This material must be read in conjunction with the Responsibility Statement

CONTENTS

THE ANNOUNCEMENT
WHO IS AFFECTED?
WHO PARTICIPATES IN MANAGEMENT, CONTROL OR CAPITAL?
WHICH TRANSACTIONS ARE INCLUDED?


News that the Inland Revenue have confirmed that it will not be its practice to apply the new transfer pricing rules in Schedule 28AA ICTA 1988, so as to impute rental income to an overseas resident company controlled by a UK resident where that company owns a house in the UK which is occupied by that UK resident rent-free, will no doubt come as something of a relief to taxpayers involved in such structures.

Since the enactment of Schedule 28AA, this issue has arisen on a number of occasions and has gradually received increasing publicity. The first public statement on the Revenue position was in a note published in the Tax Journal (29th March 1999) and referred to in Taxation (1st April 1999). Although the news will be welcomed by those affected, taxpayers will continue to scratch their heads and wonder about the true scope of the new transfer pricing legislation.

THE ANNOUNCEMENT
The Inland Revenue have apparently written to solicitors who sought guidance on the application of the new transfer pricing rules to non-domiciliaries with United Kingdom homes held by offshore companies. The publicity indicates that the Revenue does not admit that the rules do not apply. The Revenue indicate strongly that they will not enforce the rules in such cases. This, the authors of the note conclude, must mean that the decision is a political one. Does this mean that there is a new, and as yet unpublished, extra-statutory concession on this? Only time will tell. If the Inland Revenue believe that they do apply, it would be helpful to know the basis for saying so and the extent to which the concession, if indeed it is one, applies. For example, would the concession apply equally to chattels such as works of art or antiques owned by offshore companies in similar circumstances? Since corporate taxpayers will generally be within Schedule 28AA since 6th April, resolution of a question of such wide-ranging importance is clearly pressing.

WHO IS AFFECTED?
The fact that the question has arisen at all and the manner in which it appears to have been addressed to date, raise far broader questions about the new transfer pricing legislation than the homes of some non-domiciled individuals. Schedule 28AA requires an arm’s length provision to be substituted for all terms and conditions involving transactions between "affected persons" as defined for the purposes of that Schedule. The issue of homes owned by offshore companies and their occupiers simply illustrates the problem of determining the parties who are within the ambit of the rule.

Affected persons are "any two persons" where one participates directly or indirectly in the management, control or capital of the other or where both have common participation in their management, control or capital. Does it only apply between two business enterprises as Article 9 of the OECD Model Convention clearly states? Is it sufficient if one party out of the two is an enterprise? What is an enterprise under domestic law? Although I have advised that these rules do not generally apply to homes of non-domiciliaries owned by offshore companies, the answers to these questions are not obvious when reading the legislation. In order to analyse the question, recourse must be had to the OECD Model Double Tax Convention and the OECD Transfer Pricing Guidelines, and perhaps to parliamentary materials in order to start mapping out the scope of the rules.

WHO PARTICIPATES IN MANAGEMENT, CONTROL OR CAPITAL?
Opaque drafting of Schedule 28AA gives rise to the uncertainty which is revealed by the issue relating to the homes of non-domiciled individuals. Other taxpayers will also have difficulty deciding whether they are within the new rules. These include smaller closely held and family companies and their shareholders. Very wide meaning is given to "indirect participation in the management, control or capital of another person" in Paragraph 4(2). The attribution of rights and powers of beneficiaries of trusts and creditors is intended to broaden the scope of the rule considerably. It is unclear how far it goes however. The legislation does not say what "rights and powers" are that are to be attributed. Some creditors’ rights are clearly contemplated by Paragraph 4(4)(b). The connection of connected persons to each other will result in control being found in the hands of individuals with only minor connections for this purpose. It will particularly affect companies and families who are located in several jurisdictions and who have transactions as contemplated by Schedule 28AA among them. These taxpayers are far less familiar with the transfer pricing regime than large multinational companies who have had to grapple with the rules under the previous legislation in any event.

WHICH TRANSACTIONS ARE INCLUDED?
The legislation requires adjustments in relation to provisions made by means of a transaction or series of transactions. The meaning of "transaction" is expanded in Paragraph 3(1) to include arrangements, understandings and mutual practices whether or not they are or are intended to be legally enforceable. Family businesses with international connections are perhaps the most exposed in relation to the rather vague notion of unenforceable mutual practices.

The way in which the legislation describes a series of transactions is also likely to be problematic, both in deciding what is and is not a "series of transactions" and how it impacts on provisions made between affected persons.

For owner managed businesses in particular, the question of determining arm’s length prices coming to grips with the accepted methodologies and obtaining suitable documentation will be challenging enough, without the difficulty of knowing whether they are within the rules or not.

One of the interesting features of the previous transfer pricing rules contained in ICTA 1988 Section 770 was that there were practically no cases decided on it. One Special Commissioners decision in Ametalco v IRC [1996] STC (SCD) 399 considered whether interest-free loans were within the rules. The only other important decision (Glaxo Group Ltd v IRC [1996] STC 191 (CA)) was on procedural issues. Those rules remained in place for some 50 years without reaching the Courts. The successor legislation in Schedule 28AA seems unlikely to manage the same record.

© Jonathan Schwarz 1999. All rights reserved, and all moral rights are asserted
This material must be read in conjunction with the Responsibility Statement
This article is published in Taxation 13 May 1999 volume 143 no3706 p163.