Major transfer pricing documentation changes proposed
A consultation in the UK that ran from 23 March to 1 June 2021 could have far-reaching consequences for transfer pricing compliance in that the proposals go beyond the UK’s existing rules and those in other countries. BDO UK submitted comments on the proposals.
Highlights of the proposed changes
The proposals do not so much strengthen the existing legal obligations to maintain transfer pricing documentation as create a new obligation. This is because existing UK law, curiously, does not include a legal requirement that documentation be kept. However, if adopted, the proposals will effectively mean that for the first time a transfer pricing master file and UK local file will be mandatory for the largest multinational enterprises (MNEs), and these files will have to be submitted to the UK tax authorities (HMRC) within 30 days of a request.
Although most large businesses (i.e., those with group turnover of EUR 750 million or more) already keep a master file and UK local file, there are two further proposals in the consultation that will have a significant impact: a requirement that taxpayers keep an “evidence log” that would provide specific data and facts to help better inform a transfer pricing risk assessment and an International Dealings Schedule (IDS) that would accompany annual tax return.
Keeping an evidence log
The proposed requirement that corporate taxpayers keep an evidence log goes beyond what is required by other countries. In effect, HMRC will be mandating corporate taxpayers to provide evidence to support the facts provided in the local file. This reflects the more investigative approach that we have been seeing from HMRC on other initiatives, such as Diverted Profits Tax (DPT) and the Profit Diversion Compliance Facility (PDCF), with the latter already using an evidence log. The transfer pricing evidence log would record key items such as contractual agreements and staff profiles and distinguish these from technical analysis and opinion. Businesses’ transfer pricing compliance strategies will need to be changed to accommodate the fact-gathering processes necessary to collate and document the information required.
In BDO UK’s response to the consultation, we suggested that the request for an evidence log or its equivalent should only be extended to MNEs that are subject to an audit/enquiry, thus preventing an unnecessarily onerous compliance burden for the majority of MNEs.
Compiling an International Dealings Schedule
The IDS would be in a standardised format that HMRC could analyse and interrogate by developing the automated risk assessing tools already applied to country-by-country reporting (CbCR) submissions. It is proposed that the IDS could include details of financial dealings, the nature and number of specific types of transactions, information on the transfer pricing methodologies applied and the level of supporting documentation. It may also require details of issues of special interest, such as business restructures.
It is important to note that a key difference from a CbCR is that the IDS would apply to all taxpayers falling within the scope of the transfer pricing rules, not only larger MNEs exceeding the EUR 750 million turnover threshold. From our experience of similar rules in Australia, Belgium and Denmark, compiling such data will add significant compliance costs for businesses and provide HMRC with valuable information on medium-size and large groups that will assist HMRC in identifying transfer pricing risks. It will also provide HMRC with useful additional information in respect of taxpayers that already file a CbCR.
We requested in our comments that appropriate materiality thresholds be put in place if an IDS requirement is introduced to ensure that the rules are targeted and proportionate.
It is clear from the direction of policy travel of HMRC that it will be increasingly important for MNEs to prepare accurate transfer pricing policies and documentation and to ensure these are correctly implemented and regularly updated. It is important to recognise that HMRC is not alone in tightening documentation requirements with recent changes being announced by other countries, including Denmark, Germany and Ireland.
Increased transparency, the sharing of information and data-led risk assessing are clearly going to present challenges to businesses that are not prepared. Further evidence of this is the recent policy change in the EU relating to a directive that the EU is set to approve on making CbCRs public by 2023 and takes effect in the 27 EU member states for the first financial year starting on or after 2024.
If the UK proposals become law without major changes, affected businesses should be considering undertaking a risk or gap analysis to ascertain how they will need to amend their transfer pricing compliance policies. MNEs with a clear understanding of their own data and the risk assessment techniques used by the tax authorities will be in a stronger position to focus on areas that may be perceived as a transfer pricing risk, and plan accordingly. This is important not only from a tax compliance perspective but also in the context of evolving environmental, social and governance (ESG) strategies and corporate governance environment.