Reform of UK transfer pricing documentation requirements

The government has issued a consultation document entitled "Transfer Pricing Documentation", which considers bringing in more standardised methods of reporting transfer pricing information in the UK. In particular, the government is considering bringing in a requirement for large MNEs to maintain a Master and Local File as recommended by the OECD BEPS Action 13 report. In addition, the consultation also covers the possible introduction of a wider requirement for UK businesses with transfer pricing transactions to produce an International Dealings Schedule (IDS) as part of the tax return.

The consultation is an early stage consultation designed to set out the government's objectives and identify possible options. As such, affected businesses should certainly consider responding to the consultation in order to ensure that their views are heard and taken into account at this early stage in the process.

Background

At present, UK documentation requirements simply require businesses to keep and retain sufficient records to demonstrate that their tax returns are complete and accurate, including those aspects relating to transfer pricing. There is no specific requirement to produce and retain a particular format of transfer pricing documentation (although UK transfer pricing legislation incorporates the OECD Guidelines and therefore implies businesses should consider documentation which is consistent with the OECD Guidelines' recommendations).

In 2015, the OECD's BEPS Action 13 Report "Guidance on Transfer Pricing Documentation and Country-by-Country Reporting" required the introduction of country by country reporting (which was introduced in the UK) and also recommended standard documentation requirements, including adoption of a Master and Local File approach. The OECD standardised approach consists of (i) a Master File containing standardised information relevant for all MNE group members; (ii) a Local File referring specifically to material transactions of the local taxpayer; and (iii) a CbC report for the largest MNE groups containing aggregate data on the global allocation of income, profit, taxes paid and economic activity among the tax jurisdictions in which it operates.

The UK did not introduce the standardised approach to transfer pricing documentation because it believed the UK already had broad record keeping requirements, but since 2015 many other countries have adopted the Master and Local File requirements into local legislation recommended by the OECD. Accordingly, the government has decided to consult on the possibility of bringing in this widely adopted international approach in the UK.

The document suggests that a number of benefits might flow from the adoption of the Master and Local File approach, including:

• providing greater certainty for UK businesses in relation to transfer pricing documentation requirements

• providing HMRC with better quality data to enable more efficient and targeted compliance interventions and

• aligning the UK's practice more closely with the transfer pricing documentation requirements of comparable tax administrations.

Master and Local File requirements

The consultation seeks views on the introduction of a mandatory requirement for MNEs within CbC reporting groups (generally those with consolidated group turnover of €750m or more) to provide HMRC with a copy of the Master File upon request and to keep and produce on request a Local File for their UK operations. It is expected that the majority of groups within the CbC reporting regime will already be routinely creating a Master File due to wider international requirement and so providing HMRC with a copy should not impose a significant additional burden. In order to ensure that the requirement remains proportional, the government does not propose to introduce the requirement for groups not within the CbC reporting regime.

The consultation suggests that the absence of specific transfer pricing documentation requirements, and supporting guidance, in the UK has created a degree of uncertainty for UK businesses regarding the appropriate transfer pricing documentation they need to keep, leading to inconsistency of approach.

The consultation also suggests that when a transfer pricing enquiry starts, a business may spend considerable time providing HMRC with a clear understanding of the relevant facts for their transfer pricing position. The use of standardised documentation may provide greater certainty for businesses and enable a more proactive approach to record keeping, as well as enabling HMRC to ensure a more effective and focused enquiry.

As regards the Local File requirement, the consultation suggests that this should not require many UK businesses to maintain any additional underlying records (assuming that UK MNEs already keep sufficient records to demonstrate compliance with the OECD's standardised approach), but it would require them to produce summaries of the information in a prescribed manner.

