Transfer pricing and intercompany agreements

Every payment between a UK subsidiary and its parent is a tax event in two countries. The UK requires the price to be what independent parties would have agreed, and it will adjust the UK profit upward if it is not. The parent's country runs the same test from the other side. A group that has not written its intercompany arrangements down is exposed in both places, and the fix is a policy and a set of agreements put in place before the first charge is made.

The UK rules

• Transfer pricing applies to transactions between connected companies and follows the OECD arm's-length principle.
• Groups that are small, with fewer than 50 staff and either turnover or balance sheet of €10 million or less, are exempt. Medium-sized groups, with fewer than 250 staff and turnover of €50 million or less or a balance sheet of €43 million or less, are also exempt at present, though HMRC can direct otherwise. The test counts the whole group worldwide.
• Larger groups must be able to show their pricing is arm's length, and groups with consolidated revenue of €750 million or more must keep a master file and a UK local file in a prescribed form.
• Whatever the size, HMRC expects the charges to be documented, and undocumented charges are disallowed for corporation tax first and argued about later.

The four arrangements almost every subsidiary has

1. Services from the parent. Management, finance, HR, IT. Usually charged at cost plus a modest margin under a services agreement, with the cost base and the allocation key written down.
2. Services from the subsidiary. Sales, marketing or development done in the UK for the group. The UK company is entitled to an arm's-length return for that work, and HMRC will look for one if the UK company runs at a permanent loss while the group does not.
3. Licences. Use of the parent's brand, software or technology, charged as a royalty.
4. Loans. Funding from the parent, with an interest rate a bank would have charged and terms a bank would have set. Interest deductions are restricted for groups with more than £2 million of net UK interest a year.

Withholding tax

The UK charges no withholding tax on dividends paid to a parent anywhere. Interest and royalties are different: UK tax at 20% is deducted at source from payments to an overseas company unless a double tax treaty reduces it, and the reduction has to be claimed in advance, not assumed. For royalties and interest paid to a parent in Germany, France, the Netherlands, Ireland, Switzerland, the UAE or South Africa the treaty rate is nil once the claim is in place. For the USA the treaty rate is nil for interest and royalties in most cases. For India, Australia, Canada and Singapore the treaty reduces the rate rather than removing it, and we confirm the figure for the payment concerned. Where tax is withheld, it is accounted for to HMRC on a quarterly return, and the parent claims credit for it at home.