Understanding Transfer Pricing for UK Businesses: Rules, Exemptions, and Compliance
Transfer pricing is a term that many business owners have heard of but fewer fully understand. At its core, it is straightforward: when two companies that are connected – for example, a UK parent and its overseas subsidiary – trade with each other, the price they charge for goods, services, loans, or intellectual property must reflect what unconnected parties would have agreed in the same circumstances.
The reason these matters to HMRC is equally straightforward: if a UK company charges an artificially low price to its overseas subsidiary (or pays an artificially high one), profits are shifted out of the UK and UK Corporation Tax is reduced. Transfer pricing rules are designed to prevent this.
This guide explains the UK transfer pricing framework, who it applies to, what the exemptions are (including the important SME exemption), and what compliance looks like in practice.
Does Transfer Pricing Apply to Your Business?
This is the first question to answer, and the answer is not the same for every business.
The UK’s transfer pricing rules are contained in Part 4 of the Taxation Act 2010 (TIOPA 2010). They apply where:
- There is a ‘participation condition’ – broadly, where one party controls the other, or both are controlled by a common party
- The actual terms of the transaction differ from what would have been agreed between independent parties
- The UK tax position of one of the parties is advantaged as a result
In practice, this means the rules are most likely to apply to:
- UK parent companies with overseas subsidiaries
- UK subsidiaries of overseas parent companies
- UK companies that are part of international groups with common ownership
The SME Exemption: Most Smaller UK Businesses Are Not in Scope
This is the most important section for the majority of Cigma’s clients.
Section 166 of TIOPA 2010 provides a general exemption from the UK’s transfer pricing rules for small and medium-sized enterprises (SMEs). If your business qualifies as an SME under the relevant definition, you are not required to apply transfer pricing rules to your related-party transactions or prepare formal transfer pricing documentation.
The SME definition for these purposes is based on EU Commission Recommendation 2003/361/EC (as adopted into UK law). The thresholds are tested by reference to the entire group of which your company forms part:
| Category | Employees | Turnover | Gross Assets |
|---|---|---|---|
| Small enterprise | Fewer than 50 | €10 million or less | €10 million or less |
| Medium enterprise | Fewer than 250 | €50 million or less | €43 million or less |
| Large enterprise (in scope) | 250 or more | Over €50 million | Over €43 million |
Small enterprises are fully exempt. Medium enterprises are generally exempt, though HMRC has the power to issue a transfer pricing notice requiring a medium-sized enterprise to apply the rules in specific cases, particularly where transactions involve non-qualifying territories (broadly, tax havens or territories with which the UK does not have a double tax treaty).
Confirmed for 2025–26: Following an HMRC consultation that ran from April to July 2025, the government confirmed that the SME exemption will remain in place. A proposal to remove the exemption for medium-sized enterprises was considered but not adopted. SMEs will continue to benefit from the existing exemption.
When the exemption does not apply: Even if you qualify as an SME, the exemption will not protect you if your transactions are with entities in non-qualifying territories, if HMRC issues a transfer pricing notice, or if you elect to disapply the exemption. Transactions with entities in tax havens or countries on HMRC’s non-qualifying list carry more risk regardless of company size.
The Arm’s Length Principle
For businesses that are within the scope of the rules, the arm’s length principle is the foundation of transfer pricing compliance. It states that prices charged between related parties should be the same as those that would be charged between independent parties dealing at arm’s length in comparable circumstances.
This sounds simple but applying it in practice requires finding appropriate comparable transactions – which may not always be straightforward, particularly for transactions involving unique goods, services, or intellectual property.
