Key takeaways and comments

Introduction

HMRC developed the GfC7 to help customers mitigate common avoidable risks in transfer pricing. These include risks due to:

• Transfer pricing policies carrying inherent risk of enquiry or adjustment;
• Errors or oversights when implementing TP policy;
• Business changes and developments that aren't included in updated transfer pricing approaches;
• Insufficient scope of compliance work;
• Documentation inaccurately describing the business; and
• Avoidable errors when calculating and reporting outcomes.

The aim is to help customers identify and retain supporting information contemporaneously, as the absence of such information is known to be a key driver of protracted enquiries.

HMRC articulated that it is not intended for businesses to adopt all best practices for every topic or area set out in the GfC7, acknowledging that as this would be overburdensome and time-consuming for many taxpayers.

However, HMRC does recommend that taxpayers consider all their risk areas and evaluate whether they need to increase their compliance focus or activities in the areas most relevant to their businesses, particularly where complex or high-risk transactions are identified.

Application of the GfC7 guidance will be a factor in how HMRC views a business's attitude towards risk, which in turn influences HMRC's selection of businesses for enquiry. For those businesses assigned a customer compliance manager (CCM), how the group incorporates the GfC7 guidance into its compliance processes will be assessed as part of the taxpayers annual business risk review (BRR).

Part 1 – Managing compliance risk for UK businesses

Part 1 of the GfC7 is designed to help UK risk leads collaborate with their relevant group functions and any outsourced providers to establish an effective and evidenced UK transfer pricing compliance process. A UK risk lead is typically a UK employee with detailed working knowledge of the UK business.

HMRC emphasised that it is insufficient to rely solely on external advisors or offshore group tax teams who may not fully understand the UK business or the necessary compliance scope. Therefore, it is crucial for taxpayers to identify personnel within the group who are familiar with the UK business to ensure the scope of work is appropriate, factual content is accurate, and outcomes reflect the business model.

Best practices for effective UK TP compliance planning and scoping include:

• Understanding the group transfer pricing compliance model and its impact on UK assurance: This involves a higher degree of engagement with the group TP compliance model, reviewing outputs, and localising or customising group compliance approaches to meet UK rules. The scope and depth of work required for UK compliance, along with a higher frequency and level of implementation process controls and monitoring checks, are expected to provide greater UK assurance in the compliance model and reduce overall compliance risk.
• Being aware of group transfer pricing policies and intra-group agreements that affect the UK business: When these policies and agreements are set outside of the UK, there is a risk that they may not reflect the profile of the UK business. Therefore, it is recommended to review documented policies and terms with commercial or operational colleagues, identify any high-risk policy indicators with specialists, and highlight unrecorded transactions to reduce compliance risks.
• Scoping compliance activities for developments since the prior period, materiality, proportionality, and depth: This includes, but is not limited to, identifying significant changes in intra-group goods and services, new third-party contracts, mergers, disposals or restructurings, transfers of intangible assets, and changes in senior staff or governance which may require in-depth review to mitigate compliance risks.
• Scoping compliance activities for developments since the prior period, materiality, proportionality, and depth: This includes significant changes in intra-group goods and services, new third-party contracts, mergers, disposals or restructurings, transfers of intangible assets, and changes in senior staff or governance.

It is crucial for those in the UK processing these transactions to be aware of the terms of the TP policy and understand how to implement it practically. This helps to limit errors in calculating or omitting intra-group transactions.

Best practice suggestions to avoid calculation pitfalls, typically performed by UK risk leads, include:

• Collaborating with specialists to determine and review whether the actual profits or losses achieved are arm's length;
• Calculating TP policies separately to avoid double counting of profit or loss, and reconciling calculations to statutory accounts; and
• Specifically flagging new or other transactions which are not covered by the TP policies under consideration.

Lastly, HMRC recommends creating a 'supporting information file' that houses all relevant information in a single location. HMRC notes that the examples of such supporting evidence set out in Appendix 1 to the GfC7 guidance are not intended to be a checklist or comprehensive in nature.

The aim of the recommendation is to help taxpayers reduce any future burden in identifying records and information which goes to demonstrates the level of care taken to calculate the arm's length return for penalty determination purposes.

Part 2 – Common compliance risks

Part 2 of the GfC7 provides a practical risk framework cycle through the compliance cycle to help customers identify common compliance risks that HMRC frequently encounters during enquiries. This section is primarily aimed at TP specialists and focuses on how UK taxpayers can adopt recommendations, document filing positions, and mitigate high-risk indicators.

HMRC emphasised the importance of a thorough and timely functional analysis.

Together with the accurate delineation of other economically relevant characteristics set out in the OECD Transfer Pricing Guidelines (i.e., contractual terms, character of property or service, economic circumstances, or business strategy), a well-documented functional analysis adds credibility.

Ideally, best practice would be to conduct a functional analysis before the tax return is filed. If not, HMRC cautions that conducting a functional analysis post filing a return carries the risk that conclusions in the filed return may be unsupported by the actual functions performed, thereby increasing the risk of penalties.

HMRC also highlighted that it frequently finds insufficient depth in taxpayers' analysis of intangible assets. A complete an accurate analysis should include detailed descriptions of R&D functions, product development processes, and the UK's role in the development, enhancement, maintenance, protection, and exploitation (DEMPE) of intangibles. Taxpayers should also take care to cross reference such analysis with documentation supplied in R&D credit and/or related patent box claims. Inconsistency between submissions will likely indicate a higher risk profile of a taxpayers' compliance processes by HMRC.

By following the guidance set out in Part 2 of the GfC7, HMRC hopes that businesses and TP specialists can better navigate the compliance cycle and mitigate common risks identified. Where proper documentation reflects the underlying work accurately, this will help to reduce unnecessary compliance burdens.

Part 3 – Indicators of TP policy design risk

Part 3 of the GfC7 is relevant to in-house tax and TP specialists involved in setting TP policies or reviewing risks in existing TP policy approaches. This section contains more complex areas of transfer pricing, including:

• Intangibles;
• Above-market intragroup services;
• TP target margin models;
• Cost of sales-based rewards for services; and
• Franchise fees or similar single fee arrangements.

Given the potential complex nature of such transactions, HMRC recommends that UK businesses with these types of transactions consult with deep specialists to ensure thorough consideration and compliance.

Conclusion

The HMRC TP webinar offered valuable insights into the practical application of HMRC's guidelines and the expectations for transfer pricing compliance. It provided further clarity on how businesses can manage transfer pricing risks and ensure adherence to HMRC's standards.

Please contact us, or your regular Baker McKenzie contact, should you have any questions or want to discuss further.