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Global transfer pricing guide

Transfer pricing - United Kingdom

30 Sep 2023

Please click on each section to expand further:

Introduction to UK transfer pricing
Transfer pricing rules
  • The UK’s transfer pricing legislation is in the Taxation (International and Other Provisions) Act 2010 (‘TIOPA 2010’) Part 4, and is based on the arm’s length principle as per Article 9 of the OECD Model Tax Convention on Income and Capital, ie it follows the OECD Guidelines. The rules are not heavily formulaic but instead are principles-based.
  • The transfer pricing legislation apply to UK taxpayers, including UK branches of overseas companies and there is a self-assessment regime, ie the onus is on the taxpayer to confirm its transfer pricing meets the standard or to adjust its tax return accordingly.
  • The regime is a 'one-way street', ie upwards-only adjustments are permitted, and offsets between years and entities may not be accepted.
  • A consultation led by HM Revenue and Customs (HMRC) is underway in 2025 to review:
    • The potential removal of UK-to-UK transfer pricing, which would reduce the UK compliance burden. 
    • Lowering the thresholds for exemption from transfer pricing for medium sized businesses to align with international peers and manage risks to the UK tax base, retaining an exemption for small businesses. 
    • Introducing a requirement for multinationals in scope of transfer pricing rules to report cross-border related party transactions to HMRC. This will help facilitate better identification of transfer pricing risk and allow for more targeted enquiries.
    • Reviewing the transfer pricing treatment of cost contribution arrangements, where the costs and benefits of developing intellectual property are shared by group companies. This will ensure that the rules are certain and do not act as a deterrent to investment that brings economic benefits to the UK.
    • Supporting the OECD’s Pillar One Amount B initiative.
  • There are four tiers of transfer pricing documentation requirements in the UK. These tiers are dependent upon thresholds which are based on group consolidated figures.
  • Groups that are considered small and medium sized (SME) are currently (subject to change following the consultation) excused from preparing formal transfer pricing documentation (although medium sized business can still be requested to provide documentation by HMRC). However, it is still considered prudent for these businesses to prepare intra-group agreements and policy documents. These documents will not constitute formal transfer pricing documentation, but they will provide support for transfer pricing policies and a basis for intercompany governance. 
  • For large groups, which are not formally obliged to keep and preserve a Master File and UK Local File, HMRC is of the view that an appropriate way to demonstrate that provisions between related parties adhere to the arm’s length principle is to still prepare documentation in line with the OECD’s recommended approach i.e. a Local File. At a minimum a report should include functional and economic analyses. A Master File is only required if overseas jurisdictions in which a group operates have a lower documentation threshold than the UK.
  • The mandatory UK documentation requirements for the largest groups (>€750m) aligns with the OECD’s standardised approach (Master File, Local File and Country by Country Report).
  • The documentation should be prepared in advance of a company filing its UK corporation tax return.
  • Guidelines for Compliance (GfC) 7 was published by HMRC in the autumn of 2024 and is focused on reducing uncertainty for UK businesses by providing greater clarity and transparency of HMRC’s transfer pricing compliance expectations.
OECD guidance
  • The UK’s transfer pricing rules follow the OECD Guidelines. The Guidelines, updated in January 2022 are mentioned in UK legislation, and unlike in many countries, they must be used for interpretation of the arm’s length principle.
  • HMRC has an International Manual providing guidance for Inspectors on its view of transfer pricing matters, and much of this content is publicly available.
  • GfC7 was issued on 10 September 2024 and is relevant for businesses where Master and Local File documentation requirements apply (largest), businesses who may be exempt from the Master and Local File documentation requirements but must still file and be able to support an arm’s length return (large and certain medium sized enterprises) and businesses falling within the scope of transfer pricing rules for the first time.
  • The guidelines are practical and set out transfer pricing risks alongside recommendations as to the evidence that taxpayers might need to look for in their business to help them understand and document those risks. Most of the risks are already highlighted in HMRC’s International Manual however, this is the first time that they have been collated in one place with practical mitigating solutions suggested. It is important to note that these risks are not presented as an exhaustive list and are not outlined in a hierarchical manner.
  • GfC7 applies to businesses operating in the UK, or which have a presence, regardless of head office location, with transactions between parties falling within the UK transfer pricing legislation, including transactions with related UK entities. It is split into three sections, aimed at slightly different audiences.
    • Part 1 is aimed at ‘UK risk leads’ and their associated group functions in establishing and evidencing effective UK transfer pricing compliance processes. These ‘risk leads’ could include the UK tax compliance manager, finance director, finance controller, environmental, social and governance (ESG) lead and Senior Accounting Officers (SAOs).
