Latest UK Transfer Pricing Guidance Is Vision for Risk and Audit

The UK tax authority, His Majesty’s Revenue and Customs, published guidelines this month setting out its expectations and views on best practices for an end-to-end transfer pricing compliance process. This lengthy and wide-ranging document—covering policy design, implementation, monitoring, and documentation—provides significant insight into how HMRC will approach transfer pricing risk assessment and audits moving forward.

The guidelines are another step in the UK tax authority’s increasingly prescriptive approach to transfer pricing matters. This follows new transfer pricing documentation requirements and its guidance on the OECD’s risk control framework, and is a further effort to influence business behavior through “upstream compliance.”

The HMRC guidelines are a key resource for multinationals, including non-UK parented businesses, seeking to manage transfer pricing compliance and controversy risk. We expect the guidelines will form a key part of business conversations with HMRC on transfer pricing, including under the business risk review process, and they provide insight into where future compliance activity may be focused.

We consider here some key takeaways for tax and transfer pricing teams in both UK and non-UK headquartered multinationals and how businesses may consider responding.

Functional analysis. The guidelines make clear HMRC’s expectations on what constitutes a proper functional analysis under OECD transfer pricing guidelines. HMRC wishes to see detailed and UK-centric analysis—making the point 14 times that they commonly see functional analysis with insufficient “depth” and that this presents risk.

One-size-fits-all analysis and documentation that doesn’t properly capture the reality of the functions performed on the ground in the UK, or simply reflects an intended or outdated operating model, isn’t sufficient.

HMRC draws attention to centrally or offshore-prepared analysis and sets out detailed expectations of how such analysis should be appropriately “localized.” This emphasis will be particularly important for non-UK parented businesses.

Businesses should be aware that the level of analysis performed should reflect scale and materiality. It’s also important to take a two-sided view, as a low-risk transaction in the UK may be suggestive of high risk elsewhere.

UK risk lead. To combat perceived inadequate functional analysis and other common issues, HMRC has defined the role of a “UK risk lead.” In some ways this role seeks to build on the success of the senior accounting officer regime on tax accounting matters, albeit in a non-statutory fashion, and focuses the responsibility for meeting HMRC’s expectations onto a named individual or individuals.

Part 1 of the HMRC guidelines is aimed at UK risk leads and provides their wide-ranging responsibilities, including:

• Defining the “scope and depth” of work performed
• Testing whether the underlying facts of the UK business are adequately represented and the transfer pricing policy is appropriate in light of this
• Identifying and understanding business change
• Monitoring compliance risk areas
• Ensuring accurate implementation

While it’s unclear precisely how HMRC will test the oversight and decision-making of UK risk leads, it’s expected to be scrutinized as part of the business risk review process or during an audit.

Businesses should select UK risk leads carefully and should also consider developing a process/governance framework for managing the significant responsibilities and requirements designated to them under the guidelines.

HMRC indicators of transfer pricing policy risk. Following a growing tax authority trend, HMRC has provided prescriptive and wide-ranging transactional-level indicators of transfer pricing risk. This goes further than the principle-focused guidance that HMRC has largely favored to date, although it stops short of the approach of some other tax authorities, notably the “traffic light” system under the Australian Taxation Office’s practical compliance guidelines.

While the usual suspects are present (such as intangible ownership/performance of development, enhancement, maintenance, protection and exploitation functions, and the appropriateness of sales-based rewards considering contributions), HMRC also provides other risk indicators that are increasingly seen in audits. Examples include UK-based global or regional roles considered to benefit territories other than the UK, and fee arrangements that may bundle asset and services—such as franchise, value-based, and variable fees.

In many ways the formalizing of HMRC’s views in these areas simply reflects its risk assessment and audit approaches in practice over recent years. However, given the wide-ranging nature of the indicators, one would expect nearly every multinational business operating in the UK to be covered. It’s therefore increasingly important that businesses understand how they line up against these risk indicators given the expected intensification of audit focus.

Penalties. The guidelines don’t represent a change in HMRC policy. It remains the case that penalties may apply where an incorrect return arises because of a failure to take reasonable care. Practically, however, the guidelines provide considerations that HMRC is likely to take into account when thinking about penalties.

Key Takeaways

Business should take a risk-based approach, taking into account materiality, complexity, and competing pressures when considering how to respond to the HMRC guidelines. As a first step, it will be important to assess where current transfer pricing policies and processes sit against HMRC’s compliance expectations and key risk indicators.

Careful consideration and discussion of the appointment of UK risk leads is paramount given the wide-ranging and critical responsibilities these individuals will have in the transfer pricing lifecycle and in managing controversy risk. Such individuals should ideally have a strong understanding of the UK business, be equipped to influence change internally, and be well placed to build a productive relationship with HMRC.

UK risk leads should consider developing a process/governance framework to ensure there is a structured and verifiable approach to their “signing off” of a tax return as arm’s-length compliant, given HMRC’s increased expectations.

Businesses should consider possible preemptive actions and strategies in light of their assessment of the key risk indicators, in anticipation of HMRC questions and to mitigate potential compliance risks.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jamie Bedford is transfer pricing partner and UK controversy lead with Deloitte.

Alexander Duric is transfer pricing director with Deloitte and former OECD transfer pricing adviser and UK competent authority with HMRC.

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