Navigating Transfer Pricing Risks: Key Insights from HMRC’s New Guidance

HMRC recently released updated guidance, Help with Common Risks in Transfer Pricing Approaches. While the risks outlined are not new to us or our clients and generally reflect what we have already seen during enquiries, Advance Pricing Agreements (APAs) and Mutual Agreement Procedures (MAPs), the formalisation of these insights into official guidance shows that businesses should now take these risks even more seriously. This article offers an overview of the new guidance, highlights the key risks, and explains how to mitigate these challenges effectively.

Key Transfer Pricing Risks Identified by HMRC

HMRC’s guidance outlines risks that businesses must focus on to ensure compliance with the arm’s length principle. These risks are classified into three categories:

1. Governance Risks: Poor oversight and mismanagement of transfer pricing policies and practices can expose businesses to significant risks. HMRC emphasises the importance of having well-documented, consistent processes that align with the company’s overall governance framework.
2. Design Risks: These risks relate to how a company structures its transfer pricing policies. HMRC warns that weak policy design choices can lead to non-compliance, particularly if they don’t reflect the business’s commercial realities (e.g., in transactions involving intellectual property (IP), shared services, or complex financial instruments).
3. Execution Risks: Misapplication of transfer pricing policies is another key risk. HMRC identifies key areas where companies often fail to update their policies or maintain adequate documentation to justify intercompany pricing decisions, resulting in execution gaps.

Practical Steps to Mitigate Transfer Pricing Risks

To meet HMRC’s expectations, businesses should focus on the following actions:

• Strengthen Documentation: One of the most critical aspects of transfer pricing compliance is maintaining thorough documentation to substantiate pricing decisions. This includes contemporaneous records that can withstand scrutiny from tax authorities.
• Implement Robust Governance Structures: A centralised team or dedicated individual responsible for transfer pricing can help ensure policies are consistently reviewed and updated to prevent governance issues.
• Regularly Review Transfer Pricing Models: As business models evolve, transfer pricing arrangements should be regularly revisited. This is particularly important for multinational companies dealing with complex cross-border transactions, such as IP arrangements.
• Focus on Substance Over Form: HMRC’s guidance stresses that transfer pricing policies must accurately reflect the commercial and economic reality of transactions. Tax authorities are increasingly focused on substance, meaning that businesses must ensure their arrangements are not only compliant on paper but also what is happening in practice.

High-Risk Areas to Watch

HMRC has flagged several high-risk areas where businesses should exercise caution:

1. Transactions with Low-Tax Jurisdictions: These transactions will be scrutinised to ensure that pricing reflects the value provided by each party, rather than shifting profits to achieve tax savings.
2. Intellectual Property and Intangibles: Given the complex nature of intangible assets, transactions involving IP, such as licensing or the transfer of intangible assets, are often a high-risk area. HMRC expects businesses to accurately value IP and ensure that profits allocated to intangible assets are justified by economic activities.
3. Intragroup Financing: Financing arrangements between related parties, particularly those involving low-interest or interest-free loans, are often scrutinised. Companies should ensure that such arrangements are in line with market terms and are supported by robust documentation.
4. Business Restructuring: When a business restructures its operations, such as shifting functions or assets to another jurisdiction, transfer pricing risks increase. HMRC expects companies to carefully assess the transfer pricing impact of such changes.

Proposed Action Plan

With HMRC increasing its focus on transfer pricing risks, it is essential for companies to adopt proactive measures to ensure their policies are both compliant and defensible. The following action areas could help meet the expectations outlined in the guidance:

• Transfer Pricing Risk Assessment: This involves conducting a thorough review of current transfer pricing arrangements to identify potential risk areas, and considering steps to mitigate these risks, such as reviewing documentation, refining governance processes, and ensuring the design of transfer pricing policies to make every effort to meet HMRC’s expectations.
• Managing High-Risk Transactions: In cases involving intragroup financing, IP transfers, or transactions with low-tax jurisdictions, companies may benefit from structuring these arrangements carefully to ensure compliance. This could include strengthening support for key valuation assumptions, conducting benchmarking, and enhancing documentation to support your pricing policies.
• Responding to HMRC Enquiries: For businesses facing an HMRC enquiry, understanding the enquiry process will be crucial. Effectively engaging with HMRC and presenting well-supported transfer pricing arrangements can help reduce potential challenges.
• Ongoing Compliance and Monitoring: To stay ahead of regulatory or personnel changes in the business and minimise the risk of non-compliance, companies should consider regular updates to transfer pricing documentation, in particular up to date functional analysis and benchmarking studies to ensure alignment with the latest guidance.
• Achieving Tax Certainty: For those companies seeking to minimise tax risks, applying for Advance Pricing Agreements (APAs) may offer long-term certainty. A strategic approach, supported by careful preparation, can lead to complete certainty over transfer pricing arrangements.

Conclusion

HMRC’s new guidance on transfer pricing risks underscores its growing focus on robust governance and Senior Accounting Officer related compliance. Businesses must take proactive steps to strengthen governance, documentation, and transfer pricing policies to ensure compliance and avoid costly disputes.

If you would like to discuss how we can assist with your transfer pricing policies or review your current arrangements, please get in touch with our team.