INTM610200 | Profit Fragmentation Adjustments

Paragraph 7 Schedule 4 Finance Act 2019 describes the adjustments that need to be made in relation to Profit Fragmentation Arrangements. A resident party with Profit Fragmentation Arrangements must make adjustments as described by this paragraph to the amounts included in their self-assessment returns, or must make a self-assessment return to report the relevant amount.

The adjustments must:

• relate to the expenses, income, profits or losses of the resident party for the tax period in which value is transferred as a result of the material provision,

• be based on what those amounts would have been if the value transferred had resulted from a provision made or imposed as between independent parties acting at arm’s length, and

• be just and reasonable.

The definition of arm’s length in this paragraph should be interpreted in line with the guidance given at INTM610100.

The nature of the adjustments to be made under this schedule mean that the legislation only applies to tax advantages that can be counteracted on a just and reasonable basis by making adjustments to the expenses, income, profits or losses of the resident party.

These adjustments are to be made in order to counteract any tax advantages arising from the Profit Fragmentation arrangements that remain after the application of other provisions.

Example 20 – Profit Fragmentation Adjustments

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.

A UK company (the resident party) makes arrangements with a Bermudian company (the overseas party) to provide administrative services to the UK Company to support its UK business.

The UK Company pays the Bermudian company £100,000, however, the arm’s length price of the services actually provided by the Bermudian company is only £10,000. The Bermudian company later makes a loan to a participator in the UK Company (the related individual) that is not taxable in the UK, meaning the enjoyment condition is met.

There is no commercial reason for the excessive payment and it is reasonable to conclude that the arrangements were entered into to obtain a tax advantage. The UK tax that would have been paid on the £90,000 diverted would have been £18,000 and the Bermudian tax paid on the £90,000 was £0, meaning the tax mismatch test was met.

These arrangements are Profit Fragmentation Arrangements so adjustments must be made to the amounts to be included in the UK Company’s tax returns.

The Profit Fragmentation legislation ensures the amount of profit that should be taxable in the UK is fully taxed in the UK. In this case the amount relating to the arrangements that should be taxed in the UK but wasn’t is £90,000. This is the difference between the value transferred and the arm’s length price.

The UK Company should disallow £90,000 worth of their administrative services costs in their tax computation – increasing their taxable profits by £90,000.

The £10,000 that is still deducted represents the value that should have been transferred for tax purposes between independent parties acting at arm’s length.