Setting the right price for transactions between group companies is one that many boards ask themselves in order that each group company’s profit and loss fairly reflects the underlying nature of transactions. For many items an external market can act as a reference point, making this task relatively straightforward. However, this becomes more difficult when dealing with more complex transactions such as:
• Recharging management team time
• Recharging rent
• Charging for the use of intangible assets such as customer lists or licences
• Provision of finance amongst group companies
For these transactions it is not just the directors of companies that get vexed by the question of what is the right price?
International Groups in HMRC’s sights
Where groups trade internationally, the disparities in global corporation tax rates provides for groups to take advantage of more favourable tax rates. Therefore, unsurprisingly tax authorities take a keen interest in the amounts charged for intra-group transactions. In the period between 2011/12 – 2016/17 HMRC secured an additional £5.9 billion of tax receipts by challenging the transfer pricing arrangements of multinational trading groups.
Therefore, what can international groups do to get the price right? And avoid both the time and expense of a tax enquiry.
Exemptions for SMEs not straightforward
Firstly, the good news is in the UK, HMRC provides an exemption to most small and medium size enterprises (SMEs). To qualify as medium the business will have no more than 250 employees, annual turnover less than €50 Million and a balance sheet of less than €43 million.
However, this UK exemption may not apply in the following circumstances:
• Transactions with overseas subsidiaries where the UK does not have a double tax treaty including the appropriate non-discrimination article
• Where HMRC has issued a transfer pricing notice to an SME which is party to a transaction relevant to a patent box claim
• Where an SME elects that the exemption from the transfer pricing notice should not apply
• Where HMRC issued a transfer pricing notice to a medium sized enterprise
Furthermore, while the UK has an SME exemption, not all territories have one and their thresholds may stipulate different criteria. Therefore, where a group trades globally it is worth considering this issue even if at first glance it seems the SME exemption is available.
The first port of call for determining the right price are the OECD [Organisation for Economic Co-operation and Development] guidelines. These are globally accepted as the bible for providing methodology on calculating an appropriate price and the documentation which needs to be in place. Allowing for review of the pricing policy following its implementation and ongoing monitoring. At their core is the principle that transactions are at arm’s length.
Advanced Pricing Agreements (APAs)
After determining an arm’s length pricing policy, to provide additional comfort that the price is right, a group may wish to obtain an advance pricing agreement (APA) from tax authorities. Thereby agreeing the principles for calculating the price with the tax authority. The degree of certainty obtained can vary from non-binding opinions through to a form of advanced clearance on the transfer pricing policy. HMRC does not offer a simplified process for SMEs for an APA. However, other territories such as France and the USA do provide a streamlined APA process for SMEs. While, APAs do add an initial administrative burden, the clarity they provide on whether the price is right, avoids any nasty tax surprises further down line.
Overall setting the right price for transactions between group companies is not straightforward and is an issue which tax authorities globally are increasingly taking a keen interest in. Even where groups may be able to take advantage of the UK SME exemption, when trading internationally, groups need to be vigilant that these exemptions apply in other territories. Where groups do need to consider an appropriate transfer price, the best starting point are the OECD guidelines, which at their heart are based on the arm’s length principle. Finally, having determined an appropriate transfer pricing policy, to mitigate against any nasty tax surprises down the road it is worth considering obtaining an advance pricing agreement from the relevant tax authorities.