Thought leadership from our experts

Transfer pricing: the new order

The old order: certainty

This is a time of change in the world of transfer pricing. Recent developments on the international tax stage have combined to remove many of the certainties that had developed over the past ten to fifteen years. These included advance pricing agreements (APAs) being readily available in many jurisdictions, confidence that pricing arrangements were not vulnerable to a transfer pricing enquiry, and certainty for long periods, with APAs lasting several years, often with a near-certain renewal when they came up for review.

What's driving change?

The drivers of change can be divided into what could be termed external and internal factors.

External factors

There has been a significant increase in tax transparency, with governments committing to share tax information and in particular tax rulings (including APAs), which the European Commission in particular has specifically targeted. The OECD's project to counter Base Erosion and Profit Shifting (BEPS) has also been a major contributor, with all OECD members and many other countries adopting country-by-country reporting under Action 13, as well as accepting enhanced transfer pricing documentation standards.

Information exchange and sharing in themselves are leading to tax authorities picking up ideas from their counterparts, in some cases leading to near identical audit approaches and even similar legislation.

Historical tax rulings (i.e. unilateral tax agreements) given in relation to transfer pricing have attracted some unwelcome attention. In particular, the recent European state aid decisions in the cases of Apple and Fiat have shone the spotlight on rulings issued by the Irish and Luxembourg tax authorities. The Apple state aid decision in itself has created uncertainty, with the European Commission seeming to apply its own version of the arm's length standard. These decisions, together with the "Lux Leaks" revelations and accusations of "sweetheart" tax deals with multinationals, have created a reluctance to grant rulings that might not stand up to state aid scrutiny. A further factor that could cause tax authorities to step back from rulings and settlements is the fear of the taxpayer revealing details, leading to adverse publicity and questions being asked.

The pressure has intensified on tax authorities from media, politicians and NGOs to increase tax collection and not to be seen in cosy relationships with big business. Much of this pressure focuses on multinationals' effective tax rates, which can often be explained but nevertheless creates a misleading impression without the fuller picture.

The BEPS transfer pricing Actions 8-10, that aim to align transfer pricing values more closely with value creation, have already seen parts of the OECD Transfer Pricing Guidelines rewritten, with the most recent development being new draft guidance on pricing hard-to-value intangibles. This has introduced new concepts and approaches into the transfer pricing arena, but interpretations can differ widely leading to uncertainty as to outcomes.

Technological developments are also agents of change, with both businesses and tax administrations able to use increasingly sophisticated systems and data.

Many of these factors have combined to increase competition between tax authorities in different countries to tax the same amount of income, with the inevitable consequence being a rise in disputes over double taxation.

Internal factors

Without doubt, we have now entered a new order: one of uncertainty, illustrated by "internal" factors that taxpayers in many countries are experiencing. For example, tax authorities seem to be issuing increasingly detailed information requests, sometimes resulting in taxpayers having to disclose thousands of documents. Correspondence about a disputed matter is protracted in many cases.

Overall, there has been a marked increase in tax audits, enquiries, discussions, disputes, and we now see a growing reluctance on the part of tax authorities to issue rulings, or even adjust existing rulings, and more obstacles for taxpayers in obtaining APAs. We believe this will continue to be the case moving forward.

A UK perspective: specific recent developments


In the UK there has been a noticeable shift in dealings with HM Revenue & Customs (and, to an extent) other tax authorities. In some cases, APA negotiations have been delayed or stalled. The increase in information-sharing between tax authorities means that any agreements of this nature will be much more closely scrutinised, so this development is at least partly responsible for the trend. Information on the value chain analysis is now routinely requested in enquiries and APA negotiations, with far greater interest being shown by HMRC in the global supply chain and how the UK entity fits within it. In addition, there are more discussions around whether profit-split mechanisms are relevant, and a move away from using cost-plus for sales-related functions.

The introduction of diverted profits tax (DPT) from April 2015 has had a significant impact on APAs, with HMRC including as part of the process in each case a review as to whether DPT could apply. The information gathered and related HMRC governance has had the impact of extending the time needed to obtain transfer pricing certainty to an almost unacceptable extent.

HMRC have also during the last year updated their guidance on the APA process. This places an increased emphasis on bilateral (rather than unilateral) APA arrangements and includes an express requirement that the formal APA application must be made within 6 months of any statement by HMRC that they are willing to accept an APA proposal (or longer as agreed). In addition, the level of documentation required has increased significantly.