    • Parts 2 and 3 is relevant for ‘transfer pricing specialists’ in best practice policy and documentation approaches. These ‘specialists’ include individuals who have experience in transfer pricing compliance and is relevant to both in-house tax and external transfer pricing specialists. 
    • Annex A assists all with examples of helpful supporting records and information
  • Financial transactions are only touched upon in GfC7, but in the future HMRC may develop further GfCs to cover these transactions in depth. 
Transfer pricing methods
  • The most appropriate pricing method should be selected on a transaction by transaction basis, providing the most reliable measure of an arm’s length result in each case. The current OECD methods, namely the comparable uncontrolled price, resale price, cost plus, transactional net margin, and profit split methods are all accepted but the method used must be in line with the functional and risk profile of the entity. Other methods can also be used if justifiable and appropriate.
  • There is no set hierarchy as the UK legislation currently refers to the 2022 OECD Guidelines. In practice, however, a ‘natural hierarchy’ may be said to favour the comparable uncontrolled price method.
Self-assessment
  • The UK has a self-assessment regime, where the onus is on the taxpayer to ensure that transfer pricing regulations are adhered to. There is a ‘tick box’ on the tax return form for taxpayers to confirm their eligibility for the small and medium-sized enterprise (‘SMEs’) exemption from the transfer pricing rule, and a second ‘tick box’ for taxpayers to claim corresponding adjustments (for UK–UK transactions). HMRC requires taxpayers to make computational adjustments in cases where transactions, as recorded in the statutory accounts, are not on an arm’s length basis and the taxpayer is potentially advantaged in respect of UK tax.
Transfer pricing documentation
Preparation of transfer pricing documentation
  • The UK accepts the OECD transfer pricing documentation model based on the Master File and Local File templates. This approach is considered best practice in the UK.
  • Lack of carefully prepared documentation will generally be seen as (at least) 'careless' behaviour and any adjustment will likely result in penalties.
  • The UK introduced CbCR regulations for fiscal years starting on or after 1 January 2016 for groups with revenues over €750m.
  • Any documentation should be prepared in English and be available by 12 months from the accounting period end, before the tax return is submitted.
Master File and Local File
  • From April 2023, the largest businesses are required to maintain a Master File and Local File. The definition of ‘largest’ aligns to the CbCR threshold: ie, multinational groups with annual consolidated revenue in the immediately preceding period of equal to or more than €750 million are considered ‘large’. 
  • HMRC has confirmed the 30-day timescale for the provision of the Master File and Local File following request. The purpose of the Master File and Local File is to support the transfer pricing policies underlying the filed corporate tax return and therefore should be prepared in advance of the annual filing.
  •  Where a UK based group self-assesses that all of its international related party transactions are immaterial (<£1m per transaction), it does not need to complete a Local File or make an annual declaration. Instead HMRC expects such groups to keep a record of any analysis undertaken to support that self-assessed position and provide that analysis upon request, within the same 30-day time scale as for documentation.
  •  Currently, unless a group is covered by the UK’s SME exemption, then profits or losses should be calculated with reference to the arm’s length principle. Records and evidence are required to be kept in order to demonstrate to HMRC that the results of transactions with related businesses are determined with reference to the UK’s transfer pricing rules and the application of the arm’s length principle. Transfer pricing documentation should be proportionate to the nature, size and complexity of a group’s business and consist of information and records relating to a period covered by the tax return.
  • In reality since the publication of the BEPS Action 13 report and the updated OECD Guidelines, more and more groups have been using the OECD Local File and Master File templates to prepare their transfer pricing documentation – whether they cross the €750 million threshold or not. We have also found in our experience that this is expected by HMRC tax Inspectors.
  • Transfer pricing documentation must be preserved until the latest of six years from the end of the accounting period, the date on which any enquiry into the return is completed, or the date on which HMRC is no longer able to open an enquiry.
  • Changes to HMRC information powers specifically in relation to obtaining transfer pricing related records (which will be defined in the regulations to be laid) also came into force from April 2023. Changes were to be made to ensure that the relevant transfer pricing documents can be requested outside of an enquiry and to remove the requirement for the documents to have to be in the ’possession or power’ of the UK entity in question when they are in the ’possession or power’ of another person within the multinational group.
Some risk factors for challenge
  • High risk business models include commissionaire and toll manufacturing.
  • Limited risk distributor and contract services/ contract R&D arrangements could also potentially be affected, especially where significant people functions are in the UK.
  • Persistent losses in a 'low risk' entity.
  • Licensing payments to low tax jurisdictions.
  • Business restructurings, or changes in TP model, can also trigger a challenge but needless to say, businesses can evolve, and if the previous TP method no longer appears the most appropriate, it should always be reviewed, rather than being ignored for the sake of maintaining consistency.
Penalties
  • Penalties in relation to transfer pricing documentation are derived from the general record-keeping requirements. Two main types of penalties may apply; penalty for failure to keep or produce documentation and a tax geared penalty for a careless or deliberate error.
  • The fixed penalty for failure to keep or produce documentation records is currently £3,000. From April 2023, for large businesses, failure to do the work necessary to maintain the relevant records or to produce those records on request will lead to the presumption that an inaccuracy is careless. The taxpayer can only displace this presumption by providing the documents and evidencing the underlying transfer pricing information had been prepared in advance of filing their Corporation Tax return, or otherwise showing they took reasonable care.
  • The tax-geared penalty dependent on whether the inaccuracy is considered:
    • careless (maximum penalty of 30% of potential lost revenue (PLR))
    • deliberate but not concealed (70%)
    • deliberate and concealed (100%).
  • Where there is a reduction in the amount of losses carried forward, a penalty of 10% of the reduction may be due.
  • A business may receive a mitigation of a penalty for behavioural factors and/or if it had made a reasonable attempt to demonstrate an arm’s length result.
  • An enquiry into a tax return by HMRC may be made up to 12 months from the due filing date of the tax return, unless the return is filed late in which case the enquiry can be made 12 months after the return is filed. In practice, this usually means two years from the end of the accounting reference date, and if no enquiry notice is issued then the tax return may be considered closed.
  • HMRC may in certain circumstances make an enquiry on a company for prior years (a 'discovery' assessment) under certain circumstances. Discovery assessments can be raised where the loss of tax is not due to careless or deliberate behaviour– up to four years; careless– up to six years; deliberate– up to 20 years.
  • Non-compliance with CbCR and notification requirements can draw penalties ranging from £300 to £3,000. Daily penalties may also apply where information is consistently not provided.
Economic analysis and how to demonstrate an arm’s length result
  • HMRC will expect to see that a search for potential internal comparables has taken place before defaulting to an external database search for comparables. The only exception is when the Simplified Approach is used for Low Value Adding Services (LVAS).
  • Where the Simplified Approach is adopted it should be applied, as far as is possible and practicable, consistently on a group-wide basis.
  • The group should maintain documentation detailing:
    • the nature of each category of low value-adding intra group services and why they are believed to fall within the definition;
    • the benefits believed to be received by the recipients of those services;
    • the allocation keys adopted for each category of low value-adding services and the reasons they are believed to be appropriate;
    • relevant contracts between the parties; and
    • calculations of the charges made by or to relevant group members in accordance with the process outlines in HMRC’s guidance.
  •  Local comparable companies are preferred, whilst EMEA or regional comparable companies can be accepted.
  • Note that where databases are used, contrary to popular understanding, there is no specific requirement that the interquartile range be used (however, it will often be calculated as a means to eliminate outliers, given that incomplete information will always be an issue in external database searches).
  • Note also that HMRC is not permitted to use 'secret comparables'. There are also no published TP 'safe harbours' or norms in the UK, and the key is always the facts and circumstances of the specific case.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
  • Advanced Pricing Agreements (APAs) are written agreements between a business and HMRC to govern the appropriate transfer pricing method for a forward-looking period. 
  • APAs are also used in financing and thin capitalisation cases, where they are known as ATCAs.
  • HMRC no longer accepts unilateral APAs (excluding ATCAs).
  • The UK has an extremely extensive treaty network, and the Mutual Agreement Procedure (MAP) will often be available when double tax occurs. 
  • They will not allow “DIY MAP” or downwards profit adjustments by taxpayers on their tax returns.
  • There is no charge for APA or MAP, unlike in many countries, but HMRC may refuse to accept a case, for example where it is deemed insufficiently complex.
  • It is UK policy to allow for arbitration in the event that agreement cannot be achieved and it will seek to include such a provision in its tax treaties. Following the UK’s departure from the EU, the EU Arbitration Convention will no longer be available, but the UK has ratified the OECD Multilateral Instrument (MLI) and hence where the other country (treaty partner) has also agreed, arbitration should be available to eliminate double taxation. NB this must be checked on a country by country basis.
Exemptions
  • There are exemptions from transfer pricing documentation rules for SMEs, dormant companies, charities, and life assurance companies. The SME exemption only applies if the transactions are between a UK taxpayer and a related party in a qualifying territory, which is broadly a territory that is not a tax haven.
