United Kingdom
Alan Rajah
by Alan Rajah
Global transfer pricing disputes are escalating, subjecting multinational companies to heightened scrutiny in their transfer pricing practices.
Transfer pricing plays a crucial role in influencing the application of other tax regulations, as it adheres to the concept of the arm’s length principle, which directly affects tax calculations.
UK statistics from His Majesty’s Revenue and Customs (HMRC) reveal a remarkable surge between 2016 and 2021 of 250% in transfer pricing yield, surpassing GBP 2 billion during the 2020–21 UK financial year.
Although 2021–22 data indicates a rise in enquiry numbers but a decline in yields, it underscores HMRC's intensified focus on intricate transfer pricing matters and the substantial stakes involved.
The UK's transfer pricing (TP) rules under Part 4 TIOPA 2010 are built upon the foundation of the arm's length principle, as per Article 9 of the OECD Model Tax.
The basic rule states that if a transaction between related parties could lead to a tax advantage, the profits and losses of the advantaged party should be calculated as if the transaction was done at a fair market price.
This principle-based model approach allows for a broader application to a wide range of transactions.
The UK also employs the tax advantage rule, often known as the “one-way street”, which prevents unilateral negative adjustments to profits or losses that could lead to non-taxation.
UK enterprises, including foreign entities operating in the UK through a permanent establishment, are subject to TP rules unless specific exemptions apply.
For larger groups with annual consolidated revenue exceeding EUR 750 million, the UK has implemented country-by-country reporting requirements and TP documentation obligations.
There are exemptions to the basic TP rules in certain situations, such as transactions involving small or medium-sized enterprises (SMEs). In order to reduce the compliance and cost burdens for SMEs, HMRC introduced simplified transfer pricing arrangements.
The UK follows the OECD guidelines and accepts various TP methods, including the comparable uncontrolled price, resale price, cost plus, transactional net margin, and profit split methods. Companies may use other methods if they are justifiable and appropriate.
Selecting the most appropriate method depends on the functional and risk profile of the entities, and its relevance should be carefully considered for each transaction.
The UK's TP rules explicitly reference the OECD guidelines, emphasising their importance in interpreting and applying the arm's length principle. This alignment ensures consistency and global harmonisation in transfer pricing practices.
UK enterprises are responsible for self-assessing their compliance with TP rules when filing tax returns. If an enterprise is deemed an “advantaged person”, it must make necessary TP adjustments on their tax returns.
For large groups with annual consolidated revenue exceeding EUR 750 million, the UK has implemented Country-by-Country Reporting (CbCR) requirements. CbCR aims to enhance transparency by requiring multinational enterprises to provide information on their global allocation of income, taxes paid, and other indicators of economic activity.
Since 01 April 2023, there has been a standardised approach for TP documentation where all larger groups are required to maintain master and UK local files. This requirement is in addition to CbCR. Previously, the UK TP rules did not explicitly require OECD master and local files to be prepared, and only required the provision of “sufficient documentation”.
To comply with the UK's TP rules, enterprises are required to prepare documentation which proves that transactions with related parties are conducted on an arm's length basis.
From 01 April 2023, the UK has followed the OECD TP documentation model, requiring the preparation of master files and local files. All documentation must be prepared in English and be available before the tax return deadline and submission. This is crucial as HMRC is able to request the documentation with a 30-day deadline, and failure to respond may result in penalties.
HMRC also planned to introduce the requirement of a summary audit trail – a short questionnaire detailing the main actions undertaken in preparing the local file. However, this has now been delayed pending a consultation in 2023.
The master file provides an overview of the group’s business and nature of its operations, its overall TP policies, and its global allocation of income and economic activity.
The UK local file analyses entity-level arrangements, detailing any material intercompany transactions and transfer pricing positions taken between the UK company and any overseas affiliates. This should include relevant financial information, comparability analysis, and selection method for the most suitable TP method.
UK-UK transactions are not required in the local file, but supporting analysis should be available upon request. Generally, UK-UK-related party transactions are subject to TP rules, but documenting them in the local file is not mandatory.
TP documentation must be preserved for at least 6 years from the end of the accounting period, unless subject to an HMRC enquiry.
The self-assessment approach in the UK implies the potential for interest and penalties for “carelessness” in filing.
Maintaining accurate and complete TP documentation is crucial to avoid penalties and demonstrate compliance with UK rules. Failure to provide adequate records may result in fixed penalties of GBP 3,000, and tax-geared penalties based on the level of inaccuracy.
For the largest businesses, not meeting the requirements leads to a presumption of “careless inaccuracy”, a ruling which can only be overturned with the required documents and evidence. Tax-geared penalties range from 30% to 100% of potential lost revenue depending on the level of inaccuracy and behaviour.
Generally, to establish arm's length pricing, businesses are expected to conduct economic analyses. HMRC encourages businesses to search for potential internal comparables before resorting to external database searches.
In the case of Low Value Adding Services (LVAS), if the simplified approach is used, it should be consistently applied across the group where appropriate. The nature and benefits of LVAS should be documented, along with relevant contracts, allocation keys, and calculations of charges.
The UK allows businesses to enter into advanced pricing agreements (APAs) with HMRC. These agreements govern the appropriate TP method for a forward-looking period, providing certainty and reducing the risk of disputes.
When double taxation occurs, the Mutual Agreement Procedure (MAP) is also available. The UK's extensive treaty network allows for the resolution of TP disputes through negotiation with the treaty partner.
Navigating the UK's transfer pricing regulations requires a comprehensive understanding of the legislation and compliance obligations. By adhering to the requirements for TP documentation, conducting economic analyses, and utilising mechanisms such as APAs and MAPs, enterprises can ensure compliance with UK transfer pricing rules. Staying informed about the evolving nature of TP regulations is essential to mitigate risks, avoid penalties, and foster certainty in cross-border transactions.
Lawrence Grant LLP, Chartered Accountants provides audit, accounting, tax, business advisory, and cross-border tax advice. They are focused on providing business solutions to clients to enable them to grow their businesses both in the UK and overseas. In an era of digital transformation, the firm offers a selection of cloud and digital sowtware solutions using AI technology.
GGI member firmLawrence Grant LLP, Chartered AccountantsLondon, UKT: +44 20 8861 7575
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Alan Rajah joined Lawrence Grant LLP in 1994 and he is involved in all areas of general practice, specialising in cross border tax planning, due diligence, mergers and acquisitions and inheritance tax planning. His client portfolio includes UK and overseas companies and individuals. Alan is the Global Vice Chair of the GGI International Tax Practice Group and a Trustee of British Foundation for International Reconstructive Surgery & Training (BFIRST).Contact Alan.
