In December 2021 HMRC published a draft version of The Transfer Pricing Records Regulations 2023 for consultation.
The draft regulations require Multinational Enterprises (“MNEs”) with turnover of €750m or more, to keep and preserve a Master File and Local File in accordance with the OECD Transfer Pricing Guidelines.
The regulations have effect:
- for Corporation Tax purposes, in relation to accounting periods beginning on or after 1 April 2023
- for Income Tax purposes, in relation to the tax year 2024 to 2025 and subsequent years
Background
Transfer pricing refers to the prices at which an enterprise transfers either physical goods, intangible property or services, including financing arrangements, to associated enterprises. For these purposes “associated” broadly mean one party controls the other or both parties are under common control. The rules also apply to certain joint venture arrangements.
The UK transfer pricing rules require an adjustment of profits for tax purposes where a transaction between associated persons is not undertaken at arm’s length and has created a potential UK tax advantage – for instance a UK company’s tax liability being less than it would have been if arm’s length prices had been used.
There are exemptions from the UK transfer pricing rules for small and medium sized enterprises (“SMEs”). The definition of SMEs largely follows the EU definitions subject to some modifications. The SME limits apply to the group as a whole, as the rules refer to “linked enterprises”. A company/group is an SME if it does not exceed the following thresholds:
- Fewer than 250 employees, and
- Annual turnover not exceeding €50 million, or
- Balance sheet total not exceeding €43 million.
HMRC does have the power to give notice to a medium sized enterprise requiring it to compute profits / losses for a particular period of assessment in accordance with arm’s length provisions, however this is only possible after a notice of enquiry has been raised.
Transfer pricing documentation
UK tax rules currently require that taxpayers keep sufficient records to enable them to make a correct and complete return. This means that companies within the transfer pricing rules should put in place and maintain transfer pricing documentation.
Current HMRC documentation requirements are not prescriptive as regards the format of transfer pricing documentation, however HMRC lists the likely components of transfer pricing documentation as being:
- a functional analysis
- details of the reviewed transactions
- details of the OECD methodologies reviewed, and most appropriate method selected to set prices
- the selection of comparable enterprises or transactions
- the arm’s length range of results
- consideration of where the tested party’s results are in the arm’s length range.
What is changing?
In 2015, the OECD published its Action 13 Final Report on Transfer Pricing Documentation and Country-by-Country Reporting. The report recommended a standardised three-tiered approach to transfer pricing documentation, consisting 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 (transaction-based documentation); and
(iii) a Country-by-Country Report containing certain information relating to the global allocation of the MNE’s income and taxes paid, together with certain indicators of the location of economic activity within the MNE group.
Broadly, the Master File provides an overview of a group from a transfer pricing perspective and the Local File analyses and explains why the arrangements at an entity level are consistent with the arm’s length standard. This is achieved through a functions, risks and assets analysis, as well as an economic analysis.
The UK has implemented Country-by-Country reporting, but did not introduce a requirement to keep and preserve the Master File and Local File. However, following a consultation in 2021, HMRC announced in 2022, they would consult on draft legislation for a measure requiring large multinational businesses operating in the UK to maintain a Master File and a Local File in a prescribed and standardised format.
A HMRC policy paper published in July 2022 stated that:
“Experience has shown that the absence of specific transfer pricing documentation requirements, and supporting guidance, has created a degree of uncertainty for UK businesses regarding the appropriate transfer pricing documentation they need to keep, leading to inconsistency of approach”.
This policy paper was accompanied by draft legislation to create new powers to enable regulations to specify certain transfer pricing records which must be kept and preserved. HMRC have now published the draft regulations accompanying that legislation.
Under the draft regulations, a person must keep and preserve specified transfer pricing records in relation to periods in which the person, together with one or more persons, constitutes an MNE Group which meets the threshold requirement (broadly, that the total consolidated annual group revenue is at least €750 million). The specified transfer pricing records are a Local File and a Master File.
HMRC has confirmed that following a request there will be a 30-day timescale for the provision of the Master File and Local File. As the purpose of the Master File and Local File is to support the transfer pricing policies underlying the filed corporate tax return, the documents should be prepared in advance of the annual filing. Failure to prepare the Files in advance may lead to penalties. There is no requirement to prepare a new set of documentation each year, however documentation should be reviewed annually prior to the submission of the relevant tax return, and should be amended if the type of transactions or other circumstances have changed.
Changes to HMRC information powers specifically in relation to obtaining transfer pricing-related records will also come into force from April 2023.Transfer pricing documents will be able to be requested outside of an enquiry by HMRC, for example as part of a risk review. The requirement for the documents to be in the possession or power of the UK entity has also been removed. This means that if a UK company has an overseas parent and that parent holds the documents, the documents can still be requested by HMRC.
Smaller groups
Businesses with a consolidated revenue of more than €50m but less than €750m and more than 250 employees are also required to maintain transfer pricing records. As the requirements for a Local File are similar to the documentation expectations that HMRC sets out in its existing guidance, it would be prudent for businesses to prepare transfer pricing documentation that follows the Local File template, irrespective of whether they are a member of an MNE.
Summary Audit Trail requirements
HMRC intends to consult separately during 2023 on the introduction of a requirement for MNEs to produce a Summary Audit Trail (“SAT”), which is a document covering the steps taken by members of a MNE in completing their Local File. Following that consultation, a decision will be made regarding the commencement of the SAT requirement.
Penalty changes
Two main types of transfer pricing penalties can apply:
- a penalty for failure to keep or produce documentation; and
- a tax-geared penalty for a careless or deliberate error.
The fixed penalty for failure to keep or produce documentation records is currently £3,000.
From April 2023, for the largest businesses, failure to do the work necessary to maintain the relevant records or to produce those records on request will lead to the presumption that any inaccuracy is careless. The taxpayer can only displace this presumption by providing the documents and evidencing that the underlying transfer pricing information had been prepared in advance of filing their Corporation Tax return, or otherwise showing that they took reasonable care. Deliberate behaviour is not statutorily defined for the purposes of the penalty regime, but can be taken to mean conscious and intentional acts or omissions; in this context this would be knowingly pricing transactions on a non- arm’s length basis in order to secure a UK tax advantage.
The tax-geared penalty is dependent on whether the inaccuracy is considered:
- careless (maximum penalty of 30% of potential lost revenue (“PLR”))
- deliberate but not concealed (70% of PLR)
- deliberate and concealed (100% of PLR).
Why it matters
Large groups operating in the UK should ensure they familiarise themselves with the new record-keeping requirements in advance of the April 2023 implementation date. This is particularly important given the amendments to the penalties regime, which mean that failures to do the work necessary to maintain relevant transfer pricing records or to produce those records on request will lead to the presumption that a relevant inaccuracy is careless.
