The UK’s transfer pricing legislation is relevant for all firms, particularly in the financial services sector, where cross-border transactions are common. Appropriate reviews and documentation are essential to support intragroup transaction pricing. 

Overview

The transfer pricing legislation is based on the requirement that businesses must be remunerated commensurately with the relative value of the activities that they undertake. It ensures that the arm’s length principle is applied to transactions between connected parties. The arm’s length principle treats transactions between connected parties by reference to the amount of profit that would have arisen if the same transactions had occurred between unconnected parties.

Small or medium sized enterprises (SMEs) are exempt from the preparation of annual, formal documentation but are still expected to maintain records to support that they are acting within the arm’s length principle.

It is important to note, that this exemption does not apply to transactions where one enterprise is in a territory which is not a qualifying territory. A non-qualifying territory is a territory which the UK does not have a double taxation agreement with, and which has a suitable non-discrimination provision. 

HMRC includes a list of those territories with the appropriate double taxation article: HMRC - Double taxation agreements.

It is important to keep transfer pricing documentation up-to-date, as when requested by HMRC, they must be made available within 30 days. 

Our experience

Our fund or investment management clients are typically engaged in investment management and investment support services, involving a range of different transactions including:

• Back-office support services, such as HR, finance, administration and regulatory compliance;

• Middle-office and group management services;

• Marketing and distribution services;

• Investment research services; and 

• Discretionary investment management services. 

With clients operating across and expanding into different jurisdictions including for instance the US, Europe, and the UAE, we can prepare transfer pricing local files from a UK perspective and group master files, where required. In addition, we can review any existing transfer pricing policies, providing recommendations or improvements. 

Case study – different methodologies: 

A variety of methodologies exist to prepare the correct transfer pricing documentation. The selected methodology will be determined by the nature of the transactions involved. It is important to understand the roles of the different entities and where the functions and risks lie. In our experience, the most common methods used in the financial services sector are and the Residual Profit Split Method (RPSM), with the Transactional Net Margin Method (TNMM) and Organisation for Economic Co-operation and Development (OECD) low value-added services forming part of this functional analysis. 

To demonstrate how this works in practice, we have outlined below the approach for allocating profits between a Group with the provision of investment management services as the principal activity. 

The RPSM for a fund or investment manager is usually applied in six distinct sets:

• Total investment management and performance fees are identified;

• Support services falling within the OECD’s low value-add services are identified and remunerated appropriately at a mark-up of 2-5%;

• Middle-office and group management services are benchmarked under the transactional net margin method (TNMM) and allocated an appropriate mark-up;  

• The costs attributable to capital raising services, such as the marketing and distribution function of the Group, are benchmarked and allocated an appropriate higher mark-up; 

• (Where applicable) any external third-party costs are subtracted; and

• The residual profits are then weighted and apportioned between the relevant Group entities based on the relative value-add of the investment management sub-functions.

The RPSM determines the division of profits that independent enterprises would expect to realise when performing the transactions under review. It calculates the profit from the controlled transactions and splits those profits based on the contribution of each entity and is therefore consistent with what would have occurred at arm’s length.

Companies in the financial services sector should be aware of their transfer pricing obligations, even more so when engaging in intragroup transactions outside of the UK. We see this as particularly the case for groups with existing cross-border operations in the US or Europe, and commonly in fund managers expanding into the UAE. With our experience in understanding and analysing your business, benchmarking, and preparing full transfer pricing reports for entities within the sector, we are well-equipped to help you understand your specific requirements.