Transfer pricing documentation: consultation response

The government has published a consultation response document on its proposals to introduce more formal documentation requirements in the UK. The government will take forward its proposal to require the largest companies to maintain a master file and local file documentation and will consult on legislation in 2022. However, for now, the government will not take forward proposals to introduce a requirement for business to prepare an International Dealings Schedule, but will keep this proposal under review.

Background

At present, UK documentation requirements simply require businesses to keep and retain sufficient records to demonstrate that their tax returns are complete and accurate, including those aspects relating to transfer pricing. There is no specific requirement to produce and retain a particular format of transfer pricing documentation (although UK transfer pricing legislation incorporates the OECD Guidelines and therefore implies businesses should consider documentation which is consistent with the OECD Guidelines' recommendations).

In 2015, the OECD's BEPS Action 13 Report "Guidance on Transfer Pricing Documentation and Country-by-Country Reporting" required the introduction of country by country reporting (which was introduced in the UK) and also recommended standard documentation requirements, including adoption of a Master and Local File approach. The OECD standardised approach consists of (i) a Master File containing standardised information relevant for all MNE group members; (ii) a Local File referring specifically to material transactions of the local taxpayer; and (iii) a CbC report for the largest MNE groups containing aggregate data on the global allocation of income, profit, taxes paid and economic activity among the tax jurisdictions in which it operates.

The UK did not introduce the standardised approach to transfer pricing documentation because it believed the UK already had broad record keeping requirements, but since 2015 many other countries have adopted the Master and Local File requirements into local legislation recommended by the OECD.

Accordingly, the government decided to consult on the possibility of bringing in this widely adopted international approach in the UK. A consultation document entitled "Transfer Pricing Documentation" was published in March 2021 which stressed a number of benefits which might flow from its adoption, including:

• providing greater certainty for UK businesses in relation to transfer pricing documentation requirements;
• providing HMRC with better quality data to enable more efficient and targeted compliance interventions; and
• aligning the UK's practice more closely with the transfer pricing documentation requirements of comparable tax administrations.

In addition, the consultation also raised the possibility of the introduction of a wider requirement for UK businesses with transfer pricing transactions to produce an International Dealings Schedule (IDS) as part of their tax return.

Response document: master and local file

Most respondents to the March consultation agreed that master file requirements should apply to the largest groups and that it would be appropriate to use the country-by-country reporting (CbCR) thresholds and the government has agreed that such an approach would be reasonable, effective and proportionate.

As regards the local file requirement, the government considers this will ensure a consistent approach to documentation and enable businesses to get their transfer pricing right. In addition, the government understands respondents’ preference for alignment with the OECD standard which is used internationally and will therefore closely align the requirements and guidance to the OECD standard, with the addition of a ‘Summary Audit Trail’ requirement. However, the government accepts that some businesses will potentially face issues in obtaining the detailed transactional data necessary and will consider how best to reduce this burden in accordance with the OECD standard, which does allow for focus on material transactions and for a level of jurisdictional aggregation.

The March consultation included the possibility of requiring businesses to maintain an evidence log or similar appendix to support the local file. However, having considered feedback, the government has decided not to include a requirement for a detailed evidence log in UK local files. However, the government does intend to include a more limited requirement in the form of a Summary Audit Trail (SAT). This will be a legislative requirement, which will be accompanied by supporting guidance.

In practice, the SAT will be a short, concise document summarising the work already undertaken by the taxpayer in arriving at the conclusions in their transfer pricing documentation. The response explains that the purpose of the SAT is two-fold. Firstly, the additional transparency is intended to encourage businesses to undertake sufficient work to support transfer pricing policies. Secondly, it should enable HMRC to undertake high level quality assurance on the transfer pricing documentation and therefore allow better focus on higher risk areas during enquiries. The response document stresses that the SAT will be designed to achieve these aims without imposing a disproportionate burden on businesses.

The response document also recognises the importance of further guidance on these obligations. Accordingly, the response document requests views as to the merits of further guidance, whilst recognising that anything published should be consistent with and build on the OECD guidelines. The response document indicates that the legislation will be clear but acknowledges that legislation alone is unlikely to be able to cover every scenario and therefore guidance will play an important role.

The response document confirms that the government intends to impose a 30-day timescale for provision of master files and local files, which would be required to be prepared routinely in support of a business’s filed transfer pricing position. The government considers 30 calendar days, from the date of issue of the request, a reasonable timescale for provision of existing documentation, since the purpose of the master file and local files is to support the transfer pricing policies underlying the filed return, and therefore should be prepared in advance of annual filing.

The response document acknowledges that some form of reporting threshold will be necessary and welcomes suggestions by respondents as to how it might be applied. The OECD standard specifies that focus should be on material transactions, and the government intends to align as closely as possible with that standard. Whilst the government appreciates the benefit of clear and unambiguous thresholds it also notes the need for flexibility to ensure that they work for all businesses. Clear guidance will be published to help businesses determine what might be considered material. The guidance will aim to provide practical examples as well as key principles to help guide customers in borderline cases.

Unless there is a material UK tax risk, the government will not require inclusion of UK to UK transactions for the purpose of the master and local files.

Where a business self-assesses that all of its international related party transactions are immaterial, the government does not intend to require it to complete a local file or make an annual declaration. HMRC would simply expect such businesses to keep a record of any analysis undertaken to support that self-assessed position, and to provide that analysis upon request within the same 30-day timescale as for documentation.

Response document: IDS

Responses to the March consultation highlighted that significant time and investment would be required to automate IDS specific reporting processes and make necessary system upgrades. In addition, responses highlighted the likely burdens which businesses would face in managing reporting across several different accounting systems across the MNE group and the need for human intervention to report consistent and meaningful data across different sources and accounting systems. Some responses also noted the difficulty that some businesses may have in extracting the level of data required for completion of the IDS.

As a result, the government recognises that the introduction of an IDS requirement in the UK may add to existing administrative burdens for businesses and decided not to take forward the introduction of an IDS requirement at this stage, but to keep it under review. The government still believes that an IDS requirement could have significant benefits to both HMRC and businesses and will keep the issue under consideration for possible implementation in the future. However, it was clear from responses that the compliance burden involved in the IDS proposal was a major area of concern.

Comment

The response document is a welcome development, confirming that the UK will bring in internationally recognised and compatible transfer documentation requirements, but without the additional burden of the proposed IDS. Its replacement, the SAT, should impose less of an administrative burden than initially proposed, though businesses should ensure that they remain involved in the design of this particular aspect as the focus on “evidence log” is clearly a key theme in HMRC’s recent approach to transfer pricing. As emphasized in our response to the consultation, we would hope that the final legislation will reflect HMRC’s risk-based approach, which is welcomed by taxpayers, and that the design of the requirements allow some level of flexibility such that the focus of transfer pricing documentation in the UK continues to be on substance over form.

The government intends to consult on draft legislation in 2022 to introduce a requirement for the largest businesses to maintain, and provide on request, master file and local file documentation. Further practical guidance will be issued alongside new legislation to support businesses and the government confirms that, as usual, there will be the opportunity for businesses to provide comment on draft legislation and related guidance.