group’s structural response to the increase in the IPTrate to take into account that DISL would have someadditional short-term bargaining power, as thegroup’s existing reinsurer, to negotiate more favourableterms.DSG is notable for the court’s departure from theCUP method, but also for the court’s clear emphasisthat the difference in bargaining power between thetwo parties was critical to the question of what wouldhave been agreed between the two parties at arm’slength. Whilst this may seem an obvious point, it hassignificant implications as regards captive insuranceor reinsurance companies, which (particularly at apoint at which the relationship is well established anddata regarding loss ratios is known) can be expectedto have a relatively weak bargaining position as regardstheir parent company. Therefore, whilst thecourt in DSG stated the ‘‘exceptional’’ nature of thefacts of the case because, provided that the loss ratiowas within certain bounds, the underwriting profit ofthe third party insurer and DISL was set, this decisioncould be expected to have implications for captive insuranceor reinsurance entities more generally.3. Banks and insurance companiesWith respect to banking, the relevant HMRC guidancestates that: ‘‘[w]here there has in fact been a capital allotmentbased on the economic and regulatory requirementsof the PE’s business, any tax adjustmentunder the new legislation is likely to be relativelyminor, taking into account that allotment. Where,however, the UK PE’s business is not supported, or isinadequately supported, by capital, the purpose of theUK legislation is to make an adjustment to the UK taxcomputation to align the taxable profits more closelywith those which would be achieved by similar bankingactivities carried out by a UK bank in the same orsimilar circumstances’’. The adjustment described inthis quote is referred to as the ‘‘capital attribution taxadjustment’’ (the ‘‘CATA’’).In relation to the CATA, HMRC guidance suggeststhat a useful step-by-step way by which tax inspectorscan structure their approach in determining whetherany adjustment is required (and if so, in whatamount) is as follows:i. determine the assets attributable to the PE;ii. risk weight those assets;iii. determine the equity capital that the PE would requireif it were a distinct and separate enterpriseengaged in the same or similar activities under thesame or similar conditions;iv. determine the loan capital that such an enterprisewould have had if it had the equity capital determinedunder step (iii); andv. determine the capital attribution tax adjustment tobe made, based on the difference between the PE’sactual funding costs on the combined amount representingthe equity and loan capital determinedunder steps (iii) and (iv) and the notional fundingcosts (which will include a rate of nil in respect ofthe equity capital) to be taken into account in accordancewith domestic legislation.This recommended five-step analysis therefore requiresan application of the factual and functionaltransfer pricing analysis (as described above in relationto the attribution of profits), along with an applicationof (generally) UK regulatory rules indetermining how capital would have been required tobe allocated to the PE.The HMRC guidance also suggests that, unless theactivities carried on by the PE are sufficiently differentfrom those carried on by the bank as a whole (thatis, either inherently riskier or less risky), it may bepossible to apply the capital ratios of the bank to thePE rather than applying the five-step approach describedabove. As a second alternative to the five-stepapproach, the HMRC guidance suggests that an analysisbased on UK banking comparables may be used,although it cautions that it may be difficult to find‘‘true comparables’’ in the banking context (in terms ofsize and spread of activities) and therefore suggeststhat the use of comparables might prove to be mosthelpful as a check where capital has been attributed tothe PE based on the capital mix of the company as awhole.Section 32 CTA 2009 contains provisions disallowingdeductions for payments of interest or other financingcosts by a PE to any other part of a non-UKresident company, although the restriction does notapply to the interest or other financing costs that arepayable in respect of the borrowing by the PE in theordinary course of a financial business carried on byit. ‘‘Financial business’’ for these purposes meansbanking, deposit-taking, money lending or debt factoring,or a business similar to these; and dealing incommodity or financial futures.4. Sectors in which IP is importantThis proposed 10 percent Patent Box tax regime forincome attributable to the commercialisation of patentsowned or exclusively licensed by the taxpayer willinvolve:s an assumption that a profit of cost plus 10 percentis earned on routine activities;s the determination (with a small claims exemption)of a notional arm’s length royalty payable for theuse of any marketing intangibles; and, where thepatent is being used to produce non-patented goodsor servicess the determination of an arm’s length royalty for theuse of the patent.Danny Beeton is head of transfer pricing economics at<strong>Freshfields</strong> Bruckhaus Deringer LLP in London and may becontacted by email at danny.beeton@freshfields.comMurray Clayson is a partner in <strong>Freshfields</strong> Bruckhaus DeringerLLP’s tax practice group in London and may be contacted byemail at murray.clayson@freshfields.comRini Banerjee is a trainee solicitor at <strong>Freshfields</strong> BruckhausDeringer LLP in London and may be contacted by email atrini.banerjee@freshfields.comNOTES1 See Part I of the PEs report at Section D-5(ii) (paragraph270.2See HMRC’s International Manual (‘‘INTM’’) atINTM276040.3 This is a functional rather than a legal analysis since thePE does not itself legally enter into transactions or ownassets in its own right, separate from the rest of the nonresidententity: see Part I of the PEs report at SectionB-3(i) (paragraphs 13 – 15).05/12 Transfer Pricing Forum BNA ISSN 2043-0760 8
4 Sections 5(2)/(3) and 19, 21 and 22 Corporation Tax Act(‘‘CTA’’) 2009.5 Although there is no express requirement under UK lawto interpret the corporation tax rules applying to PEs ofnon-resident companies consistently with the MTC, section164 of the Taxation (International and Other Provisions)Act 2010 (‘‘TIOPA’’) requires the transfer pricingrules in Part 4 TIOPA to be interpreted in a way so as bestto secure consistency with Article 9 and the TPG, and inpractice HMRC will apply the same approach to attributionof profits to UK PEs: see guidance published byHMRC at INTM267040. HMRC’s manuals are a publicstatement of HMRC’s views on UK domestic law but theyshould be treated with caution since they are unlikely tobind HMRC.6 Multinational Enterprise.9 05/12 Copyright 2012 by The Bureau of National Affairs, Inc. TP FORUM ISSN 2043-0760
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