HMRC’s consultation on lowering the threshold for exemption from the UK’s transfer pricing rules

The UK’s transfer pricing rules require taxpayers to ensure that all transactions with associated enterprises are priced on ‘arm’s length’ terms – that is, at a price comparable to that which would be charged were the two parties to be dealing with each other on a commercial basis and were independent of each other. HMRC also requires that documentary evidence is maintained to support pricing as being arm’s length.

What is the SME exemption?

Small and medium sized enterprises (SMEs) are currently exempt from these rules (subject to some exceptions). An SME is defined as employing no more than 250 full-time equivalent staff and having annual turnover of less than €50 million or total assets of less than €43 million.

What is the Government proposing and why?

It is proposed to remove medium-sized enterprises from the scope of the exemption. Small enterprises may continue to benefit, defined as those with no more than 50 full-time equivalent staff and either annual turnover or total asset value of less than €10 million. The consultation document is expected to be published in the spring.

Concerns around protecting the UK tax base persist, and the Government sees this as an opportunity to better align with international peers; the SME exemption has to date been a generous “safe harbour” compared to many other jurisdictions.

What does this mean for businesses?

If the changes are implemented as proposed, medium sized businesses must comply with the transfer pricing rules; this may mean introducing charges between companies, or revising those currently in place. They will also suffer the administrative burden associated with the documentation requirements.

For finance teams who have never had to consider transfer pricing before, this will present a significant learning curve, and they will likely need help in understanding the implications, as well as the cross over with other taxes e.g. VAT and customs.

However, it should be noted that many medium-sized businesses may already be subject to transfer pricing rules to an extent, and the impact of the rule change may thus not be so significant:

The SME exemption does not apply where the counterparty is in a “non-qualifying” territory.
A UK entity may be forced to operate on arm’s length terms if the counterparty to a related party transaction is located in a territory which does not have a similar SME exemption.
The profit fragmentation rules (sometimes badged as “transfer pricing for SME’s”) have been in place since 2019 and require certain related party transactions within an SME to be evidenced as being on arm’s length terms.
For an expense to be deductible for a UK taxpayer, it must be incurred “wholly and exclusively” for the purposes of its trade (or be supportable as an expense of management of an investment business). Thus, a taxpayer of any size would be denied a deduction for costs incurred on behalf of an overseas related entity.

If you have any questions regarding how your SME may be impacted by this consultation, please contact a member of our Tax team using the form below.

We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.