Transfer pricing regulations in the United Kingdom

The United Kingdom first introduced transfer pricing regulations into its domestic legislation in 1915 and was the first jurisdiction to do so. Over the years those regulations were modified and amended a couple of times, and currently, the section that governs transfer pricing is section 164 of the Taxation (International and Other Provisions) Act 2010 (TIOPA 2010).

The UK regulations largely follow the provisions of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022 (the OECD transfer pricing guidelines).

Arm’s length principle

The arm’s length principle was introduced to the domestic UK regulations as part of the Finance Act 1951. In the current regulations, the principle is mentioned in section 147 of the UK Tax Act, which states the following: “The profits and losses of each of the affected persons are to be calculated for tax purposes as if the arm’s length provision had been made or imposed instead of the actual provision.” The arm’s length provision is defined in the same section as “the provision which would have been made as between independent enterprises.”

Related party definition

The definition of related parties in the UK regulations can be divided into two categories, direct and indirect participation in the management, control, or capital of another person.

• Direct participation – Direct participation occurs if there is one party is controlled by the other party. Control is defined in section 217 of the TIOPA 2010 as “to secure . . . that the affairs of [that company] are conducted in accordance with the wishes of that person”. This can be done either by holding 50% of the shares or voting powers in the other party or via a provision in the articles of the company.
• Indirect participation – There are a few ways in which indirect participation can occur, including the following:

1. As defined in Section 159 of the TIOPA 2010, a case when a person doesn’t have direct participation but would have if additional rights were given to them. Those rights include the rights of connected persons (family and relationships created by trusts).
2. As defined in Section 160 of the TIOPA 2010 – when a person is one of the main participants in another person’s enterprise.

Transfer pricing methods

The methods that can be used to determine the arm’s length price are:

• Comparable uncontrolled price method
• Resale price method
• Cost plus method
• Transactional net margin method
• Profit split method

The Comparable Uncontrolled Price method is considered the simplest and most accurate method. If the application of this method in a certain case is difficult, then any method mentioned in the OECD guidelines can be applied, using the best/most appropriate method rule.

Comparability analysis

An important part of the transfer pricing compliance is the comparability analysis. Below is a summary of the main points regarding comparability analysis in the UK:

• The  HM Revenue & Customs (HMRC) does not use secret comparables.
• There is no preference for domestic comparables over foreign ones.
• The most commonly used databases, both by taxpayers and the HMRC, are FAME, AMADEUS, and OneSource.

Documentation requirements

Taxpayers are not required to submit the documentation with their yearly reports, only if the Assessor requests them to. They do however need to maintain documentation regarding their transfer pricing methodology.

If the entity is part of a multinational enterprise (MNE) group with a revenue of 750 million euros or more, they are required to prepare local and master files.

In addition, for fiscal years starting January 1, 2016, MNE groups with annual revenue of 750 million euros or over, with an ultimate parent entity in the UK need to submit a Country-by-Country report.

Moreover, entities with a turnover above GBP 200 million or a balance sheet above GBP 2 billion, and UK entities that are part of an MNE group that has a turnover above EUR 750 million, have to publish online their tax strategy, from the September 15, 2016 financial year.

Safe harbours

HMRC publication INTM440071, follows the approach of the OECD guidelines regarding low value-adding intragroup services, allowing for a simplified approach to their evaluation. Under this approach, services that fall under this scope should be priced at a 5% markup on costs.

Advance Pricing Agreements (APA) and Mutual Agreement Program (MAP)

Both APAs and MAPs are available in the UK.

APAs are agreements made between the taxpayer and the tax authorities, in advance, to avoid tax disputes regarding transfer pricing methodology. The HMRC can decide which cases will enter the APA program. Usually, the case will be chosen for the program if the case is complex, there is a high chance of double taxation without the agreement, or if it thinks that the request is a good use of governmental and taxpayer resources.

The HMRC offers three types of APAs:

1. Unilateral APA – between the taxpayer and the HMRC. This type of APA is less common.
2. Bilateral APA – between the taxpayer, a foreign related party, the HMRC, and the foreign tax authority. This type of APA is the HMRC’s focus.
3. Multilateral APA – between the taxpayer, two or more foreign related parties, the HMRC, and multiple foreign tax authorities.

MAPs are agreements made after an incident of double taxation has occurred. If a taxpayer believes that the taxation they are subject to, is inconsistent with the treaty, they can submit a request for an MAP. The HMRC will review the case and will decide what the appropriate action is; whether to decline the request, provide unilateral relief, or contact the other tax authority to negotiate a bilateral solution.

Approach to transfer pricing audits

In recent years, the HMRC’s focus on transfer pricing inquiries has increased, with it introducing a larger, more specialized team to handle those matters in 2008. From 2008 to 2014, this team was able to charge an additional GBP 5.8 billion in taxes and continued to charge above one billion GBP every year since, increasing the amount charged every year.

The HMRC’s approach to transfer pricing inquiries is not using an audit regime. The HMRC can open inquiries regarding tax returns within the statutory time limit for examination. Before doing so, the taxpayer must be notified within a specified time period (usually a year) about the HMRC’s intent to open an inquiry.

Once a formal inquiry is opened, it must be also formally closed, this can be done by the HMRC.

If the taxpayer believes that the inquiry is unreasonable in scope or that it has been very lengthy unnecessarily, they can request the First-tier Tribunal to order the HMRC to close the inquiry.

There are a few outcomes to the inquiry:

• No adjustment is needed, and the inquiry is closed.
• The HMRC negotiates a settlement.
• The HMRC will progress to litigation proceedings.
• If an adjustment is needed, a closing notice is issued and the taxpayer has 30 days to modify the return according to the conclusions of the inquiry. If they don’t do it in 30 days, they get additional 30 days do to so. The taxpayer has 30 days to appeal the conclusions.

The process of handling the HMRC’s inquiries requires extensive knowledge of the local legislation and expertise in the matter.

Penalties

With the exemption of Country-by-Country reporting, the UK doesn’t impose specific penalties for transfer pricing offenses, and the general rules are applicable in those cases. According to those rules, the penalties can range from 30% to 100% depending on the offense.

Regarding Country-by-Country reporting, there are specific penalties, including:

• The failure to file the report, to provide the relevant notifications, or to provide additional information as asked by the HMRC will result in a GBP 300 penalty. If there is a continued failure, a daily penalty of up to GBP 60 can be imposed.
• If incorrect information was reported in the Country-by-Country report or upon the HMRC’s request, a penalty of GBP 3,000 can be imposed.

Taxation at a glance

As mentioned above the UK’s tax authority is called the  HM Revenue & Customs or HMRC. The UK consists of four countries, England, Scotland, Wales, and Northern Ireland. Direct and indirect taxes are imposed on the national level and local authorities can impose certain taxes, such as council tax, and more.

The table below provides a summary of the main taxation rates related to businesses:

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