Transfer pricing: risk assessment: transfer pricing risk indicators: payment of significant management or service fees
Management or service fees paid to affiliates
The accounts and tax computations for a company may show significant deductions claimed for management and service fees paid to affiliates. For transfer pricing purposes, there are two key issues to consider when looking at such payments.
- The first is to consider whether the company would purchase the services if it was obliged to obtain them from an unconnected party. If the services in question do not add commercial value to the business then it may be correct to say that no tax deduction is appropriate.
- If the services do appear to add commercial value, then the second issue to consider is that of whether the price charged for them looks to have been set at arm’s length.
The OECD Transfer Pricing Guidelines explore these issues in more detail from paragraph 7.5 onwards. Paragraph 7.38 onwards offers some examples of transfer pricing issues which may arise when intra-group services are provided.
In order to help identify transfer pricing risks of this nature, the following questions should be considered where a company is paying large amounts of management or service fees to other group entities:
- From knowledge of the business, does the company seem to have a capable management team of its own? Is there potential for duplication where management fees are being charged?
- Are the fees large enough to reduce the company’s profits to negligible amounts, or even into losses? If the fees were to be added back, would the company then be making reasonable profits?
- Are the fees being paid to a connected party resident in a low tax state?
- Are the fees new; is this the first year they appear? If yes, is it clear from the detailed profit and loss account that they have replaced some previous class of expenditure, or are they likely to represent something new?
- Is the commercial benefit of the fees apparent from the description in the accounts and CT computation? Does it make sense for fees of this nature to be incurred in this type of business?