For many start-ups and SMEs, international growth is a strategic priority. Alongside the commercial drivers for business planning, the impact of doing business cross-border on the business’s international tax and transfer pricing position need to be considered. Failing to do so can mean the misreporting of profits (or losses) and taxes by group entities in different markets, tax adjustments and penalties, as well as brand and reputational damage.
Business model for international expansion
Start-ups and SMEs can be driven to expand internationally to access new consumer markets, employee talent pools, and low-cost or specialised manufacturing hubs.
A UK company’s presence overseas, however small, may trigger the taxing rights of the local market country. This may take the form of an overseas permanent establishment, for example, if local personnel act as dependant agents (e.g. sales representatives) or operate a fixed place of business (e.g. office, factory, shop) on behalf of the UK company. If an overseas branch or subsidiary is established, these are also clearly subject to international tax and transfer pricing as well as local tax rules.
Intra-group transactions and transfer pricing
When expanding internationally, start-ups and SMEs typically provide significant support to an overseas entity in its early years or continually. It’s important that this is on arm’s length terms and priced accordingly. Transfer pricing issues and disputes often arise in relation to a local market entity and other group entities, the following being common: :
Provision of management and support services: A local market entity receives strategic guidance from the business founders / management and support services (such as finance, HR, IT) from an overseas parent or other group entities, without charge
Sale of products: A local market (limited risk) distributor buys products from a group entity (e.g. at fixed prices for on-sale to local customers) with volatility in profit margins or resulting losses
Use of intangibles: A local market entity uses trademarks, technology (such as internal platforms), patents, copyright, or other intangibles (such as supplier lists) that are owned and developed by another group entity, without charge
Advance of funding: A local market entity receives a loan from a group entity, either favourable in amount or at a low or nil interest rate that is beyond what a third party would provide.
In the early years, an overseas entity is also likely to incur additional expenses to establish a new business in the local market. The bearing of risk can be acute, typically seen in large outlays on sourcing skilled personnel, customisation of products and services, and marketing campaigns tailored to domestic cultural and consumer preferences.
As a result, a key transfer pricing matter to usually address is whether the local market entity takes entrepreneurial risk and should bear the risk of operating losses, or if this resides in an overseas parent or another group company. If losses accumulate in the local market entity, a matching expectation can arise that it should retain entrepreneurial profits in the future (rather than pass these on through intra-group charges).
When start-ups and SMEs plan international operations, it is the important to manage the cross-border tax implications. If transfer pricing policy considerations are addressed after the event, there can be misalignments between the substance of the business arrangements and tax positions reported by group entities in different countries. Tax adjustments can not only deny an entity’s claims to tax losses but attribute income and profits, resulting in double economic taxation. Interest and penalties can apply depending on the level of non-compliance.
In determining the nature and pricing of intra-group cross-border transactions, withholding taxes, VAT and customs duties should also be managed.
Transfer pricing related business considerations
The transfer pricing arrangements of international groups are increasingly subject to greater reporting, documentation, information sharing, and scrutiny by tax authorities. Tax authorities are generally well attuned to and take action against any perceived tax avoidance by multinational businesses.
In the UK, SMEs should consider cross-border transaction reporting and documentation requirements in their overseas markets. The UK’s major trading partners, namely the US and EU Member States, typically have relatively low thresholds for tax compliance purposes.
As businesses grow internationally, tax transparency increases. Apart from demonstrating tax compliance by aligning value creation with profit and tax outcomes across group entities internationally, a robust transfer pricing strategy can facilitate international growth. Investors, whether through venture capital firms, IPOs or otherwise, seek confidence in business governance and compliance processes to provide funding and management buy-outs. Brand and reputation management are enhanced as well.
A transfer pricing strategy for start-ups and SMEs should recognise their specific requirements and circumstances. Entrepreneurial businesses can change rapidly, and transfer pricing policies need to be designed to be commercially adaptive, balancing cost and ease of implementation .
Our experienced Transfer Pricing team has the deep knowledge and insights to develop, document and help your business to implement appropriate transfer pricing policies in the UK and internationally. We work closely with our international network of professional advisory firms across PKF Global.
If you would like further guidance, please contact Farhan Azeem.