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Graham Aaronson, Michael Anderson and Steve Bousher provide answers to common questions on transfer pricing methods. 

Pricing methods

Accepted methods

What transfer pricing methods are acceptable? What are the pros and cons of each method?

All five traditional transaction and transactional profit methods recognised by the OECD (see paragraph 2.1 of the Organisation for Economic Co-operation and Development Transfer Pricing Guidelines (OECD TPG)) are acceptable, and the use of ‘other methods’ not described in the OECD TPG is permitted if they satisfy the arm’s-length principle and provide a better transfer pricing solution (see paragraph 2.9 of the OECD TPG). The guidance in the OECD TPG concerning the pros and cons of each method is adopted and supplemented by His Majesty’s Revenue & Customs (HMRC)’s own guidance, set out in the International Manual at INTM421000. Where a traditional transaction method and a transactional profit method can be applied in an equally reliable manner, the first type is preferable and should be applied. In broad terms, traditional transaction methods are likely to be appropriate for establishing the arm’s-length price of commodity transactions, marketing operations or transactions concerning semi-finished goods, services or long-term buy-and-supply arrangements. Transactional profit methods, on the other hand, are likely to be preferable where each of the related parties to a transaction makes unique and valuable contributions, where the parties engage in highly integrated activities or in transactions involving the transfer of intangibles or rights in intangibles.

Cost-sharing

Are cost-sharing arrangements permitted? Describe the acceptable cost-sharing pricing methods.

Cost contribution arrangements (CCAs) are permitted. There is no difference in the analytical framework for analysing transfer prices for CCAs compared to analysing other contractual arrangements (see paragraph 8.9 of the OECD TPG). Accordingly, the guidance in Chapter II (Transfer Pricing Methods) of the OECD TPG is relevant to determining the value of each participant’s contribution to the CCA, including the amount of any balancing payment required to align the value of their contributions with the value of their expected benefits, and the value of any buy-in payment or buy-out payment triggered by changes in the membership to the CCA.

Best method

What are the rules for selecting a transfer pricing method?

Given the requirement to read the legislation in a way that best secures consistency with article 9 of the OECD Model Tax Convention (OECD MC) and the OECD TPG, the United Kingdom currently follows the ‘most appropriate’ method approach set out in paragraph 2.2 of the OECD TPG (see the International Manual at INTM421010). Accordingly, the selection process should take into account:

• the respective strengths and weaknesses of the OECD-recognised methods;
• the appropriateness of the method considered in view of the nature of the controlled transaction, determined in particular through a functional analysis;
• the availability of reliable information (in particular on uncontrolled comparables) needed to apply the selected method and (or) other methods; and
• the degree of comparability between controlled and uncontrolled transactions, including the reliability of comparability adjustments that may be needed to eliminate material differences between them.

Under paragraph 2.3 of the OECD TPG there is effectively a hierarchy of methods where one or more methods are equally reliable for the transaction in question: in such cases, a traditional transaction method is preferable to a transactional profit method, and a comparable uncontrolled price method is preferable to other traditional transaction methods.

Taxpayer-initiated adjustments

Can a taxpayer make transfer pricing adjustments?

The United Kingdom has a self-assessment system for income tax and corporation tax. The responsibility for making the assessment rests on the taxpayer and the amounts in the return are conclusive unless amended by the taxpayer or HMRC within the statutory time limits. A transfer pricing adjustment can only be made where there is a potential tax advantage for the UK taxpayer in the form of an increase to chargeable profits or a reduction of losses. Part 4 of the Taxation (International and Other Provisions) Act 2010 (TIOPA 2010) permits corresponding adjustments by claim in relation to UK–UK transactions only (see the International Manual at INTM412130). The mutual agreement procedure must be invoked in cross-border cases.

Safe harbours

Are special ‘safe harbour’ methods available for certain types of related-party transactions? What are these methods and what types of transactions do they apply to?

The United Kingdom’s transfer pricing rules do not usually apply to small or medium-sized enterprises (SME) (see section 166 of TIOPA 2010) although SMEs may elect to be subject to the rules and HMRC may direct that an SME apply them. The meaning of ‘small enterprise’ and ‘medium-size enterprise’ are based on the definition in the European recommendation 2003/361/EC (see HMRC’s International Manual at INTM412080). Transfer pricing rules will also apply to SMEs if the other affected person or a party to the transaction is a resident of a non-qualifying territory. Broadly, a territory qualifies (see section 173 of TIOPA 2010) if it is one with which the United Kingdom has a double tax treaty containing a non-discrimination provision and has been designated as such in regulations made by the Treasury.

Original article can be found here: https://www.lexology.com/r/UMhKVX4/0ac581cb62/VwcN