A particular impact of the introduction of DPT is that HMRC not only have transfer pricing as a tool to adjust taxpayers' results, but they can completely recharacterise the transactions involved, most notably arguing that IP disposals would not have happened at arm's length, and taxing the profit associated with the IP at 25%. DPT is a powerful weapon, as HMRC have the ability to assess taxpayers based upon their own often very high estimates of liability, with no immediate right of appeal, and taxpayers must pay assessed amounts up front before applicability and negotiation over quantification can begin. Also, negotiation must be completed within 12 months, otherwise the tax paid can only potentially be recovered through the litigation process.

Dispute resolution

In a similar vein to the APA comments above, tax enquiries have become more resource-intensive, often requiring significant efforts by taxpayers to prepare and provide information, particularly so that HMRC can better understand the purpose of transactions and day-to-day activities of local personnel in relation to those transactions. However, it should be noted that there are still limits within UK legislation as to what, and how much, information HMRC are able to request, and at what point they should be reasonably required to come to final decisions on technical points. This was illustrated in the recent decision of the First-tier Tax Tribunal, in Eastern, London, South Eastern and UK Power Networks v. HMRC. The Tribunal's decision vindicated the taxpayers' approach of resisting detailed information requests from HMRC on the grounds of lack of relevance and seeking to have the technical debate first.

In the light of increasing expectations that the number, and intensity of, cross-border tax, and in particular transfer pricing, disputes will only increase, it will be instructive to see if the processes and recommendations introduced by BEPS Action 14 around this topic will be able to deal with this situation. HMRC appear to an extent to be struggling with the level of their own internal resources in dealing with both domestic and cross-border tax disputes, and the suspicion is that this will also be the position in many other jurisdictions.

Cash pooling

There has been much discussion in recent months on corporate interest limitation, with the UK introducing a new regime with effect from 1 April 2017, which restricts deductions for UK net interest expense in excess of £2m to 30% of EBITDA. This, together with the UK's new rules on hybrid mismatches, has dominated the discussion around financial transactions. However, with little fanfare or market notice, HMRC recently published new guidance on transfer pricing issues related to cash pooling – an issue closely aligned with inter-company debt. As companies evaluate their treasury arrangements, it is important to consider this new guidance and to assess whether the group's transfer pricing policies for cash pooling are aligned.

Through this action, HMRC is making it clear that it expects multinationals to come to terms with the challenges, and resolve them in a manner that is commercially sensible, and does not result in long-term loans disguised as a cash pool deposit, for example. The economic analysis can also be complex as groups face the task of setting rates on the cash pool that result in a sensible allocation of the overall cash pool benefit. Last but not least, HMRC also expects to see specific documentation addressing the issue.

Secondary adjustments

The Government has proposed introducing rules that will involve treating as a deemed loan any advantage arising from a transfer pricing adjustment in excess of £1 million. For example, if a UK company pays its overseas subsidiary a royalty of £10 million for a licence to use IP, and the arm's length price would have been £8 million, then following a primary adjustment, the tax deduction claimed by the UK company is reduced to £8 million, and its taxable profits increased by £2 million. However the overseas subsidiary retains the £2 million, which stays outside the UK tax net.

The secondary adjustment, if introduced, would treat the £2 million as a deemed loan from the UK company to its subsidiary, with the imputed interest (most likely at well above market rates) on that loan being taxable in the UK company's hands. It is not yet known for certain whether these proposals will be introduced, and if so, what the commencement date would be.


The pure storm of transparency under BEPS Action 13, revised transfer pricing standards under BEPS Actions 8-10 and increased interest from tax authorities and supranational bodies such as the European Commission mean that transfer pricing is at the forefront of the list of priorities for many multinationals' tax departments. The impact can be in the form of dealing with large numbers of fact-intensive tax disputes, substantial internal reviews by multinationals of long-held transfer pricing policies, resource-intensive preparation for new tax reporting processes, as well as restructuring of existing internal transactions and related transfer pricing policies in line with the BEPS outcomes. One of the main questions at this point is whether the resources of both the multinationals and also tax authorities are sufficient to cope with the high intensity level and high volume of transfer pricing-related issues arising, which are only likely to increase in the foreseeable future.