Scope of APAs and accounting periods

The Court of Appeal has upheld the decision of the Upper Tribunal in R (on the application of Refinitiv Ltd) v HMRC [2024] EWCA Civ 1412 and rejected the argument that an Advance Pricing Agreement (APA) covering periods to 2014 prevented HMRC issuing DPT notices for the 2018 period calculated in part on services provided during the period covered by the APA and using a different basis of calculation (profit split versus cost plus). The Court agreed that the APA only covered the taxation of profits in earlier periods and did not prevent HMRC taking a different approach to the transfer pricing of the same services for taxation purposes in later periods.

The decision is an important caveat on the scope of APAs and taxpayers should bear in mind this restriction when entering into negotiations with HMRC around a potential APA.

Background

The case concerns IP held by a Swiss group company (TRGR)  in the Thomson Reuters group (TRG). It was accepted that the value of that IP was enhanced by services of UK group entities. For the period from 1 January 2010 to 31 December 2014 (together with a roll-back to 2008), the arm's length pricing of those services was covered by an APA which used the Transactional Net Margin Method (TNMM) on a cost plus basis. That APA expired and was not renewed.

TRGR later disposed of the IP in 2018 and HMRC issued a DPT notice applying a profit split method for calculating the arm's length compensation due to the UK group companies. HMRC accepted that some of the DPT charge for 2018 (based on the sale of the IP) was referable to the services provided before the end of 2014 (during the period that the APA was in force).

TRG argued that HMRC's decision to issue DPT notices should be quashed on the basis that the TP treatment of the services provided prior to 2014 had been exclusively covered by the APA. As such, HMRC were not entitled to issue the DPT notices on a different basis. HMRC argued that the APA only covered the taxation of profits during the period to the end of 2014 and did not prevent HMRC issuing a subsequent DPT notice for a different taxation period calculated on a different basis.

The question in this case was whether DPT notices covering the 2018 period were inconsistent with the APA to the extent that they calculated the arm's length price of the services provided in 2008-2014 on a profit split basis, which was in addition to the price calculated on a cost plus basis in the APA?

The UT rejected that argument, noting that TIOPA 2010 s.220 gives effect to APAs providing that it applies "if a chargeable period is one to which an APA relates". In this case, the APA only related to the periods up to 2014, not subsequent periods. In addition, the UT held that there was nothing in the terms of the APA itself that required it to be construed as extending beyond 2014.

Decision of the Court of Appeal

The Court of Appeal has endorsed the decision of the Upper Tribunal. In particular, the Court noted that corporation tax is an annual tax and therefore: "in the absence of special provision either side is free to change its ground on matters of law or methodology from year to year... it is a long-established principle that the doctrines of res judicata and of issue estoppel cannot apply from one year to the next in the context of income tax, and the same must be true of corporation tax." The Court also noted that although HMRC have very wide powers of care and management, those powers do not extend to making binding agreements about the basis or amount of assessment in future years. As such, the Court indicated that it started "with a strong inclination to find the temporal scope of the APA in the present case within the four corners of the document itself, and not to expect it to exert an influence on the treatment of the tax affairs of TR UK in later years unless, of course, the APA was renewed".

Sir Launcelot Henderson concluded: "Neither party, in my judgment, could reasonably have contemplated that, if (as happened) the APA was not renewed, the methodology used and applied for the years covered by the APA should have a continuing and constraining effect on HMRC's approach to transfer pricing in future accounting periods from 1 January 2015 onwards. Those future periods lay outside the temporal scope of the APA, so in the absence of further agreement each succeeding accounting period must be examined separately for corporation tax purposes unaffected by the APA. Still less, in my judgment, could the parties reasonably have contemplated that the time-limited methodology of the APA should somehow constrain the extent or nature of any charges to DPT that HMRC might later seek to impose on TR UK under legislation that did not yet exist, and had only very recently been announced, when the five-year term of the APA came to an end on 31 December 2014."

Looking specifically at the terms of the legislation and the APA, it was clear that it "related" to the five years to the end of 2014 only. That was the simple answer. The Court bolstered its conclusion by asking the rhetorical question: "The matter may perhaps be tested by asking whether Parliament could sensibly have intended that the APA should also "relate" to unspecified future chargeable periods, however remote in time, in which an issue settled by the APA for the chargeable periods specified therein might again become relevant in some way to the determination of TR UK's future taxation liabilities.". The answer to that question was an unhesitating "no".

As a result, the Court of Appeal concluded that the 2018 accounting period of TR UK fell outside the temporal limits and the effective scope of the APA. It is not a period to which the APA relates within the meaning of section 220(1), and there is accordingly no objection in public law to the relevant assessments to DPT raised by HMRC.

Comment

The Court has taken a strict approach to the scope of the APA in this case. Despite the fact that the APA covered the same services as those included in the later DPT notice which sought to tax them on a different basis, the Court has held that there was no inconsistency since the APA was time limited and did not apply to the later accounting periods. As such, taxpayers should recognise that this is a significant restriction on the scope of APAs.

It is interesting to note that HMRC argued that applying the APA in the way TGR contended would have extremely serious consequences for HMRC's APA programme. HMRC argued that APAs have a fixed term because of uncertainties on arm's length pricing longer than that, or as international thinking or HMRC's practice may change.

Are taxpayers able to take the same approach and widen the APA to cover off the treatment of services provided on an exhaustive basis? That remains unclear as HMRC (even if in principle willing) may equally make the point (on the basis of this case) that this would go beyond the scope of an APA as provided by s.220 and so be outside their vires.

Indeed the Court of Appeal concluded its judgment with this final caveat to the claim: "It was common ground before us... that in the circumstances of the present case TR UK's public law challenge to the DPT notices for 2018 would succeed if the notices were found to be inconsistent with the terms of the APA. This was in substance a concession by HMRC. While we have been content to proceed on that agreed basis in this case, in the interests of narrowing the issues and the saving of time and costs, we would emphasise that in different factual circumstances there may be further arguments that HMRC could legitimately deploy even where the issue of a DPT notice is found to be inconsistent in some material respect with the terms of a prior APA. We must therefore not be taken to endorse the proposition that any such inconsistency will always be enough to justify a public law challenge to the validity of the notice."