New transfer pricing revenue guidance
Ireland’s transfer pricing and international tax regime has evolved significantly through the introduction of broad legislative changes to Ireland’s transfer pricing rules from 1 January 2020, such that on 24 February 2021, Irish Revenue have published an updated Tax and Duty Manual to provide guidance on the changes to the Irish transfer pricing rules.
This update aims to provide a recap on the key changes to the Irish transfer pricing rules that took effect for accounting periods commencing on or after 1 January 2020 (unless otherwise stated), as well as additional commentary drawn from the recently published Revenue guidance.
2017 OECD guidelines and updated principles
Ireland’s transfer pricing regime was updated to reflect the 2017 OECD Guidelines and other OECD guidance as a basis for determining the arm’s length price for intra-group transactions.
The new transfer pricing legislation adopts accepted practice into Irish domestic tax law, which has to date referenced a 2010 version of the OECD Guidelines. This should be welcome news for businesses that wish to comply with consistent rules across their international operations.
New documentation obligations and penalty protection regime
Larger businesses operating in Ireland must prepare OECD-standard Master and Local Files to evidence compliance with transfer pricing rules. Most Irish businesses of any size will have an annual obligation to prepare a Local File if it is a member of a global group that has turnover greater than EUR 50 million. An Irish business will have a further Master File obligation if it is a member of a global group that has turnover greater than EUR 250 million.
With the introduction of the updated documentation requirement, businesses are now also able to avail themselves of penalty protection from tax-geared penalties provided certain criteria are met, such as requiring that the Local File has been prepared by the time the relevant Irish entity’s tax returns fall due.
However, in the event that Revenue requests documentation from a business, the business has only 30 days to provide it. Failure to prepare and submit the required documentation will attract penalties of EUR 25,000 or greater for larger businesses; or EUR 4,000 for those companies under the EUR 50 million turnover threshold.
Businesses in scope for documentation requirements should bridge gaps with existing documentation to align with latest OECD standards. A critical new item in the Local File is to reconcile transfer pricing policies to statutory accounts of the Irish entity.
Re-characterisation of an arrangement
The new transfer pricing legislation contains additional provisions aimed at curtailing tax benefits of arrangements in which the substance of the commercial or financial arrangements between parties does not align with the form of an arrangement. Where this arises, Revenue can re-characterise an intragroup arrangement if it is demonstrated that the arrangement: (i) lacks the required substance (e.g. relevant people functions), and (ii) conflicts with commercial arrangements of independent parties.
Accurate delineation of financial transactions
In conjunction with the Revenue’s ability to re-characterise an arrangement from a transfer pricing perspective, the new legislation and Revenue’s guidance includes specific focus on the arm’s length nature of the quantum of debt applied in financing arrangements. This brings into Irish transfer pricing rules a quasi-debt capacity regime, whereby a business will be required to analyse and document that the characterisation of a financial instrument conforms with how independent parties would transact.
For instance, when borrowing from a related party, Irish businesses will need to analyse and document that the quantum of debt to be borrowed in an arrangement is arm’s length, through assessing debt serviceability or other financing metrics. Where the amount borrowed exceeds an arm’s length quantum of debt, the excess debt can be re-characterised (for instance, to equity), with consequences for the characterisation of related interest expense derived from the debt from an Irish tax deductibility standpoint.
As the legislation relates to the current year interest expense on financial transactions that might have commencement prior to 2020, the Revenue guidance notes that businesses should be prepared to analyse whether the quantum of debt borrowed by an Irish business was arm’s length at the time the transaction was entered into. This requires businesses to revisit their financial forecasts and decision supporting documents from the commencement of the arrangement in order to ascertain whether the current year interest expense should be considered deductible from an arm’s length perspective.
Extension to non-trading transactions
Prior to 2020, transfer pricing rules in Ireland only applied to income earned or expenses incurred related to a trade, i.e. in general terms, profits subject to the 12.5% tax rate.
Under the updated legislation, the scope of arrangements in which transfer pricing rules apply has been broadened to include non-trading transactions, but for a limited exemption for certain Irish-to-Irish arrangements.
This scope-expanding amendment has the impact of curtailing cross-border interest-free loan financing arrangements in cases where the lender is an Irish business, resulting in the imputing of interest income and potentially an increased tax burden in cases where these arrangements remain.
Extension to capital transactions
Intra-group sales and purchases of assets will be subject to Ireland’s transfer pricing rules if the market value of the assets is greater than EUR 25 million. If valuations of those assets do not satisfy the OECD arm’s length standards, then Irish businesses can be exposed to further capital gains tax on sales or reduced capital allowance relief (i.e., tax depreciation) on acquisitions. While Ireland’s tax regime contains pre-existing provisions with regard to capital transactions, the extension of transfer pricing rules adds prescribed documentation obligations and compliance requirements for asset transfer transactions.
In certain conditions, other provisions in tax legislation supersede transfer pricing rules, thereby removing the arm’s length value requirement for pricing the relevant assets.
Distinct from the other updates to the transfer pricing legislation, the extension of transfer pricing rules to capital transactions took effect from 1 January 2020 (regardless of the accounting period commencement date).
What to do next?
Given the fundamental reforms witnessed across many international tax issues this year, many businesses operating in Ireland continue to evaluate the impact to their commercial, finance and tax structures and obligations.
For companies wishing to avail themselves of penalty protection on their transfer pricing arrangements in Ireland, now is the time to consider their documentation obligations in order to meet the documentation deadline. For example, companies with a year end of 31 December 2020 should complete their Local File on or before 23 September 2021.