Top tips for transfer pricing

Stuart Duff

Stuart Duff

Transfer Pricing and International Tax Manager

Transfer pricing refers to the terms and conditions of transactions between associated parties, such as companies within the same group. In this blog, we explain why transfer pricing is an important consideration for international and UK-based businesses and our top tips for ensuring you are compliant with this often-complex legislation.

Transfer pricing (TP) rules aim to ensure that transactions between connected parties are carried out at the same price as they would be between two independent parties in the same circumstances. This is known as the “arm’s length” principle.

For TP purposes, the definition of transactions includes a number of activities between related parties such as:

  • Sale of goods
  • Group financing
  • Provision of intellectual property such as use of patents or know-how
  • Manufacturing services
  • Distribution and sales agency
  • Strategic management and administrative services
  • Business restructuring

UK transfer pricing considerations

In the UK, the Small and Medium Enterprise exemption means that groups with fewer than 250 staff and less than either €50m turnover or €43m Balance Sheet total are exempt from applying TP rules. Many businesses in the UK benefit from this, however TP considerations should still be a high priority for those who are exempt.

HMRC can, where it suspects the SME exemption is being misused, issue a TP notice to a medium sized enterprise requiring that it calculate its taxable profits in accordance with the arm’s length principle. Therefore, businesses relying on the exemption should review whether the current pricing elicits a reasonable and defensible UK result.

Businesses operating internationally should also bear in mind the jurisdictions in which they are operating, as  these will follow their own legislation which may not include a reciprocal SME exemption. A group can be exempt from TP rules in one territory but fall within the TP rules of the territory on the other side of the transaction. It is therefore important to be aware of the TP requirements in every territory you operate in.

Further, businesses should be aware of whether countries they are operating in have a double tax treaty with the UK. A double tax treaty is an agreement between two jurisdictions which prevents double taxation (taxpayers, either individuals or businesses, being taxed on the same income in both countries). If a business is conducting transactions with a related business in a territory with which the UK does not have an appropriate double tax treaty then there is a risk of double taxation.

The UK rules require that taxpayers within the TP regime review their related party transactions on a regular basis, consider the most appropriate pricing, and document their thinking. Groups that are growing and approaching the SME boundary need to prepare for doing so and be proactive. TP documentation should be reviewed regularly as your business changes, so you should review, plan and document TP policies well in advance of the exemption ceasing to apply.

It is also worth noting than an SME can elect for the SME exemption not to apply, and to apply TP rules instead. This can be appropriate in order to claim a corresponding adjustment in a state with a higher tax rate than the UK.

Top tips

Here are our top tips for transfer pricing:

  • Be proactive in setting intra-group pricing policies and reviewing these as your business develops. Ensure that these support commercial operations and reflect accurately the reality on the ground.
  • Defensible TP is based on an appreciation of the functions performed, assets employed, and risks borne between the companies in your Group.
  • Prioritise high-value and complex transactions, as these are likely to be the most difficult to price and therefore the most susceptible to challenge in a tax audit.
  • Produce TP documentation that demonstrates that your TP model aligns profit with economic substance and value creation.
  • Manage TP risk through proper analysis and OECD-compliant documentation.
  • HMRC will always consider penalties in TP enquiries and, if found to be due, these can be substantial and have a significant impact on business. While well founded policies and documentation cannot guarantee protection from audit or dispute, they can protect against penalties being charged by demonstrating you have taken reasonable care.
  • Where there is an obligation to demonstrate that TP meets the arm’s length standard, HMRC recognises that compliance costs should not be disproportionate and requires documentation that is reasonable. It is worth giving some careful thought to what reasonable looks like for your business. This will depend on the nature, size and complexity of your group and transactions but need not necessarily be burdensome or complex.

How we can help

Our specialist International Tax team can help you ensure that your pricing policies are robust and adhere to the relevant regulations in the territories your business operates in. For more information on how we can support you, get in touch with me here or contact your present Johnston Carmichael adviser.