INTM610090 | Profit Fragmentation Arrangements: Tracing Value

Paragraph 3(3) Schedule 4 Finance Act 2019 states that when considering whether value has been transferred from the resident party to the overseas party value can be traced through any number of entities, however long and complex that chain may be.

If a chain of entities includes a number of UK resident persons all of them could fall within the meaning of a resident party. However, typically HMRC would expect to treat only the final entity from which value is transferred out of the UK as the resident party, unless the facts and circumstances indicate otherwise.

In considering which entity should be classified as the resident party, consideration should be given to the enjoyment conditions and where the business activity takes place. The enjoyment conditions require that there is a related individual with a connection to the resident party. The business activities need to be considered when making adjustments under Paragraph 7 of the legislation as these adjustments need to take account of the value that would have been transferred if the provisions had been made or imposed between independent parties acting at arm’s length.

If the final entity to which the full value was transferred was a UK resident it may not be reasonable to conclude that there was a tax advantage purpose, in which case the arrangements would not be Profit Fragmentation Arrangements.

Example 9 – Tracing Value Through Transactions

In the following example UK1, UK2 and UK3 are UK resident companies, and OS1, OS2, and OS3 are non-UK resident companies. Each of these companies is party to arrangements whereby value is transferred for which nothing is received in return. As with other examples in this guidance, it is likely that accounting principles, other legislation or case law would ensure the appropriate amount of profits are charged to UK tax: the following example illustrates how Profit Fragmentation rules would apply if that were not the case.

The following series of transactions is carried out:

• UK1 transfers £1,000 of value to OS1.

• OS1 transfers £1,000 of value to UK2.

• UK2 transfers £1,000 of value to OS2.

• OS2 transfers £500 of value to UK3.

• UK3 transfers £500 of value to OS3.

In these circumstances the resident party could be any of UK1, UK2, UK3, or indeed any combination of UK1, UK2 and UK3 each with separate arrangements, as value has been transferred out of the UK by each of them. As described above this will depend on the specific facts and circumstances surrounding the arrangements. This will include the related individual’s relationship with the companies and the nature of the activities that take place in each of these companies.