Accounts and the limits of ‘Power’ and ‘Reasonably Required’

Background to the dispute

LPE is a distributor of nutritional health supplements which purchased the majority of the products it sold from its US parent but also purchased some goods from various third parties.

HMRC opened a transfer pricing enquiry because LPE’s net profit margin (NPM) in its company accounts had reduced significantly after the introduction of a new transfer pricing policy in 2014, despite significant growth in LPE’s turnover. The new policy applied the transactional net margin method (TNMM), treating LPE as a routine distributor and the US parent as the entrepreneurial entity.

During the enquiry, HMRC were informed that "LPE's reduction in NPM was due to corrective actions taken with the Company's transfer pricing policy in 2014. A new CFO joined Eurark in late 2013, who soon discovered that the original transfer pricing policy provided LPE with excess profits, while Eurark incurred losses."

HMRC challenged whether TNMM was the most appropriate method and instead argued that the Resale Price Method could be applied based on internal comparable uncontrolled transactions (incorrectly referred to as applying the Controlled Uncontrolled Price method), drawing on the pricing and resulting gross margins for products sourced from third‑party manufacturers.

HMRC requested sight of the US parent company’s consolidated and entity financial statements to verify that it was loss making prior to 2013 but was advised that these were not in the power or possession of LPE and would not be provided by the US parent. HMRC later sought to obtain this information from the US Internal Revenue Service (IRS) via an Exchange of Information request under the UK/US double taxation agreement. The request was refused by the IRS on the grounds of relevance.

In the course of settlement discussions, LPE provided detailed data indicating that material adjustments were required to HMRC’s proposed internal comparable analysis (without accepting the validity of HMRC’s method selection).

HMRC considered that the adjustments put forward by LPE indicated that group level financial information must have been made available to LPE and the materiality and nature of the adjustments being made to HMRC’s internal comparables analysis demonstrated the relevance of the US parent company financials to the enquiry. HMRC then issued a formal Schedule 36 notice seeking the US parent’s consolidated and entity‑level accounts for the periods from 2014 to 2022, which LPE appealed to the FTT.

‘Reasonably required’ and the rational connection test

A central issue was whether the requested accounts were ‘reasonably required’ for the purpose of checking the UK company’s tax position. The FTT reaffirmed that this requires a rational connection between the documents sought and the identified tax issue; Schedule 36 cannot be used to obtain material that is merely informative or contextual, in other words ‘fishing expeditions’.

On the facts, the FTT found that HMRC’s enquiry was focused on the selection of the appropriate transfer pricing method (TNMM versus CUP) and on the functional characterisation of the UK entity. Against that background, HMRC had not adequately explained how the parent’s accounts would advance that enquiry, particularly given the extensive information already provided over several years.

The FTT placed weight on the OECD Transfer Pricing Guidelines, noting that per paragraph 3.22 where a one‑sided method is selected and the tested party is the domestic taxpayer, tax administrations “generally have no reason to further ask for financial data of the foreign associated enterprise”.¹

That guidance undermined HMRC’s assertion that the accounts were necessary to verify the arm’s length outcome under TNMM.

Possession or power

Even if the documents had been reasonably required, the FTT held that they were not within LPE’s possession or power. In respect of 'possession', it was common ground that LPE did not have possession of the consolidated group accounts or the US parent company accounts. The burden of proof was on HMRC to demonstrate prima facie that LPE had the power to obtain possession of the financial information requested by HMRC.

Applying established authority on disclosure and control, the FTT emphasised that ‘power’ requires either a presently enforceable legal right to obtain the documents or a standing arrangement amounting to general consent.

The evidence showed that the US parent was a privately held company, not subject to UK jurisdiction, and had expressly refused to provide its accounts. There was no ongoing arrangement under which the UK subsidiary could freely access them. The fact that some senior individuals held roles in both companies (e.g. the US Parent company’s CEO was LPE’s Company Secretary) did not alter the analysis: Directors/officers owe duties to each company separately and cannot be compelled to use their influence in a way that would create conflicts of interest.

Furthermore, the FTT was satisfied that the company had made serious attempts to obtain copies of the Parent company accounts, a request which the Parent had refused for sound reasons.

Practical implications

While fact‑specific, Lifeplus provides useful authority for taxpayers seeking to resist broad or late‑stage demands for consolidated group accounts or overseas entity financial statements in transfer pricing enquiries. The case also has broader application and importance regarding the limits of when something can be said to be in a taxpayer’s ‘power’.

The key takeaways are:

• UK subsidiaries should carefully assess whether overseas group documents (not in the subsidiary’s possession) are truly not within their power before resisting a Schedule 36 request on that ground
• HMRC must articulate a clear and objective rationale linking the documents sought to the specific tax issue under enquiry;
• Where a taxpayer has adopted a one‑sided method such as TNMM with the UK entity as tested party, OECD guidance supports the position that non-public foreign parent accounts are not required to be provided to HMRC, where this falls outside of information included in Master File and Country by Country Reporting requirements where applicable; and
• Extensive prior cooperation and information provision may be relevant when a Tribunal is assessing whether further requests are genuinely necessary.

For further information please contact:

• Phil Roper
• Kevin Elliott