Managing Transfer Pricing Compliance Risks for UK Businesses

HMRC recently introduced guidelines for transfer pricing compliance that provide clarity and transparency of HMRC’s compliance expectations. The guidelines aim to help businesses reduce uncertainty in their transfer pricing compliance by highlighting the common risk areas that may impact the businesses and clarifying HMRC’s expectations of the steps UK businesses can take to manage these compliance risks.

The guidance impacts in house tax and external transfer pricing specialists that are involved in setting transfer pricing policies, performing transfer pricing analysis and preparing requisite compliance documentation.

Common Compliance Risks

HMRC often encounter transfer pricing documentation, which is too high level, lacks sufficient evidence or where functional analysis has not been correctly performed. There are several factors that can impact the quality of transfer pricing documentation. These include tight compliance budgets, tight deadlines for compliance work, multi territory approach and limited access to UK business date and resources. 

Compliance risk arises where a detailed analysis is not undertaken in a timely manner which may result in additional enquiry costs, unforeseen transfer pricing adjustments or penalties for non-compliance.

We have discussed below the common compliance risks that arise during the functional analysis carried out by UK businesses. Businesses should make sure they understand how different approaches to functional analysis affect their risk profile.

Common Issues with Functional Analysis

It is important that the facts included within the functional analysis accurately reflect the UK business activities and inter group transactions. HMRC has encountered the following issues for approaches used for functional analysis.

• Timing of functional analysis-most analysis is carried out after the statutory accounts are finalized, in the months before the filing deadline for tax returns. While this could be sufficient time to provide supporting evidence for an arm’s length return, it may limit scope for downward adjustment to the corporation tax returns. On the contrary, functional analysis conducted after the tax return is filed carries implicit risks and UK businesses may be unable to support their conclusions at the time of filing the return or may face penalties for incorrect returns where any issues are identified.
• Multi-territory functional analysis prepared centrally- functional analysis may be performed centrally to cover many regional or global territories. Compliance risk may arise where facts and analysis do not include enough UK entity localization. The localisation leverages knowledge of the UK entity to produce compliant transfer pricing analysis and documentation.  The degree of localisation required will depend on facts and circumstances of the UK entity.
• Re-use or roll forward of functional analysis-where transfer pricing from prior period is rolled forward, an annual check would be needed to ensure the facts and analysis are still consistent and valid. Compliance risk would arise where functional analysis is relied upon without annual checks or the same comparables are used for more than 3 years without an updated search being performed despite annual checks. Roll forward of prior period’s functional analysis would not be helpful where a detailed and robust functional analysis was not performed for both the parties in the prior period or where the business activities of the parties and the comparables have changed.
• Reflecting business change in functional analysis and delineation conclusions-issues arise where substantive fact finding, and consideration of the impact on transfer pricing analysis and conclusions do not cover business change or restructuring during the period. Where business restructuring has occurred, transfer pricing documentation should aim to set out the impact on the UK business functions, asset and risks, delineation, and its intra-group transactions.
• Functional Analysis-risk analysis- compliance risk arises for UK business under enquiry where there is a mismatch exists between risk analysis descriptions in the transfer pricing documentation and the facts established under enquiry regarding how risk in reality arises and is managed or controlled.
• Functional analysis-intangibles- functional analysis often lack sufficient in-depth analysis and supporting information for intangible assets. Risk profile for UK businesses would increase where inconsistencies exist between details provided for transfer pricing and those provided for R&D reliefs or patent box claims.
• Evidencing people functions- issues may arise where there is a mismatch between functional analysis within the transfer pricing documentation and facts established through review of UK staff and functions during an enquiry. High quality functional analysis would require documentation of employee functional profiles and functional interviews.

Please contact our international services team to help you navigate the complex transfer pricing compliance regulations. We can assist you to operate a clear and effective transfer pricing compliance framework that aligns with the UK transfer pricing rules and consists of processes, checks and controls. We can help you implement detailed functional analysis documentation for each category of controlled transactions, highlighting any changes compared to prior years.