Foreign national companies that pay little tax into Treasury coffers are one of the chief targets of the current Inland Revenue crackdown on transfer pricing schemes designed to avoid corporation tax.
Inside the Revenue, senior officers are growing increasingly restless at the thought of companies like Rupert Murdoch’s News International continuing to pay an effective tax rate of 7% when everyone else is supposed to hand over 31%.
German electronics groups and most of the major Japanese car makers have been found paying much lower rates of tax than the chancellor would normally hope for.
Until last year, the Revenue had conducted a holding operation – trying not to let the situation get any worse. But large and small companies are now reporting incidents that add up to a campaign by the Revenue to reverse the trend.
The attack has been focused so far on medium-sized companies, according to Bob White, head of transfer pricing at Deloitte & Touche. ‘At the moment, the Revenue is concentrating not so much on the household names, but on the medium-sized companies with overseas operations.
It looks like the Revenue is using smaller companies to cut its teeth,’ he says.
John Hobster, head of transfer pricing at Ernst & Young, agrees: ‘All multinationals will need to up the ante because this is not just about the top 350 companies, it is about everybody.’
Coopers & Lybrand partner Mike Godbee says: ‘The Revenue sent a very detailed seven-page letter on transfer pricing to one of my clients recently. That’s more than one page for every #1m of turnover at this outfit. So it does look like the smaller ones are getting it first.’
The Revenue has already gained a raft of tough new rules to combat transfer pricing abuses. From July 1999, when self-assessment for companies begins, companies will be responsible for basing their tax returns on arms-length prices and will be subject to automatic penalties if they fail to do so.
They will be forced to present extensive documentation to support the business case for the transaction and justify why it wasn’t an elaborate tax scam.
‘Transfer pricing legislation that will be part of corporate self-assessment has given the Revenue a tremendous boost,’ says Hobster, ‘because the Revenue’s infrastructure and legal powers are being beefed up just as its resources are being strengthened.’
Targets have been set
Companies like Powerscreen, the troubled UK engineering company, will find themselves under increasing scrutiny when the new rules are in place.
Powerscreen, based in Northern Ireland, has been under investigation for accounting irregularities in a metal processing subsidiary, Matbro, for several months.
A closer look at the company’s 1995 accounts, reveals that its problems go further. An obscure subsidiary situated in Kilbeggan in the Irish Republic called Powerscreen Ltd made 35% of the pre-tax profits on just 9% of the group’s turnover. The corporation tax rate in Kilbeggan is 10%.
A tax note in the accounts reveals the company has been in dispute over transfer payments in 1995. It paid out #2.5m in settlement of a tax dispute in 1989. In the end, it paid an effective tax rate of 24%.
The Revenue has increased the number of active officers in its international divisions and large business units to investigate instances like these. Powerscreen, where it has been crawling all over the accounts for many years, is likely to be one of many victims by the time self-assessment comes in.
In the meantime, larger multinationals are preparing to defend their transfer pricing policies. David Alvey, finance director at BAT Industries, is leading the defence from his position as chairman of the tax committee for the 100 Group of FDs.
Christopher Pearce, FD at Rentokil Initial, said several meetings had taken place since the new rules were laid out for consultation in February.
‘We have met with the Revenue to express our concerns,’ he said.
Part of the defence is that ‘there can be commercial and strategic reasons behind a policy that has a huge fiscal impact,’ according to Hobster – ‘incentives for staff, for instance. This is not about avoidance. It’s about pleasing lots of different parties – inside and outside the company – at the same time.’
Despite the pleadings, the battle is about to commence. And competition inside the Revenue for scalps is only likely to intensify the combat.
The initial target set in the Budget that Revenue officers must recover using the new rules was #50m. But that is on top of the hundreds of millions it must recover to fulfil its spend-to-save commitment.
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