CW Energy LLP

Potential Adjustments to Transfer Pricing Legislation

The government is looking at the possible introduction of a secondary adjustment rule into the UK’s domestic transfer pricing legislation. The consultation document was published on 26 May 2016 seeking views on whether such a feature should be introduced and if so its design.


Under the transfer pricing rules taxable profits are calculated based on an arm’s length price. The UK has adopted the arm’s length principle based on the OECD Model Tax Convention. Where the price is not arm’s length and a potential UK tax advantage is obtained the UK’s rules require a “primary adjustment” to be made to the original price as a tax only adjustment in calculating the taxable profits. No further consequences as regards the “overpayment” currently arise. However, the other entity will have received funds in excess of those it would have done so in an arm’s length situation.

With a view to encouraging companies to adopt arm’s length principles in their commercial arrangements, and following the approach taken in a number of other jurisdictions such as the US, Canada and France, the government believes that additional, “secondary” adjustments should be made in arriving at taxable profits to reflect the fact that the company’s resources have been depleted as compared to an arm’s length transaction.



The government proposes to address this by introducing a deemed secondary adjustment imposing a further tax charge in respect of this depletion of resources.

The OECD’s transfer pricing guidelines provide that secondary adjustments may take the form of constructive dividend, constructive equity contributions, or constructive loans.

As neither dividends nor equity injections have any immediate effect for UK tax purposes the government proposes that a constructive loan regime would achieve the policy aims. The quantum of the “primary” transfer pricing adjustment would be treated as a deemed loan from the potentially advantaged company. The loan would then bear an imputed interest which would then be treated as taxable income in the UK company until such time that an actual payment was received to negate the original transfer pricing adjustment amount.

De-minimis level

The government proposes that secondary adjustments would only have to be made where the primary adjustment was in excess of £1m.

 Potential issues

The government recognises that secondary adjustments could create a number of issues.

One issue is the creation of non-relievable double taxation. Under the arm’s length principle an upward adjustment is made in the country from which profits have been diverted and many treaties provide for a corresponding downward adjustment in the country in which the other party is located in respect of a primary adjustment. Similar corresponding adjustments for secondary adjustments are however not dealt with in the OECD Tax Model Convention and consequently not in most treaties, and double taxation could arise.

The government is also seeking views on whether such a proposal would create any accounting issues; how the interest rate to be applied to the deemed loans should be arrived at; how any receipts, if the transfer pricing benefit is repatriated, should be treated; whether any anti-avoidance provisions would be needed; and whether secondary adjustments would create any particular problems with advance pricing agreements (APAs).


Such a rule would create significant added complexity, for example presumably there could be secondary adjustments on not just primary adjustments but also the secondary adjustment itself. Where UK to UK adjustments are required there may be mismatches created; for example, imputed interest income might be taxable but with no deduction available for the charge. 

This might be a particular concern for ring fence companies.  

The prospect of such complexity and the potential for mismatches may therefore be effective in achieving the government’s objective of pushing groups to transact on an arm’s length basis rather than just accept that transfer pricing adjustments can be made in their tax returns. 

The £1 million de-minimus is however welcome.

The consultation closes on 18 August 2016 and the government expects responses in a form of answers to a number of questions addressed in the consultation document.