Moreover, the government is consulting on requiring the Local File to be supported by some form of evidence log setting out key facts, potentially as an appendix to Local File documentation. (This requirement would not apply to the Master File.) The Local File includes details of transactions and demonstrates how an appropriate transfer pricing methodology has been selected and applied. However, the consultation suggests that a common difficulty in transfer pricing enquiries relates to distinguishing underlying facts and evidence from technical opinions. The purpose of the evidence log would be to ensure that there is clarity regarding the underlying facts and evidence. The consultation notes that HMRC currently uses the evidence log approach in the Profit Diversion Compliance Facility (PDCF) and that this provides a positive benefit for both businesses and HMRC.

The consultation recognises that for groups within the CbC reporting regime it may be appropriate to consider minimum values to focus requirements on sufficiently material transactions, in line with the OECD's standardised approach. Accordingly, the consultation seeks feedback on how to determine a threshold for materiality in this context and whether a "nil return" would be required where all transactions are considered to fall under this threshold.

The Master File and Local File would need to be produced upon request and the document suggests that a period of 30 days would be allowed for production. Failure to produce the Master File and Local File within the required time would be taken into account by HMRC when considering whether reasonable care had been taken in the preparation of the tax return.

International Dealings Schedule (IDS)

In addition to the Master and Local File requirements, the consultation also raises the prospect of the UK introducing a further requirement on businesses with transfer pricing transactions to file an annual schedule providing details about cross border, intragroup transactions where the counterparty is in another territory. It should be noted that this requirement would not be limited to MNEs within the CbC reporting regime, but would apply to all UK businesses in scope of UK transfer pricing legislation would be required to file an IDS (though small and medium sized businesses are generally exempt from these rules).

The consultation notes that a number of other tax authorities already require such information and that the availability of such a schedule can be very useful for tax authorities to use for automated risk assessment actions.

Potential ideas for the types of data and information that may be required to be reported via an IDS include:

• The nature and amount of specific types of transactions

• Details of financial dealings

• Compensation, receipts or payments of a non-financial nature

• Information on restructuring activity

• Information on the transfer pricing methodologies applied

• Information on the level and type of supporting documentation for the transfer pricing methodology selected and applied

• Counterparty details for transactions including identity and country location

• Information on activities

• Corporate group information (to enable entity level data to be combined and attributed to a particular MNE group)

UK-UK transactions would be excluded to ensure that any requirement was focused on the areas of greatest tax risk. In addition, the government suggests that a materiality limit may be incorporated to exclude some transactions from reporting requirements and reduce potential administrative burdens. Transactions could be excluded according to materiality by size or nature. For example, some very small transactions may not need to be reported, or transactions of a very low risk nature could be excluded.

The expectation is that the IDS would be required to be filed as part of the normal tax return process, perhaps forming a separate schedule. The government would also explore an option for one entity in the UK group to file a version of the IDS on behalf of other UK group entities in order to help to streamline administration of the requirement.

Comments

Whilst some businesses and advisors may believe the alignment of the UK's approach to transfer pricing documentation with the OECD's BEPS Action 13 report are long overdue compared to other countries, others recognise the generic record keeping requirements provide a pragmatic approach particularly for businesses between the SME and CbC reporting thresholds. With respect to the proposed IDS which may apply to all businesses within the scope of the UK transfer pricing legislation, the practical application of various thresholds and exemptions would need to be designed to ensure HMRC's objectives are achieved in a proportionate manner particularly for those with simpler transfer pricing models.

It is clear HMRC considers transfer pricing enquiries as one of the key areas to secure additional tax revenues. This consultation demonstrates HMRC's desire to update and strengthen current requirements to provide greater certainty for UK businesses supplying HMRC with better quality data to enable more efficient and targeted compliance investigations whilst aligning to the OECD Action 13 Report recommendations. HMRC's reference to the Evidence Log in the PDCF indicates that HMRC may be willing to go beyond the Action 13 standard which needs to balance with business's overall tax compliance burdens.

The purpose of the consultation is to seek views on the policy design and any suitable alternatives and subsequent consultations of the specific proposal for reform may follow if the current proposals are taken forward. The consultation is open for comments until 1 June 2021 and they should be sent by email to: transferpricingdocumentationconsultations@hmrc.gov.uk.