Following recent consultation, the UK government is introducing more prescriptive transfer pricing documentation rules for accounting periods starting on or after 1 April 2023.

OECD documentation requirements

In scope UK entities will be required to prepare contemporaneous transfer pricing documentation in accordance with the model documentation framework in the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines). This will involve the preparation of a Master File and appropriate UK Local File. Companies operating in the UK are already required to maintain evidence that their related party transactions are at arm’s length. These new requirements specify the format of that evidence for the first time.

The OECD Guidelines set out that groups of associated companies with business establishments in two or more tax jurisdictions should prepare:

• a Master File, covering relevant information common to and for the group as a whole; and
• a Local File for relevant material transactions in each territory in which they have a taxable presence, setting out the appropriate functional analysis for local entities, together with details of the connected party transactions, and an economic analysis of and evidence to support the pricing adopted for them.

These files will now be required to be prepared for UK entities that form part of a group with annual income of at least €750m – the Country-by-Country Reporting threshold. They will not need to be filed with the UK tax authority but retained and provided on request. As is already the case, when approving the corporation tax return, the designated person confirms that the entity’s transfer pricing position is compliant.

Summary audit trail – a new addition

The new UK requirements include completion of a summary audit trail (SAT). We expect this to be a short document that summarises the main actions taken in preparing the Local File.

It is expected to take the form of a questionnaire designed to provide HMRC with confidence in the transfer pricing processes of the business. At the time of writing, however, the questionnaire has yet to be published. During the consultation on these new rules a more detailed ‘evidence log’ was discarded in favour of the less onerous SAT, so it is hoped that the SAT will be a comparatively light touch confirmation of transfer pricing actions and processes, rather than a short headline document that requires extensive additional work to complete.

Greater powers to request information

The new legislation also extends HMRC’s powers to require transfer pricing information from UK businesses, such that:

• transfer pricing documentation may now be requested without HMRC needing to open a formal enquiry; and
• HMRC may now request documents not in the ‘possession or power’ of the UK entity where they are in the possession or power of another member of the relevant multinational group.

Greater emphasis on penalties

The extended powers to request information show that HMRC clearly views the preparation of transfer pricing documentation as a standard activity across multinational groups, the evidence of which should be available on request. Consistent with this, greater emphasis will therefore be placed on transfer pricing penalties.

Where careless behaviour is identified, this could trigger a penalty of up to 30 per cent on any transfer pricing adjustments assessed. It is worth underlining, however, that the penalty is applied to the ‘potential lost revenue’ resulting from any adjustment to the entity’s taxable profit, not to the additional tax immediately payable.

When determining whether there has been careless behaviour, HMRC will apply a presumption of carelessness:

• when contemporaneous documentation in line with the OECD Guidelines is not prepared; and
• if information is not provided that is in the possession or power of the multinational group, even if it is not held by the UK taxpayer.

What do the new rules mean in practice?

Most multinational businesses that meet the size requirements to fall within the scope of the updated UK transfer pricing documentation rules will be familiar with the OECD’s Master File/Local File structure and should have transfer pricing documentation in place, as many other territories have had broadly similar requirements for some time. Similarly, HMRC’s existing expectations for transfer pricing documentation have aligned with the OECD Guidelines, even if the formal requirement has been less rigid until now.

The greatest impact from the formalisation of the UK documentation requirements is likely to be where:

• UK entities in overseas parented groups have been considered ‘low risk’ for transfer pricing documentation purposes and Local Files have only been prepared in draft, or have not been regularly updated. The UK element of these groups’ transfer pricing documentation requirements will now need to move up the list of priorities.
• UK-parented businesses do not currently prepare separate UK Local Files because a Master File is considered sufficient. Following the change in the rules, a UK Local File will now be required.

However, it is the other changes that are likely to have a larger impact.

The introduction of the SAT places greater emphasis on the business’s transfer pricing processes and governance. When preparing the documentation and the UK corporation tax return, businesses will need to have confidence that the steps they have taken are appropriate and that they have evidence available to demonstrate this. Reports prepared with minimal local input or supporting data are unlikely to be acceptable.

Businesses that do not reach the threshold for the formal Master File/Local File requirement may wish to consider how to approach UK documentation if they do not yet comply with the OECD framework. While the formal requirement has not changed, HMRC’s expectations are likely to become even more clearly focused on the provision of an appropriate Master File and UK Local File, and best practice should reflect this.

Action required

In scope UK businesses should review their UK transfer pricing documentation in advance of these changes to understand what additional work may be required and how the group’s approach to supporting the UK transfer pricing position may need to change. Addressing this effectively in ‘year one’ of the updated rules should allow robust documentation to be put in place that may then be refreshed, as appropriate, in future years.

Businesses should also look more widely at their transfer pricing policies and processes, together with the evidence they might use to support the position. This will allow the SAT to be addressed with confidence and should put them in a good position in the event of an enquiry.

For more information please get in touch with Paul Minness, Simon Taylor or your usual RSM contact.