Transfer Pricing documentation rules in the UK

The landscape of transfer pricing (‘TP’) in the UK has undergone significant changes with the introduction of new documentation rules.

These regulations are a response to the global trend towards greater transparency and compliance in tax matters, aligning with the Organization for Economic Cooperation and Development's (OECD) guidelines. The new rules came into effect for accounting periods beginning on or after 1 April 2023, for corporation tax purposes, and from the fiscal year 2024/2025 for income tax purposes.

Requirements

Documentation required includes a Master File and Local File, which contain detailed information as described in Annexes I and II to Chapter V of the 2022 OECD Transfer Pricing Guidelines (TPG). Further, a country-by-country report is also required which provides the key financial elements of each jurisdiction.

Application

The regulations apply to UK entities that are part of a multinational enterprise (MNE) with at least EUR 750 million in turnover for the relevant period, aligning with the Country-by-Country Reporting (CbCR) threshold. However, to ensure good governance it is advised that large businesses below the CbCR threshold, but with material related party cross-border transactions, voluntarily comply with the new requirements.

A UK entity, part of an MNE group, is defined as follows: 

• a UK resident company or a company which has to file a company tax return in the UK 
• a partnership which has to file a UK partnership return 
• a trust which has to file a UK return.

Guidance

HMRC guidance emphasizes the importance of maintaining accurate and timely intercompany transaction data and other relevant information for TP documentation.

Transactions between related parties within the UK are still governed by UK TP regulations. However, documentation in the Local File is not required for such domestic transactions unless they are associated with a Patent Box claim or fall under the Oil and Gas ring-fence legislation.

The guidelines also emphasise that the Senior Accounting Officer is responsible for keeping the specified TP records. If these records are not maintained, it could suggest that the organisation has not set up sufficient accounting processes and arrangements.

Timing

Documentation needs to be ready by the time the tax return is submitted (deadline is 12 months from the end of the accounting period) but does not need to be filed with the tax return. However, should HMRC request it, it must be submitted within a 30-day timeframe. Generally, records should be retained for a period of six years after the end of the accounting period.

SMEs

The UK TP regulations do not apply to Small Medium Enterprises (SMEs). The thresholds, included later, are designed to reflect the economic position and relative size of an enterprise, providing a clear demarcation for exemption eligibility. Nonetheless, there are exceptions to this exemption: 

• if a medium sized enterprise elects for the regulations to apply 
• if HMRC provides a TP notice to medium sized enterprises for the exemption to not apply 
• if HMRC issues a notice to any SME to apply TP principles in computing profits from a transaction that is relevant to a patent box claim. 
• If the SME has transactions with an enterprise in a non-qualifying territory (where the UK does not have a double tax treaty with an appropriate non-discrimination article) the exemption may not apply.

Furthermore, the profit fragmentation rules act prevents UK companies and individuals avoid UK tax. Effective from 1 April 2019, the rules target profits derived by the UK entities within territories with significantly lower taxation compared to the UK. The aim is to ensure that the full amount of profit derived from activity in the UK is taxed in the UK. In practice, these rules will mostly affect SMEs which are not within the TP legislation, and individuals, with offshore activities.

Businesses close to the exemption thresholds must be vigilant, as changes in the exchange rate or in their financial data could alter their qualification status.

These nuances are essential for SMEs to consider when navigating the tax landscape in the UK.

Penalties

The introduction of these new TP documentation requirements signifies the UK's commitment to ensuring that TP practices are transparent and adhere to the arm's length principle. It is expected that there will be stricter enforcement of penalties for non-compliance, highlighting the need for impacted groups to undertake detailed review of their TP policies and documentation practices.

There are two primary types of TP related penalties that may apply

• Penalty for failure to maintain or produce documentation
  • There is a penalty of up to £3,000 for failure to submit TP documentation within 30 days upon request by HMRC.
  • For groups subject to the mandatory Master File and Local File requirements, there is an additional penalty of up to £300 and a further £60 per day where the 30 day time limit is breached.
• Tax-geared penalty for careless or deliberate errors
  • From April 2023, for the largest businesses, failing to maintain relevant records or produce them upon request presumes a ‘careless’ approach by the taxpayer. Taxpayers can displace this presumption by providing evidence that they prepared underlying TP information in advance of filing their Corporation Tax return or showing they demonstrated reasonable care.
  • Tax-geared penalties vary based on the nature of the inaccuracy:
    • careless: Maximum penalty of 30% of potential lost revenue (PLR)
    • deliberate but not concealed: 70% of PLR
    • deliberate and concealed: 100% of PLR.

Summary

In summary, the TP requirements for businesses of different sizes in the UK are as follows. The grouping that the requirements in the UK fall under is based on the consolidated accounting figures of the worldwide group.

1. Small groups

• Definition
  • Small groups have a maximum number of 50 staff and either annual turnover of less than EUR10 million or balance sheet total less than EUR10 million.
• Documentation requirements
  • While there is not a specific mandate for the UK, as discussed above, it is advisable to ensure there are intercompany agreements for any transactions. Demonstrating adherence to the arm’s length principle through documentation is important.

2. Medium groups

• Definition
  • Medium groups have a maximum number of 250 staff and either annual turnover of less than EUR50 million or balance sheet total less than EUR43 million.
• Documentation requirements
  • TP Policies: It is recommended to develop defined TP policies for UK entities and regularly monitor these against actual outcomes.
  • Benchmarking and documentation: It is advised for the UK to have a TP policy memo, intra-group agreements and appropriate benchmarking for relevant transactions.

3. Large groups

• Definition
  • Large groups have more than 250 staff but fall below the threshold of the largest groups. Alternately, they may have less than 250 employees but both annual turnover of more than EUR50 million and balance sheet assets of more than EUR43 million.
• Documentation requirements
  • TP Policies: Large groups should ensure their related party transactions are conducted at arm’s length and they have defined TP policies for UK entities and regularly monitor these against actual outcomes.
  • Benchmarking and documentation: The UK should have a TP policy memo with functional analysis or Local file (OECD prescribed format) and appropriate benchmarking for relevant transactions. 

4. Largest groups

• Definition
  • The largest groups have breached the CbCR threshold of EUR 750 million in turnover for the relevant period.
• Documentation requirements
  • In addition to benchmarking and accurate TP policies, the UK should have the following documentation.
    • Master File: This provides an overview of the group’s business, global operations, value drivers, overall TP policies, and global allocation of income.
    • Local File: This includes details of material intragroup transactions for the local taxpayer and supporting pricing analysis for each entity.
    • Summary Audit Trail (SAT): The SAT is a short questionnaire detailing the main actions undertaken in preparing the local file. This has not yet been implemented.

What action should you take?

In light of these developments, it is crucial for MNEs with UK operations to undertake detailed TP review. This includes:

• identifying transactions that require documentation
• gathering accurate and timely intercompany transaction data
• understanding the additional information required for compliance
• preparing and keeping up-to-date TP documentation

HMRC is expected to enforce penalties more stringently for non-compliance under the new regulations. Early adoption of these practices can help in identifying and rectifying any potential issues before they lead to non-compliance penalties.

If you would like further help and assistance for your business, contact Rafaela Oplopoiou-Chapman or your usual Crowe contact.