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Transfer Pricing will expand to SMEs, are you ready?

Deirdre and I recently finished watching BBC’s 2018 series “The Split”; okay we’re a bit behind. It deals with the three Defoe sisters two of whom are lawyers and the youngest is a childminder. The latter (“Rose”) is about to marry one of my species, an accountant. She is chatting with her sisters about the husband-to-be and bellows frustratingly “what is Transfer Pricing” presumably to demonstrate the scintillating level of conversation had with her beloved. To be clear, all my species are not the same!

I was reminded of that scene when reading the Department of Finance’s Public Consultation document on Transfer Pricing (TP). That consultation (another one!) ended last week. The paper, like independent economist Seamus Coffey’s report before it, which looked at Ireland’s Corporation tax system, recommended extending TP’s application to SMEs. Such entities are currently excluded from the application of Ireland’s TP rules so it’ll be a whole new world for them in 2020, or later, assuming these proposals are adopted as part of the Finance Bill.

I say “or later” in that the Department’s document explains that “to address the issues around uncertainty, legislation extending transfer pricing rules to SMEs could be made subject to a Ministerial Commencement Order”. This means that the Minister for Finance could include the rules in the upcoming Finance bill and press the “on” switch at a later time or amend them again in a future finance bill before switching them on. These orders are not unusual having being done many times before in tax law.

Such a move would be welcome in that certain SME’s will have a steep learning curve in relation to its application and switching on such law just after Christmas may bring about the exact uncertainty that the Department’s document wants to avoid. That said SME’s should commence preparations for such a change in their modus operandi.

To answer Rose Defoe’s question, TP includes the policies and procedures associated with the way in which a company prices goods, services and intangibles transferred to another related company. It requires an arm’s length price be charged and justified. The OECD’s most recent TP guidelines, which are enshrined in this proposed law, explains that the application of the arm’s length principle depends on determining the conditions that independent parties would have agreed, and here’s the science bit “in comparable transctions in comparable circumstances”. So “walk a mile in my shoes” and charge accordingly!

Right now TP doesn’t apply to SMEs which are defined as enterprises with less than 250 employees and either a turnover of less than €50 million or assets of less than €43 million. Seamus Coffey’s report suggested applying TP to all companies irrespective of their size or activity and the Department’s document outlines various snippets of legislation which may be copied and pasted into our law to implement certain elements of that report.

For example, take an entrepreneur who sets up one company for one activity, say selling goods, and another company to make those goods. Both are small companies. When the law comes into effect those companies would, for the purposes of computing the profits chargeable to corporation tax, have to charge an arm’s length price for selling those goods between them. If they don’t then Revenue can, in accordance with this newly suggested law, adjust their profits, and hence their tax, accordingly.

But here’s the thing, it matters what type of activity each company is engaged in order to determine the application of the TP adjustment. In the above example, it’s assumed that both companies are trading and their profits are subject to tax at the 12½% rate. Take for example, the situation where an entrepreneur has a small trading company and its profits are taxable at the 12½% rate and it rents a property from another small company within the same corporate group which pays tax on it at 25%. The first company pays rent to the second each month but above the market rate. In this instance the trading company will see its rental deduction reduced to the market rate (and thereby increasing its taxable trading profits). If neither company were trading then there should be no adjustment because the rules don’t apply to non-trading income in such situations unless there’s avoidance going on and that’s whole different ball game. There are also separate provisions where Capital Gains Tax is applicable.

An argument for not applying TP rules to SMEs is to avoid undue administrative burdens, particularly in the area of the associated paperwork requirements. The OECD TP Guidelines note the increase in SMEs entering into the area of TP and “the number of cross-border transactions is ever increasing. Although the arm’s length principle applies equally to small and medium sized enterprises and transactions, pragmatic solutions may be appropriate in order to make it possible to find a reasonable response to each transfer pricing case.” EU and other jurisdictions often exempt or apply less onerous paperwork requirements for SMEs, or publish tailored guidance for them.

This is recognised in the suggested law in that certain documentation requirements are completely disapplied for small companies and certain medium sized companies. Okay this might get around the paperwork but the numbers still have to add up from a TP perspective for both small and medium companies i.e. the calculator is mightier than the paperwork here, unless the Minister brings about additional changes or “safe harbours” as part of the legislative process.

So far, I’ve only mentioned transctions between Irish companies. The same rules will apply where the transactions occur between an Irish company and a foreign associated company. However (isn’t there always a however) even though a transction was not part of the Irish company’s trade then TP will apply to the transction such that the Irish company may see its Irish taxable profits increase as a result. If that transction was with another Irish company then TP would not apply to the first Irish company; right now that’s how the rules are proposed.

The rules discussed above are part of a discussion document so they may change when we first see the Finance Bill and even then change again before the President signs it into law. All this may mean a seismic tax shift for SMEs depending on their activity if it’s not amended before it becomes law: Game faces people!

Tom Maguire is a tax partner with Deloitte and his column on tax matters appear in the Sunday Business Post. The above column was first published on 22 September 2019.

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