With the headline rate of CT in the UK now double that of our neighbours in the Republic, HMRC’s risk profiling is likely to result in increasing focus on NI businesses operating across the border and further afield.
For over ten years I worked as a Tax Specialist for HMRC working on a wide spectrum of tax issues but my primary focus was that of international tax issues - both investigation and litigation.
In my time I witnessed HMRC increasing its focus on international tax issues, considering these issues to be key risk areas and instructing their risk assessors to give international issues special attention. Within the international tax spectrum, a particular area of focus has been, and will continue to be, ‘Transfer Pricing’.
Transfer Pricing refers to the process of applying a price to a transaction between two connected persons. Transfer Pricing is not new- it started out as a management accounting concept decades ago when businesses wanted to understand how individual divisions were performing.
The relationship between Transfer Pricing and tax is most pertinent when you are applying a price to a transaction that crosses tax jurisdictions. The risk, from a tax authority point of view, is that some businesses will apply a ‘transfer price’ that effectively pushes profits from one jurisdiction to another.
Transfer Pricing is a global concept with the OECD (a worldwide organisation that identifies and promotes good economic practices) having developed a package that provides 15 Actions that equip governments with the domestic and international instruments to tackle tax avoidance, many of which focus on Transfer Pricing.
Profit shifting via Transfer Pricing therefore draws keen interest from many tax authorities. However, Transfer Pricing is not a typical risk area of interest for HMRC, it is one of its key ‘national’ risks. The difference is that HMRC invests a huge amount of its resources directly at mitigating key ‘national’ risks.
This increased focus starts with how they profile for the risk - every tax return that is submitted will be analysed for indicators of transfer pricing risk, the information submitted in the tax return will then also be compared against other data held by HMRC for further confirmation of a risk.
Once the computer profiling is complete, and the information is collated, teams of tax specialists investigate further using numerous other information sources on the taxpayer. These specialists are all highly trained professionals- both in tax legislation and investigative techniques.
Transfer Pricing also adds a further process, requiring the suspected tax risk to be explained to a panel for them to approve the opening of an enquiry and provide guidance and support throughout the enquiry. This ensures HMRC focuses its resource on the most ‘relevant’ cases. ‘Relevance’ may be the highest yielding cases, cases that need to address a certain behaviour/interpretation or a new trend/area of concern (significant for Northern Irish businesses).
This process has been hugely successful as Transfer Pricing enquiries have been a happy hunting ground for HMRC. Over the past five years, HMRC has collected more than £8 billion of tax from Transfer Pricing enquiries.
It should come as no surprise then that HMRC continues to intensify its efforts in this area. It has not only been increasing the number of Transfer Pricing enquiries but progressing more of them to closure - Transfer Pricing settlements are up 58% in 2021-22 from 2016-17.
This is only going to increase as HMRC moves around 1,350 staff members from COVID schemes to frontline compliance and invest in staff through both internal training and external training. On top of that, HMRC also continues to externally recruit ‘senior’ international tax specialists.
Why does this matter to Northern Irish businesses? In HMRC’s eyes, I expect Northern Ireland businesses to now be considered inherently risky from a Transfer Pricing perspective.
Northern Ireland is the only region of the UK which shares a land border with another tax jurisdiction facilitates ease of cross-jurisdictional activity and trade. Furthermore, from April 2023, the Republic has had a headline rate of Corporation Tax being half that of the UK (12.5% versus the UK’s 25%).
HMRC will expect many Northern Irish businesses to have operations both sides of the borderand, whether due to inaccurate transfer pricing of transactions or the temptation to shift profits into the Republic, will anticipate profits to migrate from the north to the south.
This inherent risk, coupled with the profiling already described, leads me to believe that HMRC’s Transfer Pricing governance panel will embark on a major enquiry programme into Northern Irish businesses.
Who needs to be aware? There is a misconception that Transfer Pricing only applies to businesses defined as ‘large’, but that is not necessarily the case. The legislative obligation mandatorily applies to ‘large’ businesses, however, ‘medium’ and ‘small’ businesses are not wholly exempt from complying.
A ‘medium sized business’ (defined as having less than 250 employees together with annual turnover less than €50m or balance sheet less than €43m) can still be subjected to a Transfer Pricing enquiry by HMRC and be obligated as the result of the enquiry to apply transfer pricing principles.
The legislation exempts ‘small businesses’ (defined as having less than 50 employees and annual turnover or balance sheet total of less than €10m) and HMRC do not have the power to open a Transfer Pricing enquiry. However, Profit Fragmentation rules introduced in 2019 provide a means whereby HMRC can enquire into ‘arrangements’ that have failed to apply Transfer Pricing principles and, if HMRC deems it appropriate, it can impose the application of Transfer Pricing principles upon the business.
Essentially any business in Northern Ireland that has operations north and south of the border (or further afield) needs to be applying transfer pricing principles to mitigate the risk of enquiry.
If HMRC focuses on Northern Ireland businesses, as I suspect it will, and deploys all of the powers and resource at its command, there will be nowhere to hide. My advice would be to act now and commission a tax review of cross-border arrangements.