UK opens consultation on transfer pricing documentation and its scope

Amendments to the SME exemption:

• Impact medium-sized businesses not currently within transfer pricing.
• Affect some businesses’ experience of dealing with HMRC, as they may be required to carry out additional review of certain transactions to ensure that they are complying with the UK’s transfer pricing rules and incur additional costs as a result. 

International Controlled Transaction Schedule (ICTS):

• Impact in future on medium and large UK businesses with material overseas related party transactions, as it is currently at the stage of public consultation.
• Impact some businesses’ experience of dealing with HMRC, as they will be required to complete additional admin and may incur additional costs. 

Exemption overview

• The general exemption of SMEs from the UK’s transfer pricing rules is set out at Section 166 TIOPA.
• There are specific exceptions which can bring a SME back within scope of transfer pricing. Those are set out at Sections 167, 167A and 168 TIOPA. – Broadly those exceptions are where the taxpayer elects to forego the exemption, where HMRC issues a transfer pricing notice, or where transactions are linked to non-qualifying territories.

Rationale for reforms to the SME Exemption

• Transfer pricing rules play a pivotal role in protecting the UK tax base – This protection is notably absent for a sizeable proportion of the population due to the SME exemption.
• The UK is an international outlier in having exemptions from transfer pricing – Most exempt businesses will therefore already need to apply the transfer pricing rules of another territory to their cross-border transactions with connected parties. The additional burden of applying international standards on transfer pricing in the UK may therefore be limited.

SMALL ENTERPRISE EXEMPTION

Current law

Small enterprises are those with staff headcount and either turnover or balance sheet total (or both) below the following thresholds, when combined with linked and partner enterprises.

Table 1: Small enterprise threshold

Policy proposals

• Continue to exempt small enterprises from transfer pricing.
• Continue to define small enterprises by reference to turnover, balance sheet total, and staff headcount.
• Amending the existing thresholds which refer to euros to reference turnover of £10 million and balance sheet total of £10 million. 
• HMRC proposes changing the status of an enterprise where the ‘small’ threshold is exceeded in two consecutive periods.

MEDIUM ENTERPISE EXEMPTION

Current Law

Medium-sized enterprises are those with staff headcount and either turnover or balance sheet total (or both) below the following thresholds, when combined with linked and partner enterprises.

Table 2: Medium-sized enterprise threshold

Policy proposals

• HMRC proposes to remove the exemption from transfer pricing for medium-sized enterprises. As a result, medium sized enterprises will be within the TP regime in the UK.

EXCEPTIONS TO THE SME EXEMPTION

Current law

• Both small and medium enterprises may elect to disapply the exemption from transfer pricing under Section 167(2) for a given chargeable period.
• The exemption is also disapplied for small and medium enterprises if the entity enters into a provision or series of transactions with a resident in a non-qualifying territory (Section 167(3)).
• A non-qualifying territory is defined in Section 173 as any territory not meeting the criteria for a qualifying territory. A qualifying territory must either:
  • have a double taxation agreement with the UK that includes a non-discrimination provision and not be designated as non-qualifying by Treasury regulations
  • be specifically designated as a qualifying territory in Treasury regulations.
• For small enterprises, transfer pricing notices may only be issued if the relevant provision contributes to the calculation of profits eligible for the Patent Box (Section 167A). Appeals are limited to asserting that the provision is not relevant to the Patent Box calculation.
• There is no such restriction on issuing transfer pricing notices to medium enterprises. Appeals are restricted to disputing whether the entity qualifies as a medium enterprise.

Policy proposal

• Retain the ability for enterprises to elect to disapply the exemption.
• Retain the ability to issue transfer pricing notices to small businesses where the relevant provision contributes to the calculation of profits eligible for the Patent Box.
• Possible alternative approaches to non-qualifying territory exemptions:
  • expand the definition of qualifying territory to include territories with a higher headline corporate tax rate than the UK;
  • remove the test of whether the entity transacts with related parties in non-qualifying territories. Instead, small enterprises could be required to apply transfer pricing to interest and royalties but not other transaction types.

DEFINITION OF ENTERPRISE

Current law

The term ‘enterprise’ encompasses any entity engaged in economic activity, regardless of legal form. Economic activity entails offering products or services in a direct market setting.

