188ÌåÓý

Section 1179DU and section 1179FM Corporation Tax Act (CTA)Ìý2009Ìý

If a production company incurs expenditure on a transaction with a connected party,Ìýthat expenditure is excluded up to the amount of the connected party profit, unlessÌýthe transaction is priced as if it was at arm’s length.Ìý

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Connected party profitÌýÌý

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

ExampleÌý

SM FilmsÌýLtd is a film production company that hires SM VFXÌýLtdÌýto carry out the visual effects work on its latest film. SM VFX LtdÌýis a subsidiary of SM FilmsÌýLtd.Ìý

SM VFX LtdÌýincurs expenditure of £2 million in carrying out the visual effectsÌýwork. ItÌýcharges SM FilmsÌýLtdÌý£5 million. The connected party profit is therefore £3 millionÌýâ€� the amount by which the payment by SM FilmsÌýLtd exceeds the costs incurred by SM VFX Ltd.Ìý

End of exampleÌý

‘Connectedâ€� 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.Ìý

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At arm’s lengthÌý

A transaction is entered into as if it wasÌýat arm’s lengthÌýif it makes ‘the arm’s length provisionâ€�,ÌýwhichÌýhas the same meaning as in Part 4 TIOPA 2010 (INTM412010). This essentially meansÌýthat 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?Ìý

The payment that would be made as part of an arm’s length provisionÌýcan include a mark-up or an element of connected party profit, but the company must be able to justify thisÌýamount as one that would be charged between independent parties.Ìý

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

ExampleÌý

Company A is aÌýproduction companyÌýand Company B is aÌýcompany which owns studio space for shooting films and TV programmes.ÌýCompany A and Company B are connected.ÌýCompany BÌýrents the studio space out to both Company AÌýand unconnected third parties.Ìý

IfÌýthe 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 canÌýprovide evidence of this, then any profit element to the transaction would be justified, and the expenditure would not be restricted.Ìý

End of exampleÌý

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

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

Although the arm’s 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)Ìýwhich are not otherwise within the scope of the transfer pricing legislation do not have to meet its other requirements.ÌýFor example, a small company which applies the arm’s length principle to its connected party transactions for the purposes of AVEC/VGEC will still fallÌýwithin the exemption from transfer pricing for small and medium-sized enterprises in section 166 TIOPA 2010.Ìý

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Reasonable amountsÌý

Different transfer pricing methods can give different arm’s length values. As long asÌýthe method used is reasonable, theÌýarm’s lengthÌýexception appliesÌýand no expenditure is excluded.Ìý

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.Ìý

However, if HMRC makes a transfer pricing adjustment and does not accept that the original payment reflected the arm’s length provision, then the arm’s length exception is deemedÌýto no longer applyÌýand the connected party profit is excluded in full.Ìý

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Series of transactionsÌý

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, andÌýuse the original supplier’s cost to calculate connected party profit.Ìý

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

• Company A was connected to Company B but not Company CÌý

• Company A was connected to Company C but not Company BÌý

• declare whether their claim includes any expenditure on transactions with connected parties, i.e. is any amount paidÌýor owedÌýto 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 partyÌý

• The date ofÌýtheÌýtransactionÌý

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

• A description of the goodsÌýand/or servicesÌýprovidedÌý