The rules which impose market value on appropriations to or from trading stock are generally well understood. But transfers between related parties may trigger transfer pricing rules and new provisions have applied since 8 July 2015. What do you need to know?
THE MARKET VALUE RULE - BASICS
Where a company appropriates, i.e. takes and uses, any of its trading stock for a non-trading reason, it’s treated for tax purposes as though it had been sold in the open market at the time of the appropriation. The deemed consideration is the open market value. Any actual consideration received in respect of the same stock is then left out of account.
Similar rules apply where an unincorporated trader appropriates trading stock for a non-trading reason. The trader is treated for tax purposes as though the trading stock in question had been sold in the open market at the time of the appropriation, and the value of anything given for it is left out of account.
Example. Bob builds and sells designer furniture. He takes finished goods with a selling price of £5,000 for his own home, putting £500 into the business account in exchange. On his return he would need to include £5,000 as sales and ignore the £500.
PRECEDENT TO LEGISLATION
This market value principle was established in the case of Sharkey v Wernher ( 36 TC 275) (see Follow up ). After more than half a century, it was enacted in 2008 without any change in its effect and is now contained in s.157 CTA 2009 for corporation tax and s.172B ITTOIA 2005 for income tax.
Market value also applies where a company or an unincorporated business (such as a sole trader) owns something that is not trading stock and then takes it into trading stock. In this case the cost of that trading stock for tax purposes is the amount that it would have realised if sold in the open market at the time of the appropriation. See s.158 CTA 2009; s.172C ITTOIA 2005 .
Pro advice 1. The market value rule doesn’t apply to services rendered to the trader personally or to members of the trader’s household, or the value of meals provided for proprietors of hotels, boarding houses, restaurants, etc. and members of their families. In such cases the cost is not incurred wholly and exclusively for the purposes of the trade, so it would be disallowed under s.34 ITTOIA 2005 .
Pro advice 2. Market value doesn’t apply to expenditure incurred by a trader on the construction of an asset intended from the outset to be used as a fixed asset in the trade.
Pro advice 3. Furthermore, market value doesn’t apply where profits of a small unincorporated business are calculated on the cash basis under s.25A ITTOIA 2005 . In this case a just and reasonable adjustment must be made to reflect the non-commercial nature of a transaction.
NON-TRADING DISPOSALS OR ACQUISITIONS
A business may dispose of or acquire trading stock by means of a transaction not made in the course of its trade, and separate but related provisions deal with such situations. Examples might include gifting trading stock to a charity, or taking over trading stock from a related business when it ceases to trade.
If trading stock is disposed of otherwise than in the course of a trade without being appropriated by the trader for another purpose, it may be accounted for under UK GAAP at cost or at the price paid, but it is treated for tax purposes as though it had been sold in the open market at the time of the actual disposal.
Likewise, if trading stock is acquired otherwise than in the course of trade without being appropriated by the trader from another purpose, the cost of the stock is taken to be the amount which it would have realised if sold in the open market at the time of the acquisition.
In a similar vein, under the intangible fixed assets regime which applies specifically to companies, transfers of intangible fixed assets between a company and a related party are generally treated as taking place at market value for tax purposes under s.845 CTA 2009 .
TRANSFER PRICING EXCEPTIONS
Until 7 July 2015, if trading stock was transferred between related parties, or if intangible fixed assets were transferred between a company and a related party, the market value rule didn’t apply where the transfer pricing rules in TIOPA 2010, Pt 4 were in point.
Where the consideration for the transfer had to be adjusted under transfer pricing, or where the transfer was within the scope of transfer pricing even though no such adjustment was required, the transfer pricing rules took precedence under s.161 CTA 2009, s.172F ITTOIA 2005, or s.846 CTA 2009 . This meant, in effect, that the transfer price was used instead of market value.
These exceptions were designed to ensure that related parties were not unfairly disadvantaged for tax purposes when accounting for such transactions in ways that were in accordance with UK GAAP. However, in certain cases it was possible for businesses to obtain a tax advantage by fixing a transfer price which was lower than market value. Because of government concerns that the provisions could be abused, they have now been revised.
WHAT HAS CHANGED?
Amendments to be made by Finance (No 2) Act 2015 provide that where the transfer pricing rules apply to the disposal or acquisition of trading stock on or after 8 July 2015 (whether or not those rules actually require an adjustment), a further adjustment may be necessary to ensure that the acquisition or disposal proceeds are recognised at full market value for tax purposes.
They also provide that where the transfer pricing rules apply to the value of trading stock in connection with the cessation of a trade, a further adjustment may be necessary to ensure that the full value of the stock is brought into account for tax purposes.
A further amendment applies when intangible fixed assets need to be valued for tax purposes when they are transferred between a company and a related party. This provides that where transfer pricing applies, a further adjustment may be necessary to ensure that the full market value of the intangible asset is brought into account for tax purposes.
EFFECT OF THE CHANGES
The new changes aim to ensure that the correct overall value is brought into account for tax purposes when rules imposing market value for the transfer and separate rules for transfer pricing both apply.
The new measure will ensure that the tax rules applying to transfers of trading stock between related parties, or intangible fixed assets between a company and a related party, bring into account the correct values for tax purposes. The intention is to prevent attempted avoidance by ensuring that, as far as possible, values brought into account are equivalent to those that would be achieved in a sale to an unconnected third party.
This is achieved, where the new provisions apply, by bringing an extra amount into account for a disposal or acquisition, where this is needed to make the total deemed consideration equal to market value.