Updated transfer pricing guidelines for compliance

In September 2024, HMRC published guidelines on common risks in transfer pricing compliance (GfC7) as part of its Guidelines for Compliance series. The guidelines contain a lengthy analysis of areas of risk and what HMRC sees as best practice for compliance and policy design in this area. For more information on the publication of the guidelines, see our earlier article New transfer pricing guidelines for compliance.

Most recently, HMRC have updated the guidelines, adding two new substantive sections on value chain analysis and offshore procurement hubs. These are important new sections and should be required reading for affected businesses in indicating HMRC's expected benchmark for compliant transfer pricing policies, documentation and activities going forwards.

Background

Guidelines for Compliance (GfC) aim to reduce uncertainty for UK businesses by providing greater clarity and transparency of HMRC's compliance expectations. They were first announced in November 2021 as part of the review of tax administration for large businesses, but only first appeared in 2024. They offer HMRC's view on complex, widely misunderstood or novel risks that can occur across tax regimes, including guidelines for employers, corporation tax and VAT, with HMRC's views on best practice set out in examples.

The guidelines are intended to help taxpayers understand HMRC's expectations and avoid non-compliance, highlighting approaches that can lead to inaccuracies and the need to pay more tax, interest and penalties. They also offer HMRC's insights into the practical application of the law and HMRC's administrative approaches, expanding the scope of HMRC material, beyond interpretation of the law. Importantly, GfC can be used to verify HMRC's "known position" for purposes of the Uncertain Tax Treatment (UTT) legislation.

Value chain analysis

Part 2 of GfC7 covers Common Compliance Risks and this section has now been expanded with the addition of new section 2.2.8 "Value chain analysis in functional analysis". Value chain analysis is essentially a functional analysis of how value is generated by the group as a whole, the interdependencies of the functions performed by the associated enterprises with the rest of the group, and the contribution that the associated enterprises make to that value creation. The new section recognises that value chain analysis is not a mandatory requirement under the OECD TP Guidelines (or UK law), but equally emphasises that it does offer "a structured approach to understand, across the different activities of a multinational enterprise (MNE), how value is: created, enhanced, [and] captured". As a result, the sections sets out HMRC's view of the best practice steps for carrying out the value chain analysis, common errors and suggested solutions.

In particular, HMRC considers that value chain analysis helps to delineate controlled transaction by both identifying the economically significant functions, assets, and risks across the group and understanding how these contribute to value creation. An MNE-wide description of the sources of competitive advantage which demonstrates how an MNE earns non-routine profit, is an important component of this analysis.

The guidelines note that a value chain analysis can be a useful bridge between relatively high level master file information on group-wide profit drivers and contributions and the more detailed UK entity level local file analysis.

HMRC considers that value chain analysis is likely to be valuable where:

• multiple entities contribute to value creation, such as in integrated supply chains, centralised procurement hubs, or shared service models
• intangibles or unique and valuable contributions are involved, and traditional one-sided methods may not capture the full picture
• business restructurings have occurred, and there is a need to assess changes in functional profiles and profit potential
• residual profits are significant, and allocation of such profits requires a clear understanding of contributions across the group.

Equally, however, HMRC recognises that not all MNEs will need to carry out value chain analysis and that the extent and depth of any value chain analysis should be guided by the principles of materiality and proportionality. For example, a value chain analysis is more likely to be appropriate where:

• the transaction or business line is material to the UK business financial results
• UK business is involved in economically significant functions, particularly in relation to intangibles or strategic decision-making
• there is a high degree of integration across jurisdictions, making it difficult to isolate contributions using one-sided methods
• a business restructuring in the MNE that affects the allocation of functions, assets, and risks.

Conversely, value chain analysis may not be necessary where the roles performed are routine, transactions immaterial or the time and effort taken to complete a value chain analysis are not proportional relative to the potential benefit, particularly if existing functional analysis already adequately reflects  value creation.

In either case, HMRC stress that it is best practice to maintain a supporting information file to include either the rationale for the value chain analysis and supporting data on which it is based or a record of how assurance was gained that the functional analysis was sufficiently robust to support the arm's length nature of the transaction without the need to perform a value chain analysis. HMRC note that this may well be helpful "should a later enquiry need to consider penalties".

Offshore procurement hubs

Part 3 of the guidelines covers indicators of transfer pricing policy design risk. HMRC have added a new section 3.8 on offshore procurement hubs, centralised structures in which an offshore principal or agent in an MNE group provides procurement services to a UK resident and other group entities by sourcing goods and or services from third parties, without significant modification.

The guidance focusses on two issues:

• business restructurings involving procurement hubs; and
• pricing involving procurement hubs.

In particular, HMRC note that they frequently observe inaccuracies arising from an excessive reward structures where there is limited functionality in the procurement hub, leading to profit shifting out of the UK or other group entities. The guidelines note that the complexity of the procurement hub's functions should determine its return. Services which amount to little more than the aggregation of buying functions typically result in a cost-plus mark-up, while more complex functions may warrant returns reflective of that complexity. However, the guidelines indicate that they would expect significant and detailed functional and comparability analysis to justify the use of transfer pricing methods other than routine cost plus. Simple savings as a result of group synergies should be shared among group entities based on their purchase volumes after any service of providing the synergy has been appropriately rewarded.

Comment

HMRC's guidance on the value chain analysis is an endorsement of its effectiveness when undertaking and importantly from a taxpayer's perspective, defending a transfer pricing analysis. HMRC's focus during enquiries and audits on the substance of value creation and the robustness of the functional analysis underpinning transfer pricing policies sets a very clear expectation on the approach businesses should take when designing and documenting their transfer pricing arrangements. As a result, a well-prepared value chain analysis can be decisive in:

• Demonstrating substance and defending transfer pricing: A value chain analysis provides a clear, structured narrative of how value is generated and shared within the group, which can be instrumental in defending the arm's length nature of intra-group transactions, particularly where HMRC challenges the allocation of profits or the characterisation of functions, assets, and risks.
• Reducing the risk of adjustments and penalties: By evidencing a thorough and proportionate approach to functional analysis, a value chain analysis can work in the taxpayer's favour when it comes to assessing penalties associated with transfer pricing adjustments in the context of an enquiry. HMRC's emphasis on maintaining a supporting information file is particularly relevant here, as contemporaneous documentation is a key factor in penalty mitigation.
• Facilitating a constructive dialogue with HMRC: A value chain analysis can serve as a common framework for discussions with HMRC, helping to clarify complex business models and the rationale for profit allocations. This can streamline the enquiry process and reduce the likelihood of protracted disputes.

The further guidance on offshore procurement hubs now captures what has been considered as HMRC's position on the matter through enquiries in the GfC7 but also outlines the threshold taxpayers have to meet in their functional and economic analysis to substantiate a pricing approach other than a routine cost plus.