If your business trades with overseas affiliates, it is vital that you understand transfer pricing.
Transfer pricing governs the prices you charge for goods, services and intellectual property moved between group companies, and it determines where profits are taxed.
If you fail to correctly apportion it, you may end up facing penalties from the relevant bodies and these can be quite costly in the long run.
How does transfer pricing work?
Transfer pricing works by setting prices for transactions within a multinational group that are comparable to what independent businesses would agree in an open market.
Tax authorities expect you to demonstrate that your internal prices mirror what independent businesses would agree in the open market and to do so you must use approved methods.
That expectation is met using recognised approaches such as comparable-price analyses, resale or cost-plus calculations, transactional margin methods and profit-split techniques.
Which method is appropriate depends on the type of transaction and the industry.
Why should SMEs care about transfer pricing?
Transfer pricing is often thought of as a multinational, Big Four problem, but HM Revenue and Customs (HMRC) and overseas tax authorities scrutinise SMEs too.
If a UK company sells goods cheaply to a high-tax affiliate, or bills for services at non-commercial rates, tax authorities can reallocate profit to protect their tax base which will trigger unexpected tax bills, interest and penalties.
Beyond the direct financial hit, challenges can damage reputation and complicate banking or investor relationships.
Even when the amounts seem modest, the administrative and advisory costs of a dispute can be significant.
What challenges do SMEs typically face?
SMEs commonly lack the in-house data and transfer-pricing expertise to benchmark prices robustly.
Currency volatility, differing local rules and limited access to comparable market data complicate the task further.
Small groups also change structure frequently with new distributors, outsourcing arrangements or IP licences all altering your transfer-pricing profile and requiring fresh analysis.
Finally, inconsistent documentation or ad-hoc pricing decisions make it harder to defend your position in the event of an enquiry.
How should you manage transfer-pricing risk?
Start with a pragmatic risk assessment wherein you map your cross-border flows, identify where margins are concentrated and flag transactions most likely to attract attention.
During this process, it is essential that you can support pricing decisions with market data to ensure you have a robust defence against any potential challenges.
Well-written documentation that explains the method, the commercial rationale and the arm’s-length evidence is your first line of defence and should be carefully constructed and maintained to avoid future problems.
You should review policies whenever the business model, supply chain or pricing strategy changes and, where comparables are scarce, consider a practical, defensible approach, such as a transactional net margin or documented profit-split.
You should seek professional advice when considering your overseas business dealings and we are on hand to help you stay compliant across territories so that you can continue to focus on growing your business.
For help with transfer pricing and other international considerations, speak to our team today!
