HMRC Guidance – Risk Indicators For TP Policy Design

HMRC UK issued Guidance for compliance (in 3 parts) on 10 Sep 2024 on common risks in TP approaches for MNE. Part 3 of the guidance sets out a list of non-comprehensive high-risk indicators (that can result monetary outflows) on TP policy design risk, which is discussed in this post. Few key takeaways from the guidance for businesses w.r.t. TP:

1. Intercompany contract to always reflect actual conduct between group entities, and returns / profits cannot be attributed solely on the basis of contract in absence of actual assumption of relevant risks / performance of functions. Further to attribute residual returns, entity to perform key functions / bear economically significant risks.
2. Functions performed / value creation of entity to be looked wholistically. Where entity performs multiple complex functions, TP policy should not fragment these functions into separate routine activities providing fixed low returns.
3. Economically significant risks w.r.t. IP cannot be outsourced and will have to be controlled by the owner, including capacity & capability to bear the risk. Where an entity undertakes future additional development (performing & controlling DEMPE) to existing IP which it does not own, such entity will have to receive the residual return attributable to additional development and not owner of original IP. Benefits should correspond to royalty / fees paid for license of IP. Entities should document internal/external CUP w.r.t. intangibles. Robust documentation for waiver of royalty w.r.t. non-sales related factors.
4. Entity in a CCA generating losses will have to be documented, as no third parties would be part of such CCA, without expected future profits. Returns to be updated & commensurate with functions, in case of material changes to functions & risks of entities in a CCA.
5. Entity performing global or regional functions, having positive impact on group entities’ revenue / profit cannot be grouped under low-value adding activities. Continuous non-charging for services rendered is not arm’s length in nature.
6. Entity to be appropriately compensated on cost or revenue as applicable. Parallelly each cost center / function or activity to be accurately delineated &compensated & not generalizing it as routine services.

Where risk indicators are identified, one can adopt the best practices in the guidance to reduce such risks, and if identified but has not resulted in TP risk – one has to maintain detailed documentation to substantiate the same.

The guidance from HMRC provides a sneak-peek partly into riskassessment framework of tax authority, ensuring transparency and certainty w.r.t. expectations of the Revenue. Though this guidance is issued by HMRC, the basis / principles of these risk indicators can be applied across jurisdictions.