Characterisation of entities

By Tolley in association with Robert Langston of Saffery Champness

The following Corporation Tax guidance note by Tolley in association with Robert Langston of Saffery Champness provides comprehensive and up to date tax information covering:

  • Characterisation of entities
  • Entity characterisation
  • Manufacturing characterisations
  • Sales characterisations
  • Cost contribution / cost sharing agreements
  • Management services
  • 'Hub and spoke' transaction model

Entity characterisation

The characterisation of a company will determine how its profits should be calculated. By establishing the functions, assets and risks of a company, its characterisation can be determined using the OECD Guidelines:

  • functions describe the activities undertaken by the company
  • assets describe the assets held by the company, including both tangible and intangible assets
  • risks include any risks assumed by the company, such as stock risk or bad debt risk

This will then assist with applying the appropriate transfer pricing method.

When undertaking transfer pricing planning, the objective is often to characterise entities in high tax jurisdictions as low risk, and therefore being entitled to lower levels of profits. This can be done by identifying what activities are undertaken and ensuring that these are undertaken in the appropriate jurisdiction.

Entity characterisations are also considered in the Effective tax rate planning guidance note.

The OECD BEPS report on Actions 8, 9 and 10 , published on 5 October 2015, requires consideration of where functions are managed, not just where they are undertaken. A similar approach is adopted for assets and risks ie where are these assets and risks managed, not just where they are legally owned. This revised approach will be reflected in the next update to the OECD Transfer Pricing Guidelines, but should still be considered as ‘best practice’ now.

Manufacturing characterisations

See also the Summary - effective tax rate planning - manufacturing characterisations.

Fully-fledged manufacturer

A fully-fledged manufacturer undertakes and manages all manufacturing activities, including:

  • quality control and quality assurance procedures
  • product research and development

More on Transfer pricing and profit fragmentation: