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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 (‘TP’) 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, i.e. it follows the OECD Guidelines. The rules are not heavily formulaic but instead are principles-based.
  • The TP rules apply to UK taxpayers, including UK branches of overseas companies and is a self-assessment regime.
  • The regime is a 'one-way street', i.e., upwards-only adjustments are permitted, and offsets between years and entities may not be accepted.
  • There are specific statutory requirements in the UK relating to the preparation of transfer pricing documentation for groups generating over €750m of turnover. These requirements include the obligation to maintain a Master File and Local File, and a supporting Summary Audit Trail (‘SAT’). The SAT is a new requirement and further detail has yet to be released but it is expected that it will be enforced in 2024. The UK has also implemented Country by Country Reporting (CbCR) for these Groups.
  • Groups below the €750m threshold must keep records which are sufficient to enable the taxpayer to deliver a correct, accurate and complete corporate tax return.
  • Businesses who are considered large (more than 250 employees or less than 250 employees with either turnover exceeding €50 million or gross assets of more than €43 million) will invariably produce transfer pricing reports in order to meet the requirement to produce records to demonstrate how they set their transfer prices and to provide evidence that those prices are arm’s length. HMRC acknowledges in guidance that a Local File in this instance would be best practice.
  • Taxpayers should evidence that their transfer pricing complies with the UK transfer pricing rules before signing the relevant tax return. In the event of an enquiry the onus is on the taxpayer to be able to explain the steps taken before filing the tax return to satisfy themselves that they were compliant with the transfer pricing rules. 
OECD guidance
  • The UK legislation must be construed in a manner that best secures consistency with:
    • the expression of the arm’s length principle in Article 9 of the OECD Model Tax Convention on Income and on Capital (Article 9) and
    • the guidance in the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the OECD Transfer Pricing Guidelines).
  • The documentation requirements are based on the OECD Guidelines.
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
  • There is a sliding scale of documentation requirements in the UK. 
  • SMEs are exempt from the preparation of annual, formal documentation but are still expected to maintain records to support that they are acting within the arm’s length principle. For example, an intra-group agreement and policy document would be considered appropriate. 
  • Large businesses are required to maintain documentation to support their transfer pricing. In recent guidance HMRC has acknowledged that this documentation should likely be in the form of a Local File, although this is not mandatory. 
  • The largest businesses (>€750m turnover) are obliged to prepare a Master File and a Local File. Neither of which need to be submitted. An additional requirement is the SAT. In December 2022 it was announced that the introduction of the SAT had been separated from the Master File and Local File obligation. HMRC still intends to introduce the SAT but it will likely not be introduced until 2024. HMRC will undertake separate consultations on the SAT and a decision on its implementation will be made following the conclusion of the public consultation. Although the SAT is not in force, the secondary legislation published by HMRC in 2023 will provide it with the power to introduce the SAT by way of a published notice. This will allow HMRC to implement the SAT at a later date without the need to make further changes to primary or secondary legislation.
  • UK-UK related party transactions therefore remain subject to UK transfer pricing but unless domestic transactions involve a Patent Box claim or are within the Oil and Gas ringfence legislation, they need not be documented in the Local File. 
  • Where a controlled transaction is covered by an APA and that APA was agreed prior to the date of commencement of the new transfer pricing records requirements (1 April 2023) details of that controlled transaction may be excluded from the Local File. For controlled transactions covered by APAs agreed on or after the date of commencement of the transfer pricing records requirements, no exclusion applies.
  • Any documentation should be prepared in English and be available by 12 months from the accounting period end, before the tax return is submitted.
  • Documentation should be provided within 30 days to HMRC when requested and 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.
CbCR
  • The largest businesses (>€750m turnover) are obliged to prepare and submit a CbCR.
  • There was an amendment to the UK’s CbCR legislation that came into effect on 26 July 2023, removing many of the CbCR notification requirements for UK businesses that had been included in UK legislation per EU directives. 
  • Since leaving the EU, the UK is free to remove or amend this requirement. In its explanatory memorandum to these amendments, HMRC noted that in the past, these notifications provided some valuable information but now that data has been gathered for several years, these notifications no longer provide useful or unique information.  
  • Broadly, the amendment strives to remove the requirement for many UK businesses to submit a CbCR notification to HMRC. This only applies to UK-based constituent entities of a group with an Ultimate Parent Entity based in a territory outside the UK with which HMRC has an activated exchange relationship for CbCR, which has filed a CbCR or the equivalent of a CbCR in that other territory. 
Some risk factors for challenge
  • When assessing a taxpayer for audit selection, HM Revenue and Customs’ (‘HMRC’) main sources of information include transfer pricing reports, legal agreements, and other business records. From April 1, 2023, these can be requested by HMRC without the need for an official audit to be opened. HMRC also uses data profiling and intelligence gathered from multiple sources (business websites, commercial databases, press reports, trade magazines and articles, internet searches, and overseas financial statements) to supplement its assessment, identifying taxpayers with specific features who might be appropriate to audit. For instance, HMRC works closely with other tax administrations to exchange information under the terms of tax treaties, including its partners in the expanding Joint International Taskforce on Shared Intelligence and Collaboration (‘JITSIC’) network. 
  • HMRC has published their key focus areas in their International Tax Manual and are due to release a Guidelines for Compliance (‘GfC’) product focused on transfer pricing this year. The GfCs are a series of products being released by HMRC with the intention of providing taxpayers with practical information about tax risks. They are viewed as an extra tool to help taxpayers manage their taxes and guide the behavior of those that wish to operate in a low tax-risk environment. The focus areas considered by HMRC are: 
    • UK taxpayers’ profits or losses appearing inconsistent either with its business activities or with worldwide group results over a cycle of, say, five years 
    • UK taxpayer providing intangibles but receiving no or low royalties and does not seem to be generating an entrepreneurial reward for its R&D. For instance, if UK R&D functions are described as managing, controlling, and performing the development of valuable intangibles in the UK for the purpose of R&D expenditure credit or patent box claims but then described as low value for TP purposes and being rewarded by reference to a modest return on costs 
    • Borrowing appears disproportionately high in relation to shareholders’ funds, bearing in mind the type of business involved 
    • Interest appears high in relation to the business’s ability to service the debt from its operating profits before tax and interest payable. What constitutes “high” is a complex issue, but the key question is whether the debt burden appears sustainable, alongside the company’s other requirements and obligations • Transactions do not appear to make commercial sense (e.g., insertion, for no apparent commercial purpose, of a new UK group holding company with substantial debt), particularly in comparison to the previous position 
    • Transactions with related parties in low tax territories
    • Payments by UK entities to overseas procurement or sourcing entities or “hubs” in low tax countries with limited functionality relative to the UK procurement function, or which relate to incidental benefits derived solely due to it being part of a larger MNE group (for example, group synergies or economies of scale) 
    • Sales and marketing entities in the UK performing key account management functions 
    • Acquisition of a UK group by a private equity firm, which will rely on heavy debt funding 
    • Notes in UK accounts, or other forms of information such as press or internet articles, which mention restructuring, acquisition/merger activity, transfer of UK activities to related parties and/or changes to the way in which the company is rewarded 
    • Disappearance of/significant decline in stock 
  • HMRC also highlights further areas as risk indicators, such as an over reliance on transfer pricing policies predicated on contractual assumption of risk and legal ownership of assets, giving insufficient weight to the location of the control functions and/or the contributions to those control functions in relation to the risk and/or the important functions in relation to the assets. In particular, HMRC focuses on legal contracts between a UK entity and an overseas entity (or entities) which allocate key risks to the overseas entity which are then purported to support a limited or reduced reward for the UK, notwithstanding that functions related to the control of those key risks are performed by the UK. HMRC states where it has observed instances where the contractual allocation of key risks may not be consistent with the control of such key risks:
    • commissionaire structures 
    • low risk distributors 
    • toll or contract manufacturing arrangements 
    • contract research and development arrangements. 
Penalties
  • Changes to HMRC information powers specifically in relation to obtaining transfer pricing related records will also come into force from April 2023. Transfer pricing documents will be able to be requested outside of an enquiry by HMRC, for example as part of a risk review. The requirement for the documents to be in the ‘possession or power’ of the UK entity has also been removed. This means that if a UK company has an overseas parent and that parent holds the documents, that the documents can still be requested by HMRC. 
  • 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 the largest 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 that 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% of PLR)
    • deliberate and concealed (100% of PLR).
  • 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).
  • They will not allow “DIY MAP” or downwards profit adjustments by taxpayers on their tax returns.
  • The UK has an extremely extensive treaty network, and the Mutual Agreement Procedure (MAP) will often be available when double tax occurs.
  • 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. Note this must be checked on a country by country basis.

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

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Liz Hughes
T +44 (0)207 728 3214
E elizabeth.hughes@uk.gt.com

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

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