What is transfer pricing?
Transfer pricing is the pricing of the provision of goods, assets and services between connected parties.
The test to determine whether two or more persons are connected for the purposes of UK transfer pricing legislation looks at “Participation in the management, control or capital”. This generally means greater than a 50% shareholding but does include a joint venture relationship where each party holds at least 40% each.
The majority of countries now have some form of transfer pricing rules in place.
The UK’s transfer pricing legislation details how transactions between connected parties are handled and in common with many other countries is based on the internationally recognised arm’s length principle.
The UK is unusual in that it applies transfer pricing rules domestically, between connected UK companies, and not just cross-border. There is, however, the ability to claim a compensating adjustment for the other party, i.e. if one party has to increase its profit, the other can reduce theirs. This provision mirrors a provision available on cross-border transactions, under Double Tax Treaty Provisions, but while the UK claim is guaranteed, the Treaty claim is not.
Purpose of transfer pricing rules
Transfer pricing rules exist to ensure that the pricing of such provisions, and therefore the allocation of related income and cost between connected parties, corresponds with third party arrangements.
These rules seek to prevent the misallocation of profit to low (or comparatively lower) tax territories.
Who is caught by UK transfer pricing rules?
Large groups (generally those with more than 250 employees) are required to comply with the transfer pricing legislation in the UK.
Where this is the case, intra group transactions (including interest charges, management charges or intra group trading) must be on arm’s length terms.
In addition, companies must have appropriate transfer pricing documentation in place to support the price at which the transfer is taking place.
The UK provides an exemption from transfer pricing for small and medium-sized enterprises (“SMEs”). Broadly speaking the following thresholds apply based on consolidated accounts for the entire group (i.e. even if the UK subsidiary company is very small, if the group is above these thresholds, the UK subsidiary must apply UK transfer pricing rules):
| Head-count | Annual Turnover | Gross assets | ||
| Small | < 50 | and at least one of: | ≤ €10m | ≤ €10m |
| Medium | < 250 | and at least one of: | ≤ €50m | ≤ €43m |
| Large | ≥ 250 | or both of: | > €50m | > €43m |
Small group
If the UK company is within a group that qualifies as small, it is exempt from the need to apply and document arm’s length prices in respect of transactions with related parties in countries with which the UK has a Double Tax Treaty with an appropriate non-discrimination article. The effect of this is that transactions a UK company has with related parties based in “tax havens” are not exempt, even if the group is small, so these transactions must be undertaken at arm’s length and documentation prepared.
Medium group
If the UK company is within a group that qualifies as medium sized, the UK company need not apply arm’s length transfer pricing unless it is dealing with related parties in territories without a qualifying double tax treaty (as above). However, HMRC can subsequently require a medium sized group to apply arm’s length transfer pricing to any of its related party transactions. For this reason, many medium sized groups decide to apply transfer pricing rules to obtain some assurance about the sustainability of pricing on related party transactions for the benefit of the UK company and the overseas parties.
The UK is unusual among tax authorities in applying an SME exemption. Most other countries do not have a similar exemption. Therefore, although a UK company may qualify for the UK exemption, it is unlikely that its overseas related companies will enjoy similar protection.
Are UK branches/Permanent Establishments caught?
UK branches/PEs of non-UK companies are caught by the legislation. In practice, transfer pricing for PEs can be more difficult than transfer pricing between two separate companies, due to the lack of separate legal identity of a PE.
If you have any questions or would like to discuss your transfer pricing requirements further, please do not hesitate to get in touch.
