Transfer pricing is a concept that refers to the pricing of goods, services, funds and tangible and intangible assets transferred or provided between associated parties. Associated parties may not be subject to standard market pressures that establish prices for similar transactions between third parties and therefore these rules govern the treatment of these transactions.

Where there are cross-border transactions between associated parties, the price that is charged can affect the amount of tax that is paid in the UK, or the other jurisdiction in which the other relevant party to the said transaction is located. Transfer pricing rules in the UK and elsewhere require that transactions between connected parties should be recognised for tax purposes by applying the amount of profit (or loss) that would have arisen if the same transaction had been carried out by unconnected parties. This is referred to as the ‘arm’s length principle.

The arm’s length principle is endorsed by the OECD (Organisation for Economic Cooperation and Development) and explained in the Associated Enterprises Article (article 9) of the OECD Model Tax Convention, as follows:

‘...[where] conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly’.

Transfer pricing is usually seen as a cross-border tax matter, but the rules also apply to transactions between UK companies.

UK transfer pricing rules

The UK’s transfer pricing rules are found in Part 4 TIOPA 2010. These rules have corporation tax and income tax implications, and can require adjustments in tax returns and supporting computations to ensure that arm’s length pricing is reflected.

Similar rules are likely to apply in most other countries, and transfer pricing should therefore be considered when looking at all cross-border transactions. Double tax treaties will typically contain an article equivalent to Article 9 of the OECD Model Tax Convention, which is based on the arm’s length principle.

Exemptions for small and medium sized companies

There are exemptions from the UK transfer pricing rules for small and medium sized companies, and also for transactions with dormant companies.

The exemption that will apply for most small and medium sized enterprises. A business is a ‘small’ enterprise if it has no more than 50 staff and either an annual turnover or balance sheet total of less than €10 million. A business is a ‘medium sized’ enterprise if it has no more than 250 staff and either an annual turnover of less than €50 million or a balance sheet total of less than €43 million. Where the entity is a member of a group, or has an associated entity, these limits apply to the whole group and not the specific entity. 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.

How Shaw Gibbs can help:

Our work involves the implementation of TP Policies (including Master Files, Local Files and corresponding functional and value chain analysis) prepared by our tax team, through the creation and implementation of effective Intercompany Agreements (ICAs). These ICAs cover all transaction types and incorporate international best practice. Our agreements are then referred to in the TP Policies, Master Files and included within the Local Files of our mutual multinational clients, as required by the OECD TP Guidelines. We can also undertake functional and economic analysis studies relevant to intragroup transactions.