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Section 1179DU and section 1179FM Corporation Tax Act (CTA)听2009听

If a production company incurs expenditure on a transaction with a connected party,听that expenditure is excluded up to the amount of the connected party profit, unless听the transaction is priced as if it was at arm鈥檚 length.听

听

Connected party profit听听

Connected party profit exists where a payment has been made to a connected party (鈥淐鈥�) in exchange for supplying goods and/or services, and the payment exceeds the expenditure that has been incurred by C in making that supply.听

Example听

SM Films听Ltd is a film production company that hires SM VFX听Ltd听to carry out the visual effects work on its latest film. SM VFX Ltd听is a subsidiary of SM Films听Ltd.听

SM VFX Ltd听incurs expenditure of 拢2 million in carrying out the visual effects听work. It听charges SM Films听Ltd听拢5 million. The connected party profit is therefore 拢3 million听鈥� the amount by which the payment by SM Films听Ltd exceeds the costs incurred by SM VFX Ltd.听

End of example听

鈥楥onnected鈥� has the meaning given by s1122 CTA 2010. It is generally when two entities are under the same ultimate ownership, or when one entity controls another. Full guidance is available at CREC052100.听

听

At arm鈥檚 length听

A transaction is entered into as if it was听at arm鈥檚 length听if it makes 鈥榯he arm鈥檚 length provision鈥�,听which听has the same meaning as in Part 4 TIOPA 2010 (INTM412010). This essentially means听that the payment made as part of a transaction must be set as if the connected parties were unconnected. If the connected party were an independent third party, what would they have charged for the goods or services supplied?听

The payment that would be made as part of an arm鈥檚 length provision听can include a mark-up or an element of connected party profit, but the company must be able to justify this听amount as one that would be charged between independent parties.听

The easiest way for a company to justify an amount is to provide evidence of similar amounts paid in comparable transactions between independent parties.听

Example听

Company A is a听production company听and Company B is a听company which owns studio space for shooting films and TV programmes.听Company A and Company B are connected.听Company B听rents the studio space out to both Company A听and unconnected third parties.听

If听the amount paid to rent the studio by Company A is at a similar rate to the amount paid by a third party and Company A can听provide evidence of this, then any profit element to the transaction would be justified, and the expenditure would not be restricted.听

End of example听

A production company may also be able to justify a profit margin or mark-up by reference to an industry standard.听For example, if there were a standard profit margin charged by most sound mixing companies in the industry, a听production company would be able to justify paying the same or a similar profit margin to a connected party听for that service.听

A full transfer pricing analysis is useful evidence, but it is not a requirement.听

Although the arm鈥檚 length provision has the same meaning as in the transfer pricing legislation, Part 4 TIOPA 2010, companies claiming Audio-Visual or Video Games Expenditure Credits (AVEC/VGEC)听which are not otherwise within the scope of the transfer pricing legislation do not have to meet its other requirements.听For example, a small company which applies the arm鈥檚 length principle to its connected party transactions for the purposes of AVEC/VGEC will still fall听within the exemption from transfer pricing for small and medium-sized enterprises in section 166 TIOPA 2010.听

听

Reasonable amounts听

Different transfer pricing methods can give different arm鈥檚 length values. As long as听the method used is reasonable, the听arm鈥檚 length听exception applies听and no expenditure is excluded.听

It is possible that, as part of a transfer pricing enquiry, HMRC may impose a transfer pricing adjustment on a connected party transaction while also accepting that the original provision was charged at a reasonable value. If the adjustment covers expenditure on which the production company has claimed AVEC/VGEC, the company should amend its claim to reflect the value agreed with HMRC. Assuming the new value is lower than the original, the company will only lose entitlement to credit on the difference between the two amounts, not the entire connected party profit.听

However, if HMRC makes a transfer pricing adjustment and does not accept that the original payment reflected the arm鈥檚 length provision, then the arm鈥檚 length exception is deemed听to no longer apply听and the connected party profit is excluded in full.听

听

Series of transactions听

If a company pays a connected party for a supply using a series of transactions, the effect of the legislation is to look through the series of transactions to the original supplier, and听use the original supplier鈥檚 cost to calculate connected party profit.听

For example, film production Company A hires sound crew from a subsidiary,听Company B. Company B charges Company A 拢100,000. Company B does not employ the sound crew directly, but听hires them from听its own subsidiary, Company C.听Company C charges Company B 拢80,000. It costs Company C 拢60,000 to supply the crew, in wages and other expenses.听

• Company A was connected to Company B but not Company C听

• Company A was connected to Company C but not Company B听

• declare whether their claim includes any expenditure on transactions with connected parties, i.e. is any amount paid听or owed听to a connected party included in qualifying expenditure for the period

• provide the number of connected parties it has transacted with in transactions included in the claim

• provide the combined value of those transactions

• The name of the connected party听

• The date of听the听transaction听

• The value of the transaction, as included in the claim (so either the arm鈥檚 length cost or the cost to the supplier)听

• A description of the goods听and/or services听provided听