More details on the current law are here: Transfer pricing scope and documentation – GOV.UK

Policy proposal

• Aligning the definition of ‘enterprise’ with the definition used under section 148 of TIOPA – enterprise would include all entities with a participatory relationship.
• Removing the concept of partner enterprises from the definition of an enterprise for the purposes of the SME exemption.

BENEFITS AND IMPACTS OF FIRST PROPOSAL

• Newly in scope groups would need to ensure that related party transactions are priced at arm’s length.
• Transfer pricing policies for UK entities would need to be defined and regularly monitored against actual outcomes.
• All businesses are required to keep records to make and deliver a correct and complete tax return. HMRC would typically expect some level of record-keeping in relation to transfer pricing policies, even where the requirement to prepare specific transfer pricing documentation is not met.

Additionally, newly in scope groups would likely be affected by the proposal to introduce ICTS should this measure be implemented

CURRENT LAW

In the UK, all businesses are required to keep records to make and deliver a complete and correct return. UK entities in scope of transfer pricing need to demonstrate that related party transactions have been identified and priced in accordance with Part 4 TIOPA.

• The UK implemented Country-by-Country Reporting (CbCR) in 2016. The CbCR requirement applies to multinationals with consolidated group revenue of at least €750 million that have 2 or more enterprises tax resident in different jurisdictions.
• In 2023, the UK introduced a requirement for UK entities that are members of groups meeting the CbCR threshold to maintain a master file and local file and provide those documents to HMRC upon request.

Proposed changes

• Introduction of a requirement for in-scope businesses (ALL BUSINESSES WHERE TP APPLIES) to report information about certain cross-border related party transactions to HMRC i.e. ICTS. The proposed scope includes dealings between a UK-resident company and its overseas PEs, and dealings of UK PEs of foreign-resident companies.
• The information in the ICTS is broadly consistent with local file. 
• The information provided on an ICTS would be highly valuable to HMRC in facilitating automated, data-led risk assessment and more accurate identification of transfer pricing risk and PE risk.

BENEFITS AND IMPACTS OF SECOND PROPOSAL

In the UK, transfer pricing is a major focus of tax compliance activity. Transfer pricing enquiries are typically complex and fact-intensive and can take considerable time and resource to resolve.

Transfer pricing documentation provides tax authorities with information facilitating both pre-enquiry risk assessment and the enquiry process.

Benefits

• The primary benefit of the ICTS would be improved targeting of HMRC enquiry activity, benefitting both HMRC and compliant businesses.
• The data provided on the ICTS will improve risk identification and provide for better quality risk assessment.
• Enquiries will in turn be more efficient and streamlined due to a reduction in the initial factfinding needed on the counterparty, nature, and value of the transactions. This will allow HMRC and business resource to be more effectively deployed.

Impacts

• Businesses would need to establish processes for collation of the required information. They would also need to prepare and file the ICTS annually, in line with the existing Company Tax Return filing deadlines.
• If the ICTS is taken forward, the government intends to develop an IT solution so that businesses can submit the information efficiently and HMRC can make effective use of it.

HOW WOULD HMRC USE THE ICTS DATA?

• The information included in the ICTS would be used for automated risk identification and manual risk assessment.
• ICTS data would also be incorporated into HMRC’s existing international tax governance processes, meaning that enquiries could not be opened without review of the ICTS by compliance teams.

SCOPE OF ICTS

• ICTS should be completed by all of the following entities with material cross-border transactions:
• UK entities within the scope of Part 4 TIOPA
• UK PEs of non-resident entities
• UK entities with foreign PEs

Businesses would therefore be excluded from scope where they are ‘small’ and if they are exempt from transfer pricing by section 166 in the relevant period.

THRESHOLDS

Businesses will not be required to complete the ICTS where both of the following criteria are met:

• there are no transactions with non-qualifying territories; and
• the aggregated total value of transactions with qualifying territories is below £1 million

Key points to note:

• The £1 million threshold would apply to the individual entity rather than the corporate group.
• The aggregate value would be the sum of income and expenses, amounts should not be netted off against one another. To illustrate its application, an entity with related party income of £3 million and related party expenses of £3 million would have a total aggregated value of £6 million.

ICTS TEMPLATE OVERVIEW

• The template includes a table for the disclosure of related party transactions (Section A).
• A separate table for information about loan relationships is also included (Section B).