New Transfer Pricing guidelines for compliance

As part of its Guidelines for Compliance, HMRC has published guidelines on common risks in transfer pricing compliance on 10 September 2024. The guidelines contain a lengthy analysis of areas of risk and what HMRC sees as best practice for compliance and policy design in this area.

These new guidelines should be required reading for affected businesses in indicating HMRC's expected benchmark for compliant transfer pricing policies, documentation and activities going forwards. They reflect areas in which we have seen HMRC focus over a number of years, and is an important resource for re-evaluating aspects which may be reviewed by HMRC during enquiries and how these may affect penalty positions.

Background

Guidelines for Compliance (GfC) aim to reduce uncertainty for UK businesses by providing greater clarity and transparency of HMRC's compliance expectations. They were announced in November 2021 as part of the review of tax administration for large businesses, but have only relatively recently been published, with transfer pricing being the latest addition. They offer HMRC's view on complex, widely misunderstood or novel risks that can occur across tax regimes, including guidelines for employers, corporation tax and VAT, with HMRC's views on best practice set out in examples.

The guidelines are intended to help taxpayers understand HMRC's expectations and avoid non-compliance, highlighting approaches that can lead to inaccuracies and the need to pay more tax, interest and penalties. They also offer HMRC's insights into the practical application of the law and HMRC's administrative approaches, expanding the scope of HMRC material, beyond interpretation of the law. Importantly, GfC can be used to verify HMRC's "known position" for purposes of the Uncertain Tax Treatment (UTT) legislation. See our previous Insights article on UTT here.

Transfer Pricing

In relation to transfer pricing, the Guidelines (Help with common risks in transfer pricing compliance: GfC7) are intended to help businesses reduce uncertainty in their transfer pricing compliance approaches by:

• providing HMRC's expectations of the role UK business should perform in managing transfer pricing compliance risk
• highlighting common risk areas to watch out for, or for which greater scrutiny is recommended, together with best practice approaches
• suggesting forms of real time information and records to be retained
• raising awareness of common risks in scoping, preparation, analysis and retention of TP documentation and best practice
• highlighting common indicators of risk in designing and selecting transfer pricing policies.

However, these GfC7 TP Guidelines are not intended to be comprehensive and should be read alongside HMRC's guidance relating to transfer pricing within its International Manual INTM410000 to INTM480000.

The GfC7 TP Guidelines are split into three sections: Managing compliance risk for UK businesses; Common compliance risks; and Indicators of transfer pricing policy design risk.

Managing compliance risk for UK businesses

This section is aimed at those managing UK TP risks to help: determine the scope of work; build governance, controls and checks; and evidence the arm's length return.

There is an important focus and emphasis on the responsibility of 'UK risk leads and their associated group functions', which is particularly of relevance for groups which engage third party transfer pricing specialists or have specialist work conducted by non-UK group functions and therefore are at risk of not being sufficiently involved in the upfront planning and scoping of UK transfer pricing compliance work. HMRC recommends identifying the UK risk leads, who are not necessarily transfer pricing specialists but who are senior finance, risk and tax roles within UK businesses who are responsible for managing UK tax risk, accounting risk and filing tax returns. These could include:

• UK tax compliance manager
• UK finance director
• UK finance controller
• UK environmental, social and governance (ESG) lead
• Senior Accounting Officers (SAOs).

The section is intended to help UK risk leads reduce their risk of non-compliance by raising awareness of:

• best practice approaches to timing and scoping of compliance work;
• common business change or trigger events requiring greater focus, such as significant change to the scope or nature of intra-group goods and services provided to or from the UK, mergers or disposals or transfers of intangible assets such as IP to or from the UK; and
• the importance of the involvement of UK risk leads in the compliance process.

Detail is provided on key aspects to consider through the transfer pricing compliance lifecycle.

Common compliance risks

The guidelines note that HMRC frequently encounter TP documentation which is too high level, insufficiently evidenced or for which functional analysis is not two-sided in nature. In these circumstances, HMRC are unable to assess whether an arm's length return has been filed. Where contemporaneous fact finding and analysis is not undertaken to an appropriate depth on a timely basis, compliance risk can be created, such that the resulting tax return may not reflect the commercial reality of UK activity and an arm's length return. As HMRC point out, this may lead to additional compliance costs of an enquiry, unforeseen transfer pricing adjustments and penalties for non-compliance.

