Whether large or small, your company will now need to take extra care on cross-border dealings.
In early October, the international community agreed to enforce a minimum rate of Corporation Tax of 15%. It’s reported that this will raise over £100bn of tax per year and while this initiative was originally directed at perceived tax management or avoidance by the large multi-nationals, the impact will be felt by smaller organisations.
Any business involved in cross-border activity, through overseas companies, branches or even representative offices will need to take extra care on their intra-group cross-border transactions or services. This desire of governments to be able to tax the right, or at least a fair division of profit in their country continues to drive the focus on anti-avoidance and supply chain manipulation.
The OECD’s Base Erosion and Profit Shifting (BEPS) 2.0 project is, among other things, designed to build a framework for a fairer distribution of taxing rights of large multinational enterprises. While the Two-Pillar approach is likely to be effective from 2023, governments are paying particular attention to intra-group transactions and the application of transfer pricing principles.
Transfer pricing addresses transactions between connected parties and looks at the amount of profit that would have arisen if the same transactions had been undertaken by unconnected parties. This is known as the arm’s length principle. In most countries this applies to intra-group cross-border activities, but in the UK, transfer pricing is also applied to UK-to-UK transactions.
The arm’s length principle aims to re-evaluate group transactions based on terms and conditions that one would expect to see between independent parties engaged in the same or similar transactions.
The application of the arm’s length principle sounds simple enough but in practice can be very complex – especially within the insurance sector. In certain cases, it can be very difficult to determine arm’s length terms especially where comparable transactions between unconnected parties cannot be readily found. This can make the benchmarking of insurance- related transactions, such as brokerage or commissions received, rather tricky because of the nature of the underlying risk.
Non-insurance transactions, such as interest on loans and recharging expenses, are far easier to benchmark because of their standard nature. So, it’s important that all insurance brokers and intermediaries review their tax policy for the intra-group recovery of expenses and income where possible.
In the UK there’s an exemption for SMEs, i.e. those firms with an income of less than €50m or a balance sheet total less than €43m and less than 250 employees, except where transactions are with countries that don’t have a non-discrimination clause in their Double Tax Treaty with the UK.
Unfortunately, in most countries there are no transfer pricing exemptions and even a small company or branch in a foreign jurisdiction will be required to assess its intra-group transactions. It will usually be required to prepare a Local File before submitting its tax return and in some countries, the Local File must be submitted along with the tax return.
The review of intra-group transactions should be conducted before year end so that if needed any necessary adjustments can be made in the UK accounts. Remember that in most cases, transfer pricing adjustments can only be made to increase a taxable profit or to reduce a taxable loss and there’s no automatic corresponding adjustment to a UK company’s taxable profits when an overseas tax authority makes a local transfer pricing adjustment to increase the branch’s income or reduces a deductibility of certain recharged expenses.
After reviewing the intra-group transactions it’s important that suitable documentation is prepared in order to explain and justify the pricing and position taken by the group at this point to any relevant tax authority. All intra-group transactions and documentation should be reviewed annually and any benchmarking undertaken should be updated at least triennially unless there is a significant change in the underlying facts. For example, intra-group loans which were benchmarked to LIBOR interest rates, should be updated to IBOR and the impact assessed and documented.
As tax governance becomes increasingly important for all sizes of brokers and insurance intermediaries, consideration must be given to updating tax policies and documenting tax systems. The UK’s compliance with overseas tax reporting continues to expand, extending beyond transfer pricing to areas such as DAC6 which requires European tax authorities to be notified of cross-border tax arrangements satisfying certain ‘hallmarks’ and FATCA reporting for US transactions.
The discipline imposed by good tax governance is important for all companies as inter-governmental exchange of information increases and the tax world becomes smaller.