the partnership can activate the tax rules to gain an advantage. HMRC have also said that they are aware this scheme is also been marketed to smaller partnerships.
The second scheme relates to individuals participating in a company who are exploiting the rules by making loans that are not on arm’s length basis. This scheme enabled the lenders to extract money from the company without paying Income Tax.
The government proposes to withdraw the ability of individuals to claim compensating adjustments where the counterparty to the transaction is a company. This will apply to amounts arising on or after the date the legislation comes into effect. So where either of the schemes is used, no compensating adjustments will be possible in respect of amounts of service fee income or interest arising to individuals on or after the effective date.
It is not intended that the changes should adversely affect genuine commercial arrangements and HMRC have said that there will be a short opportunity for discussion on the policy proposals before the legislation comes into effect.