The transfer pricing implications of Brexit

July 27, 2016

The UK’s decision to leave the European Union could have two significant impacts on the transfer pricing environment in the UK: freedom from the relevant EU Directives, and movement of companies or financial and other assets, either into or out of the UK.

In a nationwide referendum on June 23 the UK voted to leave the EU. Politicians in the UK and Europe must negotiate how this decision should best be put into practice, meaning the long term impact for UK legislation and practice on transfer pricing is uncertain.

Multinationals will need to consider how the changes made during the exit negotiations affect their transfer pricing. In particular, companies will need to examine the impact of the UK no longer being subject to EU Directives and how assets and companies can be moved into, or out of, the UK.

EU Directives

In terms of the EU Directives, the UK may no longer have to comply with the EU’s transfer pricing framework that includes the following requirements:

Requirement	Commentary
The EU common transfer pricing documentation format	To date, the EU has only recommended rather than required this format.
The European arbitration convention for resolving transfer pricing disputes	Member states have been very reluctant to use this mechanism.
The EU’s interpretation of country-by-country reporting (CbCR)	Subsidiaries of UK companies located within the EU would still need to report according to the EU format. If the parent company is not an EU tax resident and does not file a report, it must do so through its EU subsidiaries. Individual member states can choose whether to introduce such secondary reporting for the 2016 fiscal year, but becomes mandatory from the 2017 fiscal year.
The EU’s draft version of the BEPS Action 4 interