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HMRC internal manual

International Manual

Transfer pricing: Methodologies: OECD Guidelines: Which transactions to review

Intentional set-offs

A single company may have many different types of transactions with a single affiliate or a number of affiliates. The company under review may make purchases from and sales to the same affiliate; it may pay a royalty to the same affiliate for the right to manufacture. In these circumstances, it may be inappropriate to look at only the royalty since all three types of transaction form part of the overall trade of the company.

The OECD Transfer Pricing Guidelines address ‘intentional set offs’ at paragraphs 3.13 to 3.17. Essentially this recognises the fact that under commercial arrangements, parties might accept under or over pricing for certain types of transactions if they were happy with the overall receipts. If a company needs 100 units each of two products from the same supplier and the market price is £1,000 in total, then the company may be indifferent if the price of each product is £5 or the price of product 1 is £1 and the price of product 2 is £9, assuming the market price can be established. Alternatively, two companies might both buy from and sell to each other at the same time. In such circumstances they might agree a package deal covering the pricing of all the transactions.

This example illustrates the need to consider all relevant transactions between the parties. A company may ultimately accept that the price of its purchases from its parent company is too high but argue that this is cancelled out by the fact that other purchases were made at less than market price. In such a case the profits might be at arm’s length overall. It’s important to establish, as part of the initial review, risk analysis and information request, whether there are any such offsetting transactions.

More than two parties

Case teams should not accept claims that there should be set offs between more than two parties. For instance, it may be suggested that a company enjoys a lower than arm’s length profit on trade with one affiliate but a higher than arm’s length profit with another affiliate - so overall everything must be arm’s length. This does not reflect what would really happen at arm’s length - businesses endeavour to maximise their profit with every unconnected party they trade with.

The chapter on Risk Assessment (INTM482000 onwards) has further practical guidance on this issue at INTM482160.