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Tax Alert – New transfer pricing documentation requirements in UK

It is a requirement in the UK for most multinational companies (MNCs) to submit tax returns based on profits calculated by applying arm’s length pricing for all intra-group transactions and to document support for that compliance. Transfer pricing documentation requirements in the UK have however historically been non-prescriptive as to format and thus more flexible than many other territories.

The absence of a set format can, however, be problematic for MNCs in understanding whether they have been compliant, and it has also been unhelpful for HM Revenue & Customs (HMRC) in using transfer pricing documentation as a risk assessment tool in deciding which cases warrant further investigation.

Things are now set to change. During 2021, HMRC consulted on the possible introduction of more prescriptive documentation requirements, in order to provide better quality and consistent data for risk assessment to enable more efficient and targeted compliance interventions.

The resulting changes will bring the UK’s practice more in-line with many other tax Jurisdictions as they are based on the OECD BEPS Action 13 Final Report as now set out in Chapter V of the 2022 OECD Transfer Pricing Guidelines. On 20 July 2022, the draft legislation for these new compliance requirements was published.

Who will be affected?

Not all MNCs will fall within the new rules. Application of the OECD Master file/Local file requirements are limited to those groups that are already subject to the Country-by-Country Report (CBCR) requirements; that is businesses with a consolidated turnover greater than €750m.

Businesses that fall below this threshold are, however, still required to keep documentation in support of compliance with the arm’s length principle. However, the format of documentation for such businesses remains non-prescriptive as to the form in which it is to be prepared and kept. HMRCs published guidance focuses instead on the need for evidence in support of compliance with the arm’s length principle and goes on to set out situations where penalties would be eligible if such documentation fell short of their expectations, e.g. where some transactions have not been independently considered such as pan European Management functions in addition to a role as a UK distributor.

It is interesting to note in this regard that the proposed changes to UK law include provisions whereby inaccuracies in Masterfile/Local file documents will automatically be regarded as careless (penalty 0-30%) unless the inaccuracy was deliberate, requiring even more substantial penalties or where HMRC can be satisfied that reasonable care had been taken to avoid the inaccuracy.

What are the changes?

There has always been a statutory requirement for all businesses within the UK’s transfer pricing rules to prepare transfer pricing documentation. This historic requirement is that documentation has to contain sufficient evidence to support intercompany pricing for each accounting period as being in accordance with the arm’s length standard.

The new legislation will now require those businesses affected – that is those within the CBCR requirements – to prepare transfer pricing documentation in a specified format, that is in accordance with Chapter V of OECD Transfer Pricing Guidelines. The new rules also bring in a requirement for a ‘summary audit trail’.

Master file and local file requirements

So, what is now to be required for those affected businesses?

The OECD published the Action 13 (Transfer Pricing Documentation) Final Report in October 2015, introducing a three-tiered approach to transfer pricing documentation to encourage a global standardised approach that multinational businesses should follow, and this is now set out in the OECD Transfer Pricing Guidelines.

This standardised approach consists of:

  • a master file containing standardised information relevant for all multinational enterprise (MNE) group members
  • a local file referring specifically to material transactions of the local taxpayer, and
  • a CBCR for the largest groups

The UK implemented the CBCR minimum standard but had not introduced specific requirements regarding master file and local file for documentation either for those MNCs affected by CBCR or not. The new rules will change this and now mandate the master file and local file format for affected businesses, which must be provided to HMRC within 30 days of a request.

Summary audit trail

The legislation will also introduce a requirement for affected businesses to maintain a summary audit trail to support the local file. This will be a ‘short, concise document summarising the work already undertaken by the [taxpayer] in arriving at the conclusions in their transfer pricing documentation.’ This requirement comes directly from lessons learnt in HMRCs operation of their Profit Diversion Compliance Facility (PDCF) in which a record log was required to confirm the source of information set out in the PDCF report submitted to HMRC by the taxpayer. This was seen as helpful to HMRC in gauging to what extent the documentation could be relied upon without further intrusive testing.

The summary audit trail document is similarly designed to document the work performed by the taxpayer in preparing the transfer pricing documentation and is aimed at encouraging taxpayers to perform an appropriate amount of due diligence work in preparing documentation (tying entries to meeting notes etc). This is a document that HMRC are almost certain to ask for as part of an enquiry and in judging the reliability of transfer pricing documentation submitted to them.

When will the new rules come into force?

The new rules applying only to the affected businesses as set out above will apply to accounting periods beginning on or after 1 April 2023.

How we can help

While the new transfer pricing documentation requirements are directly applicable only to those large MNCs within the CBCR regime, they are simply another part of HMRC’s continued focus on transfer pricing compliance and on the reliability or otherwise of documentation submitted to them. Given the real prospect of tax-geared penalties where documentation falls short, whether within the new rules or not, we recommend that taxpayers continue to maintain and regularly review their transfer pricing arrangements and the evidence and documentation they have in support.

This is an area in which our International Tax team work closely with clients, and we would be happy to discuss the new requirements with affected taxpayers or on the adequacy of documentation outside of the new regulations.

As noted above the master file/local file format of transfer pricing documentation is now common across many jurisdictions and as such it often makes sense for MNCs not affected by the new rules to still prepare their transfer pricing documentation in this format. We have a lot of experience in helping clints address this issue.

Would you like to know more?

If you would like to discuss the above or how it applies to your business, please get in touch with James Dolan or Andy Briggs using the details on this page.