On 28 April the Government made an important set of transfer pricing policy announcements, including final decisions and draft legislation covering the package of measures consulted on during 2023, and two new proposals for consultation. While the 2023 package is largely technical, the new measures being consulted on, which for many businesses will be the most likely to have a practical impact, are aimed at improving compliance.

In this article we review the proposed measures and consider how they fit into HMRC’s overall strategy for transfer pricing compliance.

The context

In the decade since the introduction of diverted profits tax in 2015 HMRC has devoted large and increasing amounts of operational resource and policy-making bandwidth to transfer pricing compliance. That focus reflects a strong political imperative to protect the UK’s tax base from erosion, both as a result of corporate tax planning and other countries taking an overly expansive view of their taxing rights. It also reflects the significant amounts of compliance yield HMRC is regularly able to record from transfer pricing work - £1,786m for the year ended 31 March 2024.

Tax under consideration in HMRC enquiries

Despite those efforts (and a regular flow of successful settlements) the total amount of tax HMRC has “under consideration” in transfer pricing enquiries has remained high. As the table above shows HMRC’s Large Business directorate had £13.8bn at stake in “International” enquiries as at 31 March 2024 (the bulk of which we understand relates to transfer pricing), with a further £2.2bn at stake in cases being managed by HMRC’s Mid-sized Business unit. In both cases “International” is the single largest category of enquiry.

Against that background it is natural that, over the past ten years, HMRC has sought to implement a variety of measures aimed at improving transfer compliance. As shown in the pyramid table below, those measures have touched on all facets of transfer pricing compliance, ranging from substantive reforms to international transfer pricing rules, through new regimes intended to strengthen HMRC’s risk assessment capability and enhanced enquiry powers, to taking a firmer approach in individual enquiries.

The new measures proposed in the April consultation, which are highlighted in blue above, are aligned with these categories. 

Removing the exemption for medium-sized businesses

Currently, in most circumstances UK law exempts SMEs from the requirement to apply arm’s length transfer pricing rules. For this purpose an SME is defined as an entity which, when combined with linked and partner enterprises, has:

• fewer than 250 staff, and one or both of;
• annual turnover not exceeding €50m; or
• balance sheet total not exceeding €43m.

In the consultation document the Government notes that the UK’s SME exemption is unusual internationally and means that transfer pricing – arguably the single most important Corporation Tax base protection regime – does not apply to a significant proportion of the UK business population. The document does not appraise the effects of this absence of coverage on Exchequer revenues. However, it seems reasonable to infer that HMRC’s experience of transfer pricing enquiries in its Mid-sized Business unit – which as noted above has a pipeline of cases worth c.£2.2bn – has led it to conclude that there are potentially material amounts involved.

The Government is therefore proposing to reform the exemption so that it only applies to small businesses, defined as those with:

• fewer than 50 staff, and one or both of;
• annual turnover not exceeding £10m; or
• balance sheet total not exceeding £10m.

Reducing the scope of the exemption would mean many medium-sized businesses facing an increased administrative burden reflecting the need to review the pricing of their intra-group transactions and fulfil compliance requirements such as maintaining appropriate transfer pricing documentation. Given that the affected businesses will be at the smaller end of the population it is likely there will be at least some for which the cost of compliance is disproportionate to the tax revenues potentially involved.

The Government has suggested that the administrative burden should be mitigated by the proposed abolition of the requirement to apply arm’s length transfer pricing to UK-to-UK transactions in many situations, and also by the fact that many medium-sized businesses may already be complying with transfer pricing requirements in other countries. Those factors would go some way to reducing the impact of a change to the exemption, however we expect the overall effect in most cases is still likely to be an increase in costs of compliance. 

International Controlled Transactions Schedule

The increase in the transfer pricing-related compliance burden faced by businesses will be even greater if the Government proceeds with its second consultation proposal: the introduction of a requirement to prepare and file an International Controlled Transactions Schedule (ICTS). 

The ICTS is a new information report that would be filed annually with HMRC by entities that are in scope of UK transfer pricing and have aggregate cross-border dealings of at least £1m (or that have transactions with affiliates in “non-qualifying” territories, which are broadly those that do not have a double tax treaty with the UK). It would contain objective, standardised information about the filing business’s cross-border dealings, with the aim of facilitating automated, data-led risk assessment by HMRC, enabling more efficient and targeted enquiries.

The consultation document includes a draft ICTS template, which would require the following information to be reported.

• Answers to a short questionnaire about the filing entity’s characteristics.
• Information about the entity’s overseas counterparties, the basis on which transactions with those counterparties are priced and the amount of income, expenditure or asset value involved. This information would be subdivided by transaction type, for example purchases of goods, payments for intangibles, payments for services, financing costs, etc.
• Further financial information, including opening and closing balances and applicable interest rates relating to financing transactions.

Transactions would not need to be reported where the total value for the category was below a de minimis of £100,000 for goods and services, or £5m loan balance and £100,000 P&L impact for loan relationships. A higher de minimis threshold may apply for businesses already subject to detailed transfer pricing documentation requirements (for example the requirement to prepare a Master File, Local Files, and Country by Country Reports).

The ICTS is not a new idea. The previous Government consulted on a proposal to introduce a similar “International Dealings Schedule” (“IDS”) in 2021 but decided not to do so following stakeholder concerns that such a requirement would add significantly to the administrative burden on in scope businesses. The ICTS is a refined version of that IDS proposal. HMRC have sought to address business concerns in the consultation document, arguing that compliant businesses will benefit from better targeting of transfer pricing enquiries, and that similar reporting requirements exist in most other major economies.

Better targeting of transfer pricing enquiries would be a boon for businesses. Our anecdotal experience is that HMRC often have to decide whether to take up an enquiry based on relatively sparse information about a business, and once an enquiry is open building HMRC’s understanding of the facts can be a lengthy process (even in cases where HMRC then concludes there is no transfer pricing risk). The information in the ICTS, if used effectively, could plausibly improve HMRC’s case selection – and may be particularly useful in relation to the large number of medium-sized businesses that will be subject to transfer pricing if the SME exemption is reformed. 

However, those benefits are likely to feel remote for many in-house tax teams, while the need to comply with a new and unfamiliar reporting requirement will be much more immediate. While the Government’s objectives in this area are understandable, we would urge them to continue to think carefully about how to make the ICTS regime as focused as possible – and also to look for administrative burdens in other areas that might be reduced.

Next steps

The formal consultation period will run until 7 July 2025, during which HMRC will be holding a series of roundtable meetings for interested stakeholders. We expect that the Government will then announce its decision on whether and how the measures are taken forward at a Budget in the autumn. Given the tone of the consultation document, and the fact that this is the second consultation on an ICTS-type proposal, we think it is likely that both will be taken forward (although perhaps with refinements).