Judgment summary
The First-tier Tribunal (Tax Chamber), constituted by Judge Natsai Manyarara and Ian Shearer, heard and determined an appeal by Lifeplus Europe Ltd against an information notice issued by HMRC on 2 October 2023 pursuant to paragraph 1 of Schedule 36 to the Finance Act 2008.
The information notice required the appellant to produce: (1) all consolidated financial statements of its US parent company, Eurark LLC, that coincided with the appellant's accounting periods ended 31 December 2014 to 31 December 2022 (Item 1); and (2) all entity-level financial statements of Eurark LLC for the same periods (Item 2). HMRC had previously withdrawn Items 3, 4 and 5 of the original notice.
The tribunal considered two issues: whether the documents were reasonably required by HMRC to check the appellant's tax position, and whether the documents were in the possession or power of the appellant. The tribunal answered both questions in the negative and allowed the appeal.
Background
Lifeplus Europe Ltd was incorporated on 31 July 1996 and is based in Cambridgeshire [13]. It is a wholly-owned subsidiary of Eurark LLC, a privately owned limited liability company established in February 2001 under the laws of the State of Illinois and based in Batesville, Arkansas [13, 14]. The appellant acts as Eurark LLC's appointed distributor for products sold into the UK, EU Member States and Switzerland, and sells nutritional supplements and personal care products through a multi-level marketing model principally to customers in mainland Europe [13].
Eurark LLC is solely responsible for group corporate strategy, product formulation, manufacturing, strategic global marketing, global pricing and information technology, as well as designing and operating the business model and the compensation and remuneration model for independent agents called Associates [16]. Over 90% of the products sold by the group are formulated and manufactured at Eurark LLC's manufacturing plant in Batesville [14]. The appellant's role is limited to fulfilling customer orders, distributing products and paying commission to Associates [18].
In 2014, following a transfer pricing analysis prepared by BKD LLP, the appellant implemented a Transfer Pricing Policy applying the Transactional Net Margin Method (TNMM). BKD characterised the appellant as a routine distributor with limited functions and risks, and the Parent Company as the entrepreneur owning the relevant intellectual property [27]. HMRC opened an enquiry into the appellant's corporation tax return for the accounting period ended 31 December 2014 by notice dated 8 December 2016 [29], and subsequently opened enquiries into all accounting periods through to 31 December 2023 [30].
The enquiry identified a transfer pricing risk because, although the appellant's turnover grew significantly, its net profit margin fell from 13.6% in 2012 and 13.4% in 2013 to 5.4%, 4.01% and 3.00% in 2014, 2015 and 2016 respectively [36, 37]. HMRC ultimately concluded that the Comparable Uncontrolled Price (CUP) method should be the most appropriate transfer pricing method, a position the appellant disputed throughout [69, 72]. On 3 August 2023 the appellant provided financial data supporting proposed adjustments to HMRC's CUP analysis [74]. HMRC issued the information notice on 2 October 2023 citing that provision as strengthening the case for disclosure [75].
Core dispute
The central dispute concerned whether HMRC was entitled under Schedule 36 to the Finance Act 2008 to compel the appellant to produce its US parent company's consolidated group financial statements and entity-level financial statements for the accounting periods ended 31 December 2014 to 31 December 2022.
HMRC argued that the documents were reasonably required to assess the proportion of the appellant's contribution to group profits and losses, to verify figures put forward as part of the appellant's proposed adjustment to the CUP analysis, and to confirm whether the parent company was loss-making before 2013 [140, 141]. HMRC further contended that the appellant's directors, some of whom were also officers of the parent company, had the practical ability to obtain the documents when it suited them, as evidenced by the financial data provided on 3 August 2023 [262].
The appellant contended that the documents bore no rational connection to the question of whether the TNMM or CUP method was the appropriate transfer pricing methodology, that HMRC had not explained why the information already provided was insufficient, and that the OECD Guidelines specifically stated that once a one-sided method was properly selected the tax authority generally had no reason to request the foreign associated enterprise's financial data [105, 216]. The appellant further argued that the documents were neither in its possession nor within its power, as it had no enforceable legal right to access them, no standing arrangement with the parent company permitting such access, and no de facto power to compel or influence production [106].
Court findings
On the reasonably required issue, the tribunal held that the test required a rational connection between the documents sought and the underlying enquiry, and that a mere desire for background information or documents that were merely informative did not satisfy the test [181]. The tribunal found that the sole focus of the enquiry had been the transfer pricing methodology applied between the parent company and the appellant, specifically whether the TNMM or CUP method was appropriate [199, 230].
