UK TP rules

This page explains 5 key features of UK transfer pricing regulations:

1. Connected persons
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”. In practice the vast majority of cases we deal with relate to corporate groups with >50% shareholdings, either parent/subsidiary or fellow subsidiary relationships, but the legislation is broad enough to cover other and contingent control relationships. A joint venture is also caught if two partners own at least 40% each, and there are special rules for financing arrangements where a number of financiers act together.

2. Basic rule
Given two or more persons connected as above, then a transaction or series of transactions happens. The two connected persons do not actually need to be parties to those transactions, but the transactions result in “provision” between these connected parties. So what is “provision”?

“Provision” is broader than just payment, and can include a direct exchange, an offset, assumption of a liability, etc. The basic rule also brings in the concept of “arm’s length provision”, being the provision that would have been made between independent parties.

So, does the actual provision applied between our connected parties reflect what independent parties would have agreed in the same circumstances, with the same underlying transaction or series of transactions? If it does, we need to document the facts in line with transfer pricing documentation requirements. If it doesn’t, an adjustment may be required, as follows. If the actual provision differs from the arm’s length provision, but results in a higher UK tax liability, no UK adjustment is made (but there is likely to be a problem on the overseas side). However, if the result is a lower UK tax liability, then an adjustment must be made to increase UK profits (or decrease losses) to the arm’s length amount.

3. UK/UK transfer pricing
The UK is unusual in that it applies transfer pricing rules domestically, between connected UK companies, and not just cross-border. The impact of domestic transfer pricing is moderated by 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.

4. SME exemption
UK transfer pricing legislation includes certain exemptions for UK companies in groups that are defined as small or medium-sized.

The limits to apply to determine whether the whole group is small or medium-sized, are, currently:

Maximum number of staff And either :
(i) annual turnover less than
or :
(ii) balance sheet total less than
Small Group 50 10 million euros 10 million euros
Medium Group 250 50 million euros 43 million euros

If the UK company is within a group that qualifies as small or medium sized, the effects are as follow:

– 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. There is a list of territories with qualifying tax treaties on HMRC’s website (1). The main group of territories that we come across which are impacted by this provision are the so-called “tax havens”. 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 for “Small” groups 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.

– Conclusion about UK SME exemption
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. In fact we do quite a lot of work for groups that fall within this exemption for UK purposes, but their overseas subsidiaries do not get any exemption in their overseas territories. These groups recognise the need to apply and document arm’s length transfer prices overseas, and understandably wish to co-ordinate the pricing policy and method from one central point.

(1) List of territories with qualifying tax treaties with the UK is at http://www.hmrc.gov.uk/manuals/intmanual/INTM412090.htm

5. Dormant companies
There is an exemption from transfer pricing requirements for companies that were dormant at 31 March 2004, either throughout an accounting period that ended on that date or otherwise for the 3 months to that date, and have remained dormant since. However, no exemption is available for “active” companies that have transactions with related dormant companies. In many instances an analysis of a transaction with a dormant company will lead to a nil adjustment, but care must be taken because we do come across dormant companies that hold valuable assets, particularly in trades that involve property.

Frequently asked questions:
Are branches/permanent establishments (PEs) of non-UK companies caught?
Yes, 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. This is something that should be taken into account where a non-UK company wishes to operate in the UK through a branch structure rather than a separate company.

Are not for profit companies caught by the legislation?
Yes they can be. Where a company, which is intended to be run on a not for profit basis, actually carries on trading type activities, transfer pricing applies. For example, if a registered charity sets up a subsidiary to provide intra-group IT services, that subsidiary is carrying out trading activities and needs to apply arm’s length pricing.

Disclaimer
The content of this page and this website is intended to provide a general guide to the subject matter and should not be regarded as a basis for ascertaining liability to tax or determining investment strategy in specific circumstances. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without professional advice after a thorough examination of the particular situation.