Transfer pricing is the pricing of transactions between associated enterprises. Tax authorities require such transactions to be on an arm’s length basis, that is, the price that would be set between unconnected parties.
There is a rocky road ahead as HRMC and other tax authorities are increasingly likely to challenge intercompany arrangements. Transfer pricing planning and documentation are important tools to help manage those tax risks. They can also be valuable in managing reputational risks related to tax, as well as play a role in directors meeting their fiduciary duties.
Furthermore, the right transfer pricing documentation can provide a clear understanding of a group’s value chain and help guide strategic decisions in this period of change.
Before the COVID-19 crisis and the end of the Brexit transition period, transfer pricing was already in considerable flux as tax authorities tried to adapt to the challenges presented by increasing globalisation, the importance of intangibles and the growing digital economy.
COVID-19 has brought a unique challenge to nations across the world. The impact of the virus on the UK economy is difficult to exaggerate. In the second quarter of 2020, the UK’s GDP contracted by 20.4%. By comparison, the 2008 economic crisis saw UK GDP contract by about 2%. The obvious fiscal deficit facing the UK and other COVID-19 ravaged economies will likely make transfer pricing a target for generating extra tax revenues. In the year following the 2008 financial crisis, HMRC’s transfer pricing enquires increased by over 400%.
The end of the Brexit transition period also presents challenges. Changes to business operations in response to Brexit may have resulted in a shift of value within groups. Consequently, existing transfer pricing methodologies may no longer be appropriate. In addition, the valuation of goods for customs purposes may change. Pricing must be compliant for both customs regulations and transfer pricing, but these can have conflicting requirements.
Documentation changes on the horizon
Under the UK’s current rules there is no prescribed content for documentation. HMRC’s view is that it should be proportionate with the nature, size and complexity of the business.
On 23 March 2021, however, the UK Government launched a consultation on transfer pricing documentation considering two areas:
- standardisation of documentation requirements for the largest businesses, in line with the OECD’s Master and Local file requirements, along with a 30-day timescale to produce such documents; and
- an annual international dealings schedule (IDS) to notify HMRC of material cross-border intragroup transactions, aimed at all businesses within the transfer pricing regime.
While there is likely to be some flexibility for smaller multinational entities to continue to adapt their documentation approach proportionate to the complexity of the business, larger businesses may need to adapt or update their approach in the future. If the IDS is adopted, there will also be increased transparency on intragroup transactions.
Reducing scope of exemption
In the UK an exemption from transfer pricing rules is available to many small and medium-sized enterprises (SMEs) in some circumstances. The SME definition is met if a group is within the headcount limit and one or both of the financial limits.
Medium-sized groups are only able to place limited reliance on the exemption, as they can still be issued with a notice by HMRC to calculate profits by applying transfer pricing principles.
Importantly, the protection of the SME exemption has recently been significantly eroded.
Profit fragmentation rules, in effect from 1 April 2019, apply to all business including SMEs. Aimed at reducing offshore tax avoidance, these are very broad in scope. Any UK taxpayer transacting with a related party in a lower tax jurisdiction, which could include jurisdictions such as Ireland, or those with beneficial tax regimes such as R&D and intellectual property tax reliefs, will need to consider if additional UK tax should be paid as a result of profits being moved out of the UK.
These new rules will particularly impact those groups that had previously relied on the SME exemption.
How we can help
Where groups do not currently have defined transfer pricing policies, we can assist in understanding intercompany arrangements and preparing transfer pricing documentation.
For those groups with existing policies, we can review and provide recommendations to help ensure that these reflect any changes in the group and are aligned with the latest transfer pricing guidance.
Recent events may have presented an opportunity to reconsider how a group operates, leading to plans that accelerate investment and reorganisation. We can also advise on the transfer pricing implications or opportunities of a business restructuring.
Our review can be focused on transfer pricing in the UK market or consider the group as a whole. Many groups may benefit from preparing a group master file and ensuring consistency of transfer pricing across the wider group.
Through our colleagues in Nexia International, we also have a network of local specialists and can coordinate transfer pricing reviews and documentation in multiple jurisdictions.
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. Details correct at time of writing.
Tax legislation is that prevailing at the time, is subject to change without notice and depends on individual circumstances. Clients should always seek appropriate tax advice before making decisions. HMRC Tax Year 2022/23.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.