The Main Transfer Pricing Methods
HMRC, following OECD guidelines, recognises several methods for establishing an arm’s length price. The best method depends on the nature of the transaction and the available data.
| Method | How It Works | Best Used For |
|---|---|---|
| Comparable Uncontrolled Price (CUP) | Compares the price in the related-party transaction to the price in an identical or similar uncontrolled transaction | Commodity transactions or where reliable market prices exist |
| Resale Price Method (RPM) | Works back from the final sale price, deducting an appropriate gross margin | Distribution arrangements where the reseller adds limited value |
| Cost Plus Method | Adds a mark-up to the cost of producing the goods or services | Manufacturing or service transactions between related parties |
| Transactional Net Margin Method (TNMM) | Compares net profit margins of the tested party against comparable independent companies | Most commonly used method in practice |
| Profit Split Method | Allocates combined profits between parties based on relative contributions | Highly integrated transactions or where both parties contribute unique assets |
Documentation Requirements
Small Enterprises (Exempt)
No formal transfer pricing documentation is required. However, it is still good practice to maintain basic records of intercompany arrangements – intercompany agreements, pricing rationale, and financial summaries – particularly for loan arrangements or management fee charges, where HMRC may still enquire even if the formal rules do not apply.
Medium Enterprises (Generally Exempt, But With Caveats)
Medium-sized enterprises are not required to prepare formal transfer pricing documentation, but HMRC can request it in specific circumstances. A sensible approach is to maintain internal documentation of pricing policies and the commercial rationale for intercompany arrangements, even if a full Local File is not required. If HMRC issues a transfer pricing notice, the business becomes subject to the same documentation obligations as a large enterprise.
Large Enterprises (Fully In Scope)
Large groups (those above the medium enterprise thresholds) must be able to demonstrate that their transfer pricing is arm’s length. For very large groups with consolidated group revenues exceeding €750 million, mandatory documentation requirements apply:
- Master File: A high-level overview of the group’s business, global transfer pricing policies, and how profits are allocated across the group
- UK Local File: Detailed documentation of specific intercompany transactions involving UK entities, including functional analysis and economic benchmarking
- Country-by-Country Report (CbCR): A filing that shows HMRC the group’s global allocation of revenue, profits, employees, and assets across each jurisdiction. Filed with HMRC and shared with other tax authorities through automatic exchange of information
Documentation must be available for HMRC review within 30 days of a request. HMRC has made clear that poor documentation will be treated as at least careless behaviour, which affects the penalty position if an adjustment is made.
Advance Pricing Agreements (APAs)
An Advance Pricing Agreement is an arrangement between a company and HMRC (and potentially one or more overseas tax authorities) that agrees in advance the transfer pricing methodology to be applied to specific transactions for a set period – typically three to five years.
APAs provide certainty. For businesses with high-value or complex intercompany arrangements, the cost of negotiating an APA is often far less than the cost of resolving a transfer pricing dispute after the fact. HMRC’s APA programme is available to UK businesses and covers both unilateral (UK only) and bilateral (UK plus another country’s tax authority) agreements.
Common Transfer Pricing Risks for UK Businesses
Intercompany Loans
A UK parent lending money to an overseas subsidiary, or vice versa, must charge an interest rate that reflects what a third-party lender would charge for the same loan. An interest-free loan, or one at an obviously below-market rate, is a straightforward transfer pricing issue. The correct rate depends on the creditworthiness of the borrower, the term, the currency, and the security provided.
Management Fees and Shared Services
Where a UK head office provides management, finance, IT, HR, or other services to overseas entities, a charge must be made and that charge must be justifiable. A flat management fee with no documented basis for the amount charged is a common weakness. HMRC expects to see evidence that the charge reflects the actual cost of providing the services plus an appropriate mark-up.
Royalties and Intellectual Property Licensing
Where a UK company licenses intellectual property – a brand, patent, or software – to an overseas entity, the royalty rate must reflect the arm’s length price for that licence. IP licensing is one of the highest-risk areas of transfer pricing globally, as IP can be difficult to value and is commonly used to shift profits to low-tax jurisdictions.
What’s Changing: The International Controlled Transactions Schedule
From accounting periods beginning on or after 1 January 2027, a new reporting requirement – the International Controlled Transactions Schedule (ICTS) – will apply to UK businesses within the scope of Part 4 TIOPA that are not classified as small enterprises. The ICTS will require businesses to report summary information about their cross-border related-party transactions directly to HMRC as part of their Corporation Tax return.
The ICTS is intended to help HMRC identify transfer pricing risks more efficiently. Businesses that are currently outside the formal documentation requirements but trade with overseas related parties should be aware that their cross-border arrangements will become more visible to HMRC from 2027 onwards.
