Each individual corporate group member is required to submit their own tax return on a stand-alone basis, with the exception of the election available with respect to VAT (discussed below). However, there are a variety of ways in which one's relationship with fellow group members is recognised in the UK tax system for the purposes of corporation tax, VAT, SDLT, and stamp duty.
The corporation tax system includes a number of measures that advantage UK members of qualifying groups, all of which are subject to anti-avoidance measures.
Operating taxable profits and losses arising in the same period can usually be offset between UK resident 75% affiliates within a worldwide group (known as 'group relief') and certain non-UK resident 75% affiliates within the charge to UK corporation tax. This extends to offsetting the UK profits attributed to a UK PE of a non-UK resident group member, subject to additional requirements. There are some restrictions, primarily where one of the two companies is not an economic 75% subsidiary of the group or is subject to arrangements under which it might leave the group. Losses arising on or after 1 April 2017 that cannot be used by the company or group relieved in the year are carried forward and can, subject to restrictions, be surrendered as group relief in a later year.
Intra-group transfers of capital assets between UK companies, including UK PEs (and non-UK companies within the charge to UK tax on gains in respect of UK immovable property or assets that derive at least 75% of their value from UK land where the company has a substantial indirect interest in that land) are normally tax-free, though the definition of group for these purposes is slightly different than the definition of group relief for losses. This treatment is also extended to intra-group transfers of loan relationships, derivatives, and intangibles. There is generally a 'degrouping' charge if the transferee company leaves the group within six years.
There is no automatic offset of capital gains and losses where these arise in different group companies, but it is normally possible for offset to be arranged either by actual transfer of the asset prior to disposal or by election.
A UK resident group company is potentially able to claim group relief for income losses of a non-UK resident subsidiary that is resident in the European Economic Area (EEA) or has incurred the relevant losses in a PE within the EEA, provided that all possibilities of non-UK relief for the losses have been exhausted and future relief is unavailable.
In addition, the corporation tax system also has a number of measures that seek to prohibit groups unfairly manipulating the tax system by shifting profits between group members (either internationally or within the United Kingdom) in a way that is considered unacceptable.
The net interest deduction of a UK group is restricted to 30% of UK tax-EBITDA (or the group ratio for highly leveraged groups) and, in any case, cannot exceed the net interest shown in the worldwide group’s consolidated financial statements. This is discussed under Funding costs in the Deductions section.
Group companies can, subject to certain requirements, elect to account for VAT as if they were one taxable person; where this is done, no VAT is charged on intra-group supplies of goods or services. The registration is made in the name of the representative member, who is responsible for completing and rendering the single return on behalf of the group. All the companies are jointly and severally liable for any VAT debts. VAT grouping is subject to detailed anti-avoidance provisions.
Stamp duty and SDLT
Transfers of shares or real estate within worldwide 75% groups are generally exempt from stamp duty or SDLT, respectively. For SDLT, the relief can be retrospectively withdrawn in certain circumstances, primarily where the transferee leaves the group within three years of the transfer.
Transfer pricing and thin capitalisation
The United Kingdom has widely drafted transfer pricing rules that are intended to apply to almost any kind of transaction or series of transactions made or imposed between related parties that gives rise to:
- a provision that differs from one that would have been made between third parties and
- a UK tax advantage (potential or actual) to one or more of the parties.
These rules apply to UK-to-UK transactions as well as cross-border transactions. A tax advantage is one that reduces UK taxable profits or increases UK taxable loss compared to the arm’s-length position. The United Kingdom follows the guidance provided by the OECD in relation to transfer pricing.
The regime applies not only to arrangements involving products, services, and intangible property, but also to finance arrangements, including both the rate of return charged and the amount of loan principal (or equivalent) made available. It is therefore the mechanism by which the UK's revenue authorities address the issue of thin capitalisation. Unlike many other territories, the United Kingdom does not have any 'safe harbour' rules in relation to the amount of debt or interest (or equivalents), and the question of whether a UK company or group is thinly capitalised needs to be addressed on a fact-specific, case-by-case basis. However, a separate UK interest deductibility rule was introduced, effective from April 2017. This is discussed under Funding costs in the Deductions section.
Parties are considered related for the purpose of transfer pricing rules where either one controls the other or both are under common control. Control here is not confined to situations in which one party is the majority shareholder in the other. Effectively, control exists where one party has the power to ensure that the affairs of another party are conducted in accordance with the first party's wishes. The concept is also subject to two important extensions:
- The rules can apply to joint venture companies where two parties each have an interest of at least 40%.
- There are attribution rules to trace control relationships through a number of levels in determining whether parties are controlled for the purposes of the transfer pricing rules.
In addition, the regime restricts interest deductions to an arm's-length amount where a number of persons who would collectively control a company or a partnership have 'acted together' in relation to the financing arrangements of that company or partnership. An independent financier (usually a bank) can then be taken as related to the company or partnership for financing, despite the absence of any other type of participation in control, and the loan becomes subject to transfer pricing limitations.
There are a number of exemptions that essentially exclude SMEs and dormant companies from the regime, subject to certain qualifications.
The effect of the rules is to require an arm's-length provision to be substituted for the actual one, thereby increasing the party's UK tax liability and cancelling out the UK tax advantage that would otherwise have arisen.
