Taxman to investigate transfer pricing errors

Multinational companies that invest heavily in research and development and other forms of intangible assets be warned. This year the taxman is likely to be paying more attention to how these forms of intellectual property are transferred within companies.

Transfer pricing, which refers to the price that units of the same company charge each other for goods and services, accounts for more than half of all world trade. Companies are supposed to charge market rates for the internal transactions, setting prices at so-called ‘arms length’.

But tax authorities believe large companies use transfer pricing to charge artificial prices for internal transfers to avoid tax by moving their profits to low-tax countries.

HM Revenue & Customs is expected to introduce a framework for penalties applied to erroneous transfer pricing documentation in April this year. It is thought the minimum penalty applied will be 10% of the total tax lost to HMRC, with the total penalty depending on the severity of the error.

So far, the UK taxman has focused on what constitutes the market value of tangible goods and services when exchanged within a multinational company and whether the rate applied reflects the market.

However, tax experts believe that HMRC is likely to start paying more attention to the transfer pricing of intellectual property.

The pricing of IP is particularly relevant in sectors such as pharmaceuticals, where companies spend billions of pounds on research and development. In 2006

GlaxoSmithKline, the world’s second biggest drugs manufacturer, was fined $3.4bn (£2.3bn) by the US Internal Revenue Service (IRS).

But placing a value on intangibles such as commercial ideas, know-how, brands, patents and processes is difficult, according to Bill Dodwell, head of tax policy at Deloitte.

He added that tax authorities and companies would struggle to reach agreement on IP values.

Andrew Hickman, a transfer pricing partner at KPMG, said companies that transfer more intangible assets than goods and services within their group run a greater risk of tax investigations, due to uncertainty over the value of IP.܀