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The UK transfer pricing rules require an adjustment of profits where a transaction between connected parties is not undertaken at arm’s length and has created a potential UK tax advantage. Transfer pricing is a specialist area in tax and relies on an experience of similar businesses and activities. The following therefore only outlines the transfer pricing process in practical terms to allow a non-specialist to understand the methodology of a transfer pricing review.
The legislation defines an arm’s length price as the price which might have been expected if the parties to the transaction had been independent persons dealing at arm’s length, based on OECD guidelines. Application of an arm’s length principle under the OECD guidelines is based on a comparison of transactions between associated parties in a multinational enterprise (MNE) with the transactions which would have taken place between independent parties under the same circumstances; this is known as a ‘comparability analysis’. In order to undertake a comparability analysis, the business must review the commercial and financial relationships between associated parties to establish:
the contractual terms
the functions performed by each party, what assets are used and what risks are taken on
the characteristics of property transferred or services provided
the market in which the parties operate
any business strategies pursued by the parties, eg market penetration
TIOPA 2010, s 164
This is known as a functional analysis.
In practice, the steps of a transfer pricing review are outlined in the attached pdf:
These steps are summarised below with links to detailed commentary in Simon’s Taxes.
Individual businesses will have different aspects which make them unique and create value; these
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