HMRC Guidance on Risk

Delineation of transactions- risk analysis

Delineation of transactions is foundational for determining the most appropriate TP method & analysis of risk is the bedrock for accurate delineation of transactions. Recently HMRC issued guidance on risk w.r.t. transferpricing and also provided its view on certain contentious areas.

Some key takeaways from the HMRC’s Guidance for businesses is as below:

1. For TP, risks are effect of uncertainty on goals of business. Economically significant risks are relevant, not all risks. These can be identified by scale & likelihood of their realization.
2. Control over risk is not dependent on the level of management, but where decisions are taken on whether or not to pursue the opportunity as well as how to respond to risk associated when the opportunity is pursued. Hence, even a subsidiary may have control over the risk though overseen/reporting to Group, irrespective of it being party in the contract.
3. Entity having control over the risk can outsource the risk mitigating activity. Ex. entity controlling R&D risks can outsource R&D activity, provided outsourcing entity gives definite objectives for operations & supervises the other entity. Therefore, compensation for R&D service provider (or any entity to whom risk mitigating activity is outsourced) will depend on whether or not it has control over risk. In case of MNE Group having marketing entities in multiple jurisdictions with technology activity centralized in one jurisdiction, the economically significant risks w.r.t specificity & entities having control over such risks will have to be analyzed. This will decide if one-sided or two-sided method is appropriate, and for one-sided method which entity will earn routine return and retain residual returns respectively.
4. Multiple group entities may contribute to control over risk, but it will be allocated to entity having most control. Risk allocations cannot be purely based on the form of remuneration i.e., an entity compensated on variable returns as per contract does not mean the entity has de facto control over risk.
5. In most cases, compensation to entities contributing to the control over risk but not assuming (not allocated) control over risk will be priced through one-sided method. However, depending on the extent of contribution by the entity, use of a one-sided or two-sided method will be determined. Ex, where R&D risk is significant risk for a Group and 4 entities from different countries undertake R&D activities, R&D risk will be allocated to one entity which has maximum control. Whether or not the compensation for other entities will have to be priced using one-sided or PSM will depend on the extent of contributions by each of the entity.
6. Deciding the use of ex-post or ex-ante profits for PSM will depend on the extent of shared assumption of risk by the entities.