It may seem that UK small and medium sized enterprises (SMEs) benefit from a transfer pricing exemption. There are, however, numerous caveats and additional rules that SMEs should be aware of when pricing intercompany transactions to comply with HMRC and international regulations.
In the UK an exemption from transfer pricing is available to many SMEs.
The SME definition is met if a group is within the headcount limit and one or both of the financial limits.
SME size thresholds:
| Group total | Small | Medium |
| Headcount | <50 | <250 |
| Turnover | <€10m | <50m |
| Total assets | <€10m | <43m |
The SME exemption cannot be regarded as a universal solution allowing companies to avoid applying transfer pricing and adhering to the arm’s length principle for intercompany transactions.
First and foremost, HMRC may provide a transfer pricing notice to medium sized enterprises enforcing the requirement to account for transfer pricing when calculating taxable profits. This notice automatically overrules the SME exemption, which means a non-compliant medium sized company is effectively always at risk.
HMRC may similarly issue a notice to any SME to apply transfer pricing principles in computing profits from a transaction that is relevant to a patent box claim.
Moreover, all SMEs must price intercompany transactions at arm’s length if these transactions occur with related counterparties located in a jurisdiction with which the UK does not have a double tax treaty with an appropriate non-discrimination article. This includes for example, Afghanistan, Brazil, Jersey and many other.
It is also important to consider the SMEs’ transaction counterparties’ local transfer pricing requirements as many jurisdictions do not apply an SME exemption. For instance, there are no such exemptions in place for SMEs in the US, Luxembourg, Malta, Austria, Poland, and many other countries.
The protection of the SME exemption has been further eroded by the introduction of the profit fragmentation rules.
The profit fragmentation rules act to prevent UK companies and individuals avoid UK tax. Effective from 1 April 2019, the rules target profits derived by the UK entities within territories with significantly lower taxation compared to the UK. The aim is to ensure that the full amount of profit derived from activity in the UK is taxed in the UK.
These rules apply to all businesses, including SMEs. Any UK taxpayer transacting with related parties in low or no tax jurisdictions such as Bulgaria, Cyprus, Liechtenstein, will need to carefully evaluate whether or not additional UK tax should be paid as a result of profits being moved out of the UK.
A tax mismatch is created when the tax paid by a non-UK related party is less than 80% of the tax that otherwise would have been paid from the profits were these taxed in the UK.
SMEs face a higher tax mismatch risk when transacting with territories that offer lower taxation and beneficial tax regimes for smaller businesses, such as Hong Kong, Albania and Singapore. The risk is also high if related parties operate in jurisdictions that offer favourable tax regimes such as deductions of additional expenses for R&D and reduced taxation on profits derived from intellectual property income. It is important for SMEs to ensure these transactions are at arm's length and they can evidence this fact.
Nevertheless, the SME exemption offers some tangible benefits to the transfer pricing policies of SMEs
HMRC and the OECD stipulate that the analysis of non-material transactions by SMEs should be ‘proportionate and appropriate to the size and complexity of the business and transactions involved’[1]. The proposed new UK local and master file obligations will not apply to SMEs.
SMEs should therefore have proportionate transfer pricing policies in place to meet the arm’s length principle, which may take the form of a short memorandum or advisory email.
Whether your business needs support implementing transfer pricing for the first time, or assistance in evaluating the appropriateness of existing documentation, our team of experts would be pleased to arrange an initial call, and then help your business meet all its reporting and documentation requirements. If this is of interest, please get in touch with either:
Philip Newbold: philip.newbold@evelyn.com
Michael Beard: michael.beard@evelyn.com
Jekaterina Scemeleva: jekaterina.scemeleva@evelyn.com
Ana Villaveces: ana.reyesvillaveces@evelyn.com
Source:
[1] HMRC, International Exchange of Information Manual, IEIM300033 - Country-by-Country reporting: Master and Local files
Approval Code: NTGH6072242
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.
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