Price charged between two parties in a transaction is called transfer price. In the United Kingdom (UK), the legislation for transfer pricing is concerned with prices charged between connected parties in different transactions.
Risk of transfer pricing arises mainly in across the border transactions between connected companies. UK’s legislation for transfer pricing also applicable to agreements or transactions between parties situated within United Kingdom. Besides, transfer pricing risk is not only applicable to transactions between connected companies but also applicable to transactions between a company and a controlling individual.
United Kingdom has a comprehensive administration on arm’s length principle for implementing transfer pricing procedures to transactions between entities. Enterprises need to calculate taxable profits using transfer pricing adjustments (if applicable).
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The transfer pricing legislation has been introduced by HM Revenue & Customs (HMRC) to check erosion of UK’s tax base. As per Section 164 of the Taxation (International and Other Provisions) Act 2010, the transfer pricing legislation in UK must ensure that the arm’s-length principle in Article 9 of the Organization for Economic Cooperation and Development (OECD) Model Tax Convention on Income and on Capital is followed. The OECD Transfer Pricing Guidelines have been incorporated by UK into its domestic law. Legislative framework has been further supplemented by guidance issued by tax administration of UK, Her Majesty’s Revenue and Customs.
The Organization for Economic Co-operation and Development (OECD) has laid down five methods for estimating the arm’s length price. These are divided into transactional profit methods and traditional transactional methods.
- Comparable uncontrolled price (CUP)
- Resale minus and
- Cost plus
- Profit split
- Transactional net margin method (TNMM)
OECD 1995 transfer pricing guidelines outline CUP method as a preferred method and transactional profit methods as the less preferred ones. In general, as per OECD guidelines, comparable uncontrolled price (CUP) or comparable uncontrolled transaction (CUT) is most effective in assessing arm's length price.
If transfer pricing adjustment is made to one of the entities, another entity, which is not a potentially advantaged entity (as per HMRC guideline), can claim to adjust its taxable profit provided all requisite conditions are met.
The government of UK has been advocating that documentation for transfer pricing should be standardized globally. This will reduce the costs of compliance to entities that are based in multiples geographies.
Adjustments or penalties related to transfer pricing
There are no specific penalties or adjustments for documentation related errors for transfer pricing. Taxpayers are expected to keep and preserve the records. HMRC outlines that maintenance of documents and records should be reasonable due to nature and complexity of issues. Primary accounting records should be maintained at the time of transaction. The entities should be ready to produce evidence to demonstrate transactions at arm’s length if requested by HMRC. It is expected that documentation at all three levels – country-by-country report, master file and local file – is aligned and the overall content should be consistent with data from all entities in the group.
If it is found out that transfer pricing method applied is incorrect resulting in filing of incorrect tax returns, penalties may be imposed as per the statutory regime.
For transfer pricing matters, specific resolution routes do not exist. Generally, the resolution process begins with a HMRC investigation into business entity’s tax return, resulting into appeal to the First Tier Tax Tribunal. HMRC may consider solving dispute through mediation. Transfer pricing disputes are largely settled through negotiation between taxpayer and HMRC.
Read More: Self-Assessment Tax Return Investigations,
The most effective way to avoid disputes is to agree in advance on transfer pricing method to be applied. This can be done through an advanced thin capitalization agreement (ATCA). ATCA is an advanced pricing agreement (APA) dealing with interest expense in connection to intra-group financing.
HMRC always prefers bilateral or multilateral APAs involving participation of tax authorities in other jurisdictions.
For international disputes, a taxpayer can look for a bilateral APA involving surety in concerned jurisdictions relevant in cross border transaction. Incidentally, if a taxpayer has not obtained APA and suffers from double taxation, relief can be claimed under mutual agreement procedure (MAP) of the relevant double taxation agreement. MAP is applicable to dealings between geographies with double taxation treaties. It allows the taxpayer to claim to the relevant tax authority for resolution of double taxation issues.
The United Kingdom is has signed more than 100 tax treaties. These have provisions applicable on cross border transactions. The tax treaties are in line with OECD’s Model Tax Convention on Income on Capital. They include the arm’s length principle. The United Kingdom has also signed tax information exchange agreements. These agreements facilitate exchange of information concerning specific tax matters under enquiry.
Apart from these, the United Kingdom has also signed the Multilateral Convention to Implement Tax Treaty Related Measures. This will help in preventing Base Erosion and Profit Shifting (MLI).
Transfer pricing laws are not generally applicable on small or medium sized companies. However, if the concerned company elects or in certain situation receives a notice from relevant authorities, the provisions for transfer pricing become pertinent.
UK has incorporated revisions in domestic laws since April, 2016 as per OECD Transfer Pricing Guidelines implemented as a result of Base Erosion and Profit Shifting Actions. Further developments relevant to transfer pricing are expected after UK’s move to leave the European Union in June 2016.
The UK has introduced general anti abuse rule (GAAR), thus, facilitating HMRC in countering tax advantages by entities which arise from abusive schemes. Under diverted profits tax introduced in 2015, the UK government has tried to introduce a mechanism to deter the diversion of profits from UK by taxpayers. Besides, under anti-hybrid rules introduced in line with Base Erosion and Profit Shifting action, the UK government has tried to address issues like hybrid instrument or hybrid entity and tax mismatch caused by hybrid entity.