Whilst the guidelines note that how much time and resource to commit to specialist compliance activity remains a business choice, the guidelines set out approaches that are intended to minimise transfer pricing compliance risk based on high quality examples of compliance observed by HMRC.

The common quality issues covered by this section of the guidelines include, in particular, transfer pricing documentation and common issues with approaches to fact finding, analysis and adjustments. The guidelines include best practice suggestions to reduce resulting compliance risk for these areas:

• Compliance planning and scoping;
• Common issues with functional analysis;
• Common issues with comparability analysis;
• Common risks in calculations and adjustments; and
• Documenting the functional analysis.

This section is particularly of relevance where a multi-jurisdictional approach is taken in respect of transfer pricing design and compliance, which could lead HMRC to challenge TP policy on the basis that UK specific facts and circumstances are not appropriately taken into account.

Indicators of transfer pricing policy design risk

The third section of the guidelines is aimed at in-house tax and external transfer pricing specialists that are involved in setting transfer pricing policies and/or reviewing for risks in existing transfer pricing policy approaches.

The guidelines suggest that compliance risk is often created by setting transfer pricing policies which appear high level and insufficiently supported by analysis, or which do not adequately reflect the facts and circumstances of the UK business. This part of the guidelines aims to allow specialists to identify common risk indicators of policy design which may feature in their arrangements.

This content highlights HMRC's view of common indicators of high risk approaches to policy design in a number of specific areas including the following:

• General risks in policy setting, for example where there is significant divergence with how the UK business actually operates based on functional analysis and actual conduct or where the arrangements feature what may appear to be commercially irrational terms which parties would be unlikely to enter into at arm's length
• Intangible assets ownership and exploitation, where for example income is attributed to an IP owner which lacks the capability to develop, enhance and exploit the intangible asset
• Above market intra-group services, where UK staff may be under-rewarded whilst having global or regional roles which either control key DEMPE functions or economically significant risks or create the profit-earning activities and contribute to economically significant activities of the group
• Transfer pricing target margin models, when TP policy approaches are used to deliver a fixed return to UK businesses without commensurate changes to the UK functions, assets and risks
• Cost based reward for services, for example where TP policy is based upon a contractual description of the service provided without examination of the underlying conduct through functional analysis to understand the services actually being performed and risks actually borne and managed
• Sales based reward for services, where the UK is performing functions or services for which the arm's length reward is defined and measured with reference to sales
• Franchise fees and similar single fee arrangements. HMRC commonly experience issues with the design of TP policies applied to single fee arrangements that do not appropriately evidence that the TP method and benchmark reflects the constituent elements and are arm's length.

Comment

These new guidelines should be required reading for affected businesses in indicating HMRC's expected benchmark for compliant transfer pricing policies, documentation and activities going forwards. These reflect areas in which we have seen HMRC focus over a number of years, and is an important resource for re-evaluating aspects which may be reviewed by HMRC during enquiries and how these may affect penalty positions.

We see the following as interesting takeaways:

• Emphasis on raising awareness of the responsibility of 'UK tax leads' - it is important to ensure that taxpayers identify who these are and ensure that they are appropriately involved in the transfer pricing design and compliance of the UK business
• References throughout the guidelines on timing of, and need for contemporaneous, monitoring checks, adjustments, analysis and documentation - for example, HMRC notes that late analysis could undermine a businesses' ability to rely on certification that the tax return is correct and complete, and that it will inform penalty considerations where there is a transfer pricing inaccuracy in the tax return
• Importance of having a transfer pricing policy and transfer pricing documentation which reflects UK specific facts and circumstances - which is particularly of relevance where a multi-territory approach is taken by advisors or non-UK group functions.

In addition, the specific areas of TP risk identified in Section 3 of the guidelines will be of particular interest for many TP practitioners. These highlighted areas where HMRC may be expected to focus their compliance risk analysis and any businesses with activities and policies that fall within these broad brackets should pay particular attention to the guidance.

It is also worth noting that the guidelines add to HMRC's body of public information on the relevant issues. As a form of guidance, the guidelines are part of HMRC's known position for UK businesses who need to consider whether their transactions fall within the uncertain tax treatment notification obligations.