While it is essential to manage the risk of a TP challenge by either HMRC or the IRS (Internal Revenue Service), especially given the increased number of disputes we are seeing across our client base, an appropriate TP model can contribute to optimising the group’s tax position.
TP is an integral part of a business’ overseas growth plan. UK businesses expanding into the US are increasingly focused on how profits should be split between the US and the UK. TP can be used as an effective lever to expand into the US in the following ways:
After taking into account federal taxes, state taxes, sales taxes and municipal/city taxes, the US imposes a generally higher corporate tax burden than in the UK.
Provided TP principles are adhered to, an arm’s length allocation of profits between the US and UK can lead to an increase in group tax efficiency.
There may also be opportunities to enhance the utilisation of tax losses, and claim new or increased tax deductions for intragroup charges, as illustrated below.
- UK tax losses
- UK management team supports US Subsidiary
- UK owned IP is being used by US Subsidiary
- Substantial US profits, growing year on year
- Significant US cash tax charge
In the above example, establishing a robust TP policy between UK Parent and US Sub may give rise to the following benefits:
- UK Parent should charge an arm’s length fee to US Sub for UK management services and UK IP. This should reduce US Sub’s tax charge in the US, and repatriate funds to the UK.
- The additional income that will be recognised in the UK will not trigger a UK corporation tax charge if there are sufficient UK tax losses to offset.
- If the profitability of UK Parent increases as a result of the TP policy, a deferred tax asset may be recognised, thereby strengthening UK Parent’s balance sheet.
A flexible TP framework between UK Parent and US Sub may also lead to a more efficient repatriation of profits to the UK. As well as potentially reducing or eliminating withholding taxes that would have applied to dividends, it can provide a ‘real-time’ mechanism to repatriate cash to the UK quickly for investment needs and the servicing of debt.
TP is often a material area under due diligence. We are increasingly seeing TP disputes during a transaction that result in a price-chip. This may arise where, for example, the group sells US Sub in the future, or if ownership of the group changes.
Having the right TP structure in place ensures that profits are allocated to the right entities, and that entities that are sold are appropriately valued.
Provided the TP framework is robust and is appropriately documented, the risk of a price chip is significantly reduced.
A robust TP model from the outset can provide a model that is flexible for the future expansion of US operations. It may also be possible to replicate the model in other countries, which makes it easier to manage as the group expands its global footprint.
Managing TP risk
TP legislation in both the UK and US is aligned with the OECD TP Guidelines, which represents the international standard that most countries adhere to.
Whilst there are many similarities between the UK and US TP regimes, a key difference is that the UK TP rules exempt small and medium sized enterprises (SMEs) from UK TP rules subject to certain conditions. There is no such exemption under US TP rules.
Therefore any UK business, irrespective of size, that transacts with an affiliated entity in the US must adhere to relevant TP rules.
Both HMRC and the IRS perceive TP as a major area of risk and have increased their scrutiny of international arrangements for businesses of all sizes. In order to reduce the risk of a costly and time consuming enquiry and to ensure no penalties are payable businesses operating in the US should have robust TP policies, compliant TP documentation, and legal agreements in place to support the intercompany arrangements between the UK and US entities.
If UK Parent provides funding to US Sub, the level of debt funding would require careful consideration to ensure that it is provided on an arm’s length basis and complies with UK and US thin capitalisation as well as US earnings stripping rules.
Both tax authorities will assess the facts and circumstances surrounding the financing arrangement to determine its characterisation and the tax deductibility of interest.
How we can help
We have an experienced team of transfer pricing specialists, with extensive UK-US experience. We provide pragmatic advice to your business, tailored to suit your current needs. Our advice can also act as a blueprint for the appropriate pricing structures to have in place as your business grows. Our support is broader that just transfer pricing. As part of our holistic approach, we are always happy to discuss broader direct and indirect tax considerations and potential efficiencies. If you would like to find out more, please get in touch with a member of our team.
Approval code: NTEH7082348
Evelyn Partners does not offer specific US business tax advice however, as part of our membership of CLA global, we are able to coordinate cross-border projects and deliver international projects by utilising CLA’s US advisors.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.
Tax legislation is that prevailing at the time, is subject to change without notice and depends on individual circumstances. You should always seek appropriate tax advice before making decisions. HMRC Tax Year 2023/24.