The tribunal accepted the submission that paragraph 3.22 of the OECD Guidelines expressly states that once a particular one-sided method is chosen as the most appropriate method and the tested party is the domestic taxpayer, the tax administration generally has no reason to ask for financial data of the foreign associated enterprise [216]. The tribunal found that HMRC had not explained the rational connection between the accounts and the methodology question, had not explained why the information received was insufficient, and that the transfer pricing method employed by the appellant did not rely upon the parent company's accounts [229, 238, 274]. The tribunal drew adverse inferences from HMRC's failure to call any evidence from the international tax specialists involved in the enquiry [238]. The tribunal also noted that the IRS had refused HMRC's exchange of information request for the same documents, responding that the financial statements comprised activities of foreign subsidiaries not relevant to the investigation [234].
On the possession or power issue, the tribunal held that it was common ground that the appellant did not physically possess the documents [242]. Applying the principles in Lonrho Ltd v Shell Petroleum Ltd [1980] 1 WLR 627, the tribunal held that power means a presently enforceable legal right to obtain a document without needing anyone else's consent [243, 246]. The tribunal found there was no such legal right, no standing or continuing practical arrangement amounting to general consent within the meaning of Schlumberger Holdings Ltd v Electromagnetic Geoservices AS [2008] EWHC 56, and no de facto power [275]. The tribunal rejected HMRC's argument that because some of the appellant's officers were also officers of the parent company the appellant effectively controlled them, holding that each company in a group is a separate legal entity and that directors owe statutory duties only to the company to which they are appointed [265, 272]. The tribunal further held that there was no jurisdiction to order directors to attempt to obtain documents not already in their possession or power, and that any such action would compel the appellant's directors to breach their statutory duty to avoid conflicts of interest under section 175 of the Companies Act 2006 [275].
On the preliminary issue concerning Mr Sayers' witness statement, the tribunal declined to strike out or redact the statement, finding that it could assess the weight to be attached to each part and that exclusion would be draconian [126, 129]. It admitted the late-produced email from Officer Lynas dated 2 October 2023 on the basis of relevance, and accepted on balance that Officer Lynas was an authorised officer who had given the required approval under paragraph 20 of Schedule 36 [134, 136].
Outcome
The appeal was allowed [276]. The tribunal set aside the information notice in respect of Items 1 and 2, holding that the documents were not reasonably required by HMRC to check the appellant's tax position and were not in the possession or power of the appellant.
Tp method highlighted
The appellant applied the Transactional Net Margin Method (TNMM), consistent with the Comparable Profits Method (CPM) under US rules, as determined by BKD LLP following a functional analysis that characterised the appellant as a routine distributor with limited functions and risks [27, 212]. The operating margin and net profit margin were used as the profit level indicator and net profit indicator respectively [212]. HMRC's preferred method was the Comparable Uncontrolled Price (CUP) method, relying on third-party purchases that represented approximately 9% of total sales as the comparable [193]. The appellant disputed the CUP method on the ground that third-party suppliers operated primarily as contract manufacturers producing products to parent company-owned formulations, making them insufficiently comparable [195]. The tribunal noted that HMRC had not suggested BKD performed their work otherwise than in accordance with the OECD Guidelines [214], and that the OECD Guidelines state that once a one-sided method is chosen and the tested party is the domestic taxpayer the tax administration generally has no reason to request financial data from the foreign associated enterprise [216].
Major issues / areas of contention
- Whether the parent company's consolidated group financial statements (Item 1) were reasonably required by HMRC under paragraph 1 of Schedule 36 to the Finance Act 2008 to check the appellant's corporation tax position.
- Whether the parent company's entity-level financial statements (Item 2) were reasonably required by HMRC under paragraph 1 of Schedule 36 to the Finance Act 2008 to check the appellant's corporation tax position.
- Whether there was a rational connection between the documents requested and the transfer pricing methodology question at the heart of the enquiry, namely whether the TNMM or CUP method was appropriate.
- Whether the OECD Guidelines, incorporated into domestic law through section 164 of the Taxation (International and Other Provisions) Act 2010, precluded HMRC from requiring financial data of the foreign associated enterprise once a one-sided method had been properly selected with the domestic taxpayer as the tested party.
- Whether the documents were in the possession or power of the appellant within the meaning of paragraph 18 of Schedule 36 to the Finance Act 2008.
- Whether the appellant had a presently enforceable legal right, a standing practical arrangement amounting to general consent, or any de facto power to obtain the parent company's financial statements.
- Whether the separate legal personality of the parent company and the statutory duties of company directors prevented the tribunal from treating the appellant as having power over the parent company's documents by reason of overlapping directorships.
- Whether compelling the appellant's directors to seek the documents would breach their statutory duty to avoid conflicts of interest under section 175 of the Companies Act 2006.
- Whether the tribunal had jurisdiction to order directors to attempt to obtain documents not already in a party's possession or power.
- Whether Officer Lynas was an authorised officer who had given the approval required by paragraph 20 of Schedule 36 for the information notice to extend to documents originating more than six years before the date of the notice.
- Whether Mr Sayers' witness statement should have been struck out or redacted on the ground that parts of it constituted expert opinion or legal submissions rather than evidence of fact.
- Whether adverse inferences should be drawn from HMRC's failure to call evidence from the international tax specialists who were involved in the enquiry.