Transfer pricing is the pricing of goods, services, or intellectual property transferred between related entities within the same corporate group. It must follow the arm's-length principle — transactions should be priced as if between independent parties. Transfer pricing affects divisional profitability, tax obligations, and regulatory compliance.
In Depth
Transfer pricing determines how profit is allocated across entities within a group. When one subsidiary sells to another, the transfer price directly affects which entity reports profit and, critically, where taxes are paid.
The arm's-length principle, enshrined in OECD guidelines and UK tax law, requires that intercompany transactions are priced consistently with what unrelated parties would agree. HMRC actively scrutinises transfer pricing arrangements, particularly for transactions involving overseas entities.
Common transfer pricing methods include Comparable Uncontrolled Price (comparing to similar third-party transactions), Cost Plus (adding a markup to costs), Resale Price (working back from the resale price), and Transactional Net Margin Method (comparing net margins).
FP&A teams interact with transfer pricing when building divisional P&Ls, forecasting intercompany eliminations, and modelling the impact of structural changes on group tax. Changes to transfer pricing policies can shift reported profitability between divisions without any change in underlying operations.
For UK businesses, HMRC requires transfer pricing documentation for medium and large groups. The UK follows OECD guidelines with specific domestic rules in the Taxation (International and Other Provisions) Act 2010. Non-compliance can result in double taxation, penalties, and reputational damage.
Real-World Example
A UK group has a software development subsidiary in Edinburgh and a sales subsidiary in London. The Edinburgh entity develops software and licences it to the London entity, which sells to end customers. The transfer price for the licence affects how much profit each entity reports. The FP&A team works with tax advisers to set a licence fee at 30% of end-customer revenue, supported by benchmarking against comparable third-party licensing arrangements.
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