  • The exemption criteria are based on EU recommendation 2003/361/EC as follows:
    • Small: less than 50 employees, and either turnover or gross assets not exceeding €10 million
    •  Medium: less than 250 employees and either turnover not exceeding €50 million or gross assets of less than €43 million.
  • HMRC can direct that medium-sized enterprises should apply transfer pricing rules.
  • The 2025 consultation will affect the exemptions given in the UK. The potential exemption of UK-UK transactions from the UK tax legislation is to be welcomed, although this exemption is unlikely to be provided in cases of a material tax advantage. The former is yet to be defined and could include taxpayers within the bank levy charge and patent box regime or those with significant R&D credits or losses. It is also uncertain as to whether taxpayers will be able to disapply the exemption if they wish to access the compensating adjustment mechanism.
  • The impact of the introduction of the UK-UK exemption will be balanced by the expansion of the transfer pricing legislation to include medium sized businesses. A new definition of the thresholds will likely be included in the Spring consultation.
  • This will require many more organisations to prepare formal transfer pricing documentation. Although these taxpayers would not be formally obliged to keep and preserve a Master File and UK Local File, HMRC is of the view (as stated in its guidance and the GfC7) that an appropriate way to demonstrate that provisions between related parties adhere to the arm’s length principle is to still prepare documentation in line with the OECD’s recommended approach i.e. a Local File.
Related developments
The profit diversion compliance facility (PDCF)
  • HMRC launched a diverted profit tax (DPT) disclosure facility in January 2019 with the aim of encouraging groups who-ich may have previously used arrangements of a type targeted by DPT to reconsider their transfer pricing policies or restructuring as appropriate.
  • DPT is a targeted additional tax in place since April 2015 which brings the rate up to 25% (the main corporate tax rate is 19%) to counter 'contrived arrangements…that…erode the UK tax base'.
  • HMRC believes that this compliance facility gives the opportunity for businesses to come forward and in many cases to avoid the penalties for 'prompted' disclosures
  • One of the underlying drivers for the facility was that in many cases where UK profits appear suppressed, it may  in fact be the transfer pricing that should be updated.
  • This facility may potentially be relevant where cross border arrangements that have not been reviewed in recent years, where the functional profile has changed, where transfer pricing policies are based primarily on the contractual assumption of risk and legal ownership of assets and where there are inappropriate or out of date comparables.
  • High-risk business models, as noted above, include commissionaire and toll manufacturing. Those with limited risk distributor and contract services/ contract R&D arrangements could also potentially be affected.
HMRC and taxpayer behaviour
  • HMRC has recently placed a great focus on improving the standards of transfer pricing documentation and economic analyses via reviews of taxpayer and agent 'behaviour'. It will expect local reviews of functions, assets and risks, accurate characterisation, and high-quality TP documentation, otherwise penalties may be sought. HMRC is very keen to stress the benefits of “cooperative compliance”. This is emphasized in the GfC7:
    • HMRC highlights that transfer pricing should not be considered solely as a responsibility of tax teams. An active interest should also be taken by the business with transfer pricing policies being designed in tandem with, and validated by, the business. 
    • GfC7 frequently mentions the application of penalties, with greater risk of application if the involvement of the business is not evidenced. This also indicates that the trend of seeking to apply penalties to transfer pricing adjustments is not likely to abate any time soon.
    • The guidelines discuss the importance of appropriately scoping the transfer pricing work undertaken by the business or third parties, linking the effort and resources employed in the design, documentation and implementation of the transfer pricing policies to the mitigation of penalties.
    • HMRC indicates that an over reliance on contractual and legal arrangements that are divorced from operational reality carry a high risk of transfer pricing error.  For example, it is recognised that target margin policies can be appropriate but warns that these need to be supported with clear evidence that commercial activity also aligns with what has been contractually documented.
    • Services transactions are discussed at length with a focus on the analysis of the cost base and distinguishing low value services from those that could attract a greater reward.
    • Bundling and pricing transactions under a single fee may be practical for taxpayers but HMRC cautions that these arrangements often do not reflect arm’s length prices when broken into their constituent elements.
    • Centralised preparation of documentation outside of the UK needs to ensure that there is evidence of the UK business reviewing the facts supporting the functional analysis and checking the relevance of facts and analysis to the UK entity.

For further information on transfer pricing in the United Kingdom please contact:

 

Kiesty Rockall 120x120 round image.png

Kirsty Rockall

Head of Transfer Pricing
T: +44 (0)20 7728 2988
E: Kirsty.M.Rockall@uk.gt.com

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