Fintech businesses typically incur significant costs in the research and development phase. The significant “cash burning” in these early phases can result in substantial tax losses, which may also be enhanced by R&D tax relief claims, potentially even resulting in tax credits.
The technology developed in the initial phase is often later exploited in multiple jurisdictions. A huge advantage for fintechs is the ability of this technology to be used seamlessly in other countries, which allows for fast-paced, global expansion.
Amongst all this fast-paced commercial growth, transfer pricing can remain largely forgotten, particularly in the UK where many businesses seek to place reliance upon the exemption for small and medium sized businesses (SME exemption). Transfer pricing, however, as well as being a compliance obligation, is part of a group’s wider tax strategy and therefore important to consider regardless of size.
Opportunities to consider license agreements
The OECD Transfer Pricing Guidelines (TPG) provide specific guidance around the pricing of intangibles, which is relevant to most fintech businesses. This guidance focuses largely upon:
- where the DEMPE functions (development, enhancement, maintenance, protection, exploitation) are undertaken; and
- the economic ownership of any intellectual property (IP), rather than the legal ownership.
The TPG looks to align income derived from IP to the performance of these DEMPE functions. Often, the entity that has undertaken the initial R&D will retain responsibility for the IP. As a result, license agreements can be an effective way to bring income into the jurisdiction where this development took place, possibly utilising losses in the process. Fintech businesses may want to consider the appropriateness, or the terms, of license agreements from the IP holder.
The impact of Brexit on transfer pricing
For many fintechs, regulatory requirements are a key driver of the corporate structure of the business. Brexit has forced many UK fintechs to establish an entity in the EU to continue to service an existing EU client base or to grow their EU business.
The creation of an EU regulated entity can cause transfer pricing challenges, as both functions and risks transition out of the UK. It is necessary to consider how an EU entity is rewarded for taking on these functions and risks, and how the UK is compensated both for the loss of this income and for any ongoing support it might provide to the new EU business.
This links into the IP considerations, particularly if the EU business is reliant upon technology developed in the UK. For many fintech businesses, it will be necessary to consider the transfer pricing relationship between the UK and European parts of the business.
Given the significant documentation requirements for EU regulated businesses, it is important that properly established transfer pricing policies are put in place as quickly as possible to avoid issues with local tax authorities and regulators.
The impact of increased globalisation
An increasing trend, even prior to the COVID-19 pandemic, is the global nature of businesses and the rise of remote working. Fintechs have always been ahead of the curve in this area, due to the heightened investment in technology from an early phase, and to attract and retain talent.
Many businesses are now adopting a semi-permanent remote working basis, having successfully navigated the impact of the pandemic.
The possible creation of a permanent establishment as a result of remote working is a potential risk, particularly where the remote workers are senior in nature and/or are operating as part of the core business. Businesses should ensure profit attribution to these establishments is appropriate.
Guarding against due diligence processes
Whether it’s an exit event, or a fundraising round, due diligences processes form an integral part of the fintech lifecycle and, as part of these, transfer pricing is a hot topic.
There is limited reliance that can be placed on the UK’s SME exemption, because many other jurisdictions (and notably the US) do not have corresponding threshold exemptions. This means that the due diligence process often throws up large potential transfer pricing exposures, across multiple jurisdictions.
Dealing with these exposures can be extremely challenging, so getting the right transfer pricing policies in place from the start, and documenting them appropriately, can save a great deal of hassle (and money!) further down the line.
How we can help
We have an experienced team of transfer pricing specialists, with in house fintech experience. We will provide pragmatic advice to your fintech business, tailored to suit both your current needs, and providing a blueprint for the appropriate pricing structures to have in place as your business grows. Our support is wider that just transfer pricing, and as part of our holistic approach we are always happy to discuss broader tax efficiencies. If you would like to find out more, please get in touch with Michael Beard.
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.