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Beware of the taxman if you do not have transfer pricing documentation
By Les Secular
Too many companies do not have adequate transfer pricing documentation and face potential penalties. Below, Les Secular argues that as tax officers receive more training on transfer pricing, and more businesses seek to expand their activities overseas, companies should be prepared.
I make no apologies for harping on yet again about transfer pricing documentation as there are still too many companies that do not have adequate transfer pricing documentation and whom face potential penalties.
Although documentation does not have to be filed with the UK tax authorities with the corporation tax return, HMRC can ask to receive a copy of such documentation within 30 days. Failure to supply it can lead to penalties – first a flat fee of £3,000 per annum if there is no supporting documentation and, secondly, an adjustment based penalty if the documentation is found to be inadequate.
The flat fee penalty is levied per company per return. The adjustment based penalty is 10% of the adjustment irrespective of whether tax arises or not. These penalties are in addition to the “normal ” tax penalties if there is an error on a tax return that leads to additional tax payments.
“Medium sized companies should be at least preparing a group policy document that refers to the transactions undertaken.”
The penalties can no longer be eliminated through use of loss brought forward or carried back or via group relief, and companies in loss situations can now find themselves facing a transfer pricing penalty.
It is the medium sized companies that could find themselves particularly at risk. Although small and medium companies are exempt from the transfer pricing requirements, it must not be forgotten that there are also exceptions to the exemptions. First, the determination of whether a company is small or medium must be looked at on a worldwide basis and the number of employees and turnover and balance sheet values must be computed including all connected and linked parties. Secondly, the exemption for small companies does not apply if there are transactions with a connected party in a country that does not have a tax treaty with the UK. Thirdly, the UK tax authorities can remove the exemption for medium sized companies at any time through the issue of a” direction” and the company will find itself subject to the full requirements of the transfer pricing legislation.
The UK tax authorities have adapted the OECD Guidelines in terms of documentation and consider that documentation should include:
All commercial and financial transactions;
The nature and terms (including prices) of those transactions together with a comparison with arrangements with third parties;
The method or methods by which the nature and terms of relevant transactions were arrived at, including any study of comparables and any functional analysis undertaken and;
How the company adheres to arm’s length behaviour or, where it does not, what adjustment is required to the tax return and how it has been calculated.
To demonstrate arm’s length behaviour where there are not similar internal transactions with third parties, it is necessary to provide external evidence, which often requires benchmarking analysis.
Medium sized companies should be at least preparing a group policy document that refers to the transactions undertaken and the rationale for charging/non charges, thus being initially prepared should the direction be issued. It can be difficult to remember what the rationale for the pricing structure was 3-4 years ago, especially if those responsible for it have since left the company.
As tax officers receive more training on transfer pricing and more companies seek to expand their activities overseas, the level of challenges and disputes will increase; companies should be prepared for all eventualities.
Les Secular, True Partners Consulting (UK) LLP.
Tel: +44 (0)7725685363