Where both parties to the transaction are UK taxpayers, the disadvantaged party will generally be entitled to claim a compensating adjustment (except where the transaction falls within the transfer pricing regime because of the 'acting together' provisions), but only after the UK adjustment has been made by the advantaged entity. The legislation also provides that parties may make balancing payments to each other in such circumstances, of any amount up to the gross transfer pricing adjustment (and not just the tax impact), which will neither be taxable for the recipient nor tax deductible for the payer.
Where the disadvantaged party is outside the UK tax net, they can pursue a claim for relief under the relevant DTT if it provides a mechanism for such relief; where the adjustment in the United Kingdom is to reduce a deduction for an amount paid under deduction of UK tax, the compensating adjustment rules should allow the overseas party to reclaim any WHT paid on the disallowed amount, subject to time limits and other criteria.
UK taxpayers are required to self-assess their compliance with the arm's-length principle. Companies and partnerships must therefore identify and make transfer pricing adjustments when submitting their tax returns. An important implication of this approach is the application of interest and the potential for substantial penalties if the position taken in the return is subsequently held to be wrong. Transfer pricing is an area of focus for enquiries, including DPT enquiries and submissions under the Profit Diversion Compliance Facility, and HMRC expects taxpayers to be able to produce often extensive evidence that supports the conclusion that the self-assessment return reflects arm’s-length pricing.
The United Kingdom has an Advance Pricing Agreement (APA) programme that, subject to the acceptance of an application and agreement being reached between the relevant tax authorities, can provide a high degree of transfer pricing certainty on a prospective basis. A specific form of APA agreement, an Advance Thin Capitalisation Agreement, may also be agreed in relation to certain financing arrangements.
Country-by-country (CbC) reporting
In line with the OECD recommendations coming out of BEPs Action 13, 'private' CbC reporting (by which we mean multinational enterprises submitting CbC reports to tax authorities) is required for all multinational enterprises (MNEs) with annual consolidated group revenue over 750 million euros (EUR) (or equivalent). It requires the preparation of a summary report setting out the jurisdictions in which the group has operations and, for each jurisdiction, the aggregate revenue, profit, income tax, plus additional data, such as number of employees, accumulated earnings, assets, etc. This report has to be filed with HMRC where the MNE’s ultimate parent is in the United Kingdom, or, in some circumstances, where the MNE operates in the United Kingdom, alongside the tax return for the period in question. HMRC then makes the report available to other jurisdictions included within the relevant report automatically in line with/subject to the specific CbC information sharing provisions entered into between the United Kingdom and the relevant tax jurisdictions.
In some quarters, stakeholders are asking for CbC data to be made public. The Global Reporting Initiative released a new tax standard (GRI 207 - Tax) that contains public CbC data. Although it is a voluntary standard, some environmental, social, and governance (ESG)-focused stakeholders are looking for this type of information. The EU proposals for public CbC data are also moving forward. A compromise text was reached between the Parliament and Council in June 2021 and is expected to be finalised at the end of the summer.
In the United Kingdom, legislation provides for the government to bring in regulations to require publication of CbC reports for UK MNEs; however, it remains to be seen what approach the UK government will take in light of the EU developments.
The United Kingdom has not to date formally adopted the other transfer pricing documentation formats (Master File and Local File) recommended in the final OECD Action 13 report. There is a consultation process underway that is considering proposals to extend the UK’s requirements for transfer pricing documentation to include these files. The consultation is also considering the introduction of an International Dealings Schedule that would include transfer pricing information and would be submitted alongside the tax return.
Controlled foreign companies (CFCs)
Under the CFC regime, a UK resident company may be taxed on a proportion of the profits of certain UK-controlled, non-resident companies in which the resident company has an interest. The overall intention is to tax profits that have been artificially diverted from the United Kingdom.
Broadly, profits of a non-UK resident CFC will be taxed, using normal corporation tax rates and rules, on the persons controlling the CFC if (i) the profits pass through the CFC ‘gateway’ and (ii) are not exempt.
The ‘gateways’ are a series of tests that identify profits that are, broadly, artificially diverted from the United Kingdom. For example, where profits are attributable to UK significant people functions (SPFs), those profits will be taxed in the United Kingdom unless one of four conditions are satisfied (the first of which is that obtaining a tax advantage is not the main purpose or one of the main purposes of the arrangement). A range of other tests may capture other profits.
Various exemptions exist for certain types of companies, those coming into the regime for the first time, CFCs with low profits or low margins, CFCs in excluded territories, or others with corporation tax rates similar or above UK rates.
There is a special exemption for intra-group financing profits that can result in an exemption of between 75% and 100% of the financing profits on qualifying loans. In order to make the regime Anti-Tax Avoidance Directive (ATAD) compliant, the government has tightened these rules so that (from 1 January 2019) the reduced rate of tax will no longer be available in relation to profits that are attributable to UK SPFs. This exemption has been the subject of an in-depth investigation by the European Commission into whether it constitutes fiscal state aid. The European Commission has found the exemption, prior to 1 January 2019, to be partially justified. However, it has specifically stated that the rules applicable after that date no longer give rise to any state aid concerns.