EXPLANATORY NOTE

1. This clause provides for advance pricing agreements between taxpayers and the Inland Revenue. These enable complex transfer pricing issues to be resolved on a prospective basis. The provisions apply to agreements made from the day the Act is passed and for chargeable periods ending on or after that day.

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2. Subsection (1) establishes the chargeable periods for which the rules for advance pricing agreements apply. It also provides that an advance pricing agreement:

must be in writing;

can only be made in relation to certain matters;

can only be made following an application by the taxpayer;

must contain a declaration that it is made for the purposes of this provision.

3. Subsection (2) identifies the matters which can be covered by an advance pricing agreement. They all involve "transfer pricing", that is to say, the determination of the terms on which assets, services and finance are transferred between associated persons, and also the income attributable to different parts of the same enterprise.

Paragraph (a) concerns the attribution of actual or prospective income to a trade of a UK branch or agency of a foreign taxpayer; in practice it applies where there is no double taxation agreement between the UK and the foreign country.

Paragraph (b) concerns the attribution of actual or prospective income to a business of a UK permanent establishment of a foreign taxpayer or of a foreign permanent establishment of a UK taxpayer; in practice it applies where there is a double taxation agreement between the UK and the foreign country.

Paragraph (c) concerns the extent to which actual or prospective income of a UK taxpayer arises outside the UK; in practice it applies where there is no double taxation agreement between the UK and the foreign country and where credit may be available for foreign tax paid.

Paragraph (d) concerns existing or prospective transfers between a UK taxpayer and an associate; in practice, it applies to transactions across international borders, and to some transactions across the North Sea ring fence.

Paragraph (e) concerns certain existing or prospective transfers across the North Sea ring fence between different parts of the business of a UK taxpayer.

4. Subsection (3) provides that, where an advance pricing agreement is in force, the application of the arm’s length standard in respect of any relevant matter is, to the extent provided for in the agreement, to be determined in accordance with the agreement rather than the legislative provisions which would otherwise have applied.

5. Subsection (4) narrows the scope of subsection (3) where the relevant matter falls within subsection (2)(d) or (e) and not within (a), (b) or (c). It confines the legislative provisions that can be displaced to the transfer pricing rules in Schedule 28AA to the Taxes Act 1988.

6. Subsection (5) sets out what a taxpayer must do when applying for an agreement. In general terms, the taxpayer must set out his understanding of the effect in the particular case of the provisions in question, say what clarification is sought and propose how the clarification might be effected in a manner consistent with that understanding.

7. Subsection (6) says when two persons are associates. This is, broadly speaking, when one controls the other or when both are under common control. This meaning of control is to be interpreted in accordance with the definition which applies for the transfer pricing rules in Schedule 28AA to the Taxes Act 1988.

8. Subsection (7) defines "ring fence trade" for the purposes of the clause. This is, broadly speaking, the trade of extracting oil or gas from the North Sea or other parts of the UK and UK continental shelf. Profits of this trade are ring fenced by section 492 of the Taxes Act 1988.

9. Subsection (8) says when the rules take effect. They apply to agreements made from the day the Bill becomes law and for chargeable periods ending on or after that day.

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10. The term "transfer pricing" describes the process by which associated persons, such as companies in a multinational group, set the prices at which they transfer assets, services or finance between each other. This affects the amount of the profits of the persons involved and the tax liabilities which arise in the countries in which they do business.

11. There is broad international agreement that, for tax purposes, transfer prices should be set according to the "arm’s length" standard. That is to say, the prices should be equivalent to those which would be charged between independent persons dealing at arm’s length in otherwise similar circumstances.

12. The arm’s length principle has been incorporated by the Organisation for Economic Development (OECD) in Article 9 of its Model Tax Convention on Income and on Capital and reinforced in its Transfer Pricing Guidelines.

13. The United Kingdom has had tax legislation on transfer pricing applying the arm’s length standard for many years. This legislation was modernised in the Finance Act 1998 and is now Schedule 28AA to the Taxes Act 1988. The new rules enable the transfer pricing rules to be operated within a self-assessed tax system and specifically incorporate the OECD’s principles.

14. An advance pricing agreement is an agreement between a taxpayer and one or more tax authorities about appropriate pricing arrangements to be adopted by the taxpayer. These agreements offer a process for resolving complex transfer pricing issues on a prospective basis. They give the taxpayer certainty in advance of making a tax return that, if the arrangements are applied to transactions as set out in the agreement, they will be accepted as satisfying the arm’s length standard.

15. Advance pricing agreements are endorsed in the OECD’s Transfer Pricing Guidelines. Tax authorities in a number of major countries, including the USA, enter into such agreements. The Inland Revenue already enters into advance pricing agreements through the mutual agreement procedure contained in many of the United Kingdom’s double taxation agreements with other countries.

16. The proposals in the current Finance Bill would enable the Inland Revenue to enter into advance pricing agreements independently of the mutual agreement procedure. They set out the transfer pricing issues which can be covered by an advance pricing agreement, what a taxpayer must do to obtain an agreement, and how an agreement will be applied when it has been reached. They follow an announcement made by the Government at the time of the 1998 Budget that it would bring forward legislation after consulting on the details.

17. This consultation was carried out on the basis of draft clauses between December 1998 and the end of January 1999. The clauses in the Bill reflect the results of that consultation.