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HMRC internal manual

International Manual

Transfer pricing: risk assessment: transfer pricing risk indicators: comparing the results of the company and the group

Look at the group context

Case selection involves considering a number of factors together. One such useful factor can be to look at the results of the company, or a part of the group, in the context of the whole of the group’s performance.

Where a group has very few companies in the UK then it is easy to compare the results of those UK entities to the consolidated results of the group as a whole. It should be possible to take a high-level view of the functions performed, assets employed and risks assumed by the UK entities and then compare this to the wider group picture. If, for instance, it is clear that the majority of a profitable group’s key profit drivers are held by the UK entities then it is reasonable to expect that most of the group’s profit will fall to those UK entities. A significant unexplained mismatch is an indication of potential transfer pricing risk that would justify further research.

Where a large group has many entities in the UK then, unless there are consolidated accounts available, comparing the UK-wide picture to the global picture becomes more difficult. In order to make the comparison, an exercise would need to be carried out that attempted to consolidate the results of the UK entities. This can be a difficult exercise but in cases where there may be significant tax at stake it can be a worthwhile investment of resource.

Two scenarios are set out below to illustrate these concepts.

Scenario 1 is where the group as a whole is making losses.

Case teams should not accept statements to the effect that any particular company within a group should bear its ‘fair share’ of losses purely on the grounds that the group as a whole is loss-making. Each case is looked at on its own facts. A third-party business expects a profit for an activity irrespective of whether the person with whom it is trading is making a profit or a loss. If a loss-making group, for example, decided to outsource its warehousing, a third-party business might be engaged to provide those services. The third party would negotiate for the terms of the contract to be set in such a way that it would expect to make a profit.

Scenario 2, which is perhaps more common, is where the group as a whole is making healthy profits and a particular company (or set of companies) within the group is either making losses or minimal profits.

The issue of a company making consistent losses is considered in more detail at INTM482080. At first glance, it might seem significant that the company results are worse than those of the group as a whole. However, the functions performed, assets employed and risks assumed by the company must be compared with what the group does elsewhere. If, for instance, the company’s activities are the same as the group activities, and it owns an appropriate proportion of the group’s intangibles, then a direct comparison of results may be valid. The company however may own little or nothing in the way of intangibles. If the company, for example, merely carries out contract manufacturing for the group, and the group owns valuable intangibles, then the company’s profitability might well be lower than that of the group as a whole. Similarly, if the company is distributing well-known, popular branded goods, and it does not actually own any of those brands, then its profitability will be likely to be lower than the group’s as a whole. The key here is to ask whether the functions, assets and risks are earning an arm’s length reward.

A large disparity in the results of the company, compared with the group as a whole, is not in itself a good reason to select the case for a transfer pricing enquiry. Comparison must also be made between the functions performed, assets employed and risks assumed by the company and by the wider group, to put the results into a proper context. Comparing not just the results of the company and the group, but also the respective functional analyses of each, can greatly assist in securing a good understanding of the business as a whole.