The UK allows a broad exemption from transfer pricing rules for small and medium-sized companies (SMEs) – in most situations:
- Small enterprises – no more than 50 staff and either an annual turnover or balance sheet total of less than €10 million.
- Medium enterprises – no more than 250 staff and either an annual turnover of less than €50 million or a balance sheet total of less than €43 million.
However, as of 1 April 2019, an anti-profit-fragmentation rule becomes effective to prevent UK businesses from avoiding UK tax by arranging for business profits to accrue to entities resident in jurisdictions with significantly lower tax rates than in the UK. These provisions effectively impose transfer pricing rules on certain SMEs requiring them, in fact, to demonstrate that transactions with offshore entities occur at arm’s length.
The profit fragmentation arrangement rules apply where an entity conducting a trade in the UK intentionally diverts profits to an entity offshore in a jurisdiction with a significantly lower rate of taxation. More specifically, the rules apply where:
- There is a transfer of value derived from a UK trade to an entity in a lower tax jurisdiction; and
- The extra tax payable overseas is less than 80% of the reduction in UK tax (broadly); and
- A UK related entity has arranged for the profits to be diverted and can continue to “enjoy” them; and
- The value transferred is greater than it would have been had the transfer occurred between independent parties acting at arm’s length.
In this case, a UK business transacting with a related party in a lower tax jurisdiction will have to demonstrate that such transactions are arm’s length to avoid adjustments. This applies to SMEs that might otherwise avail of the general transfer pricing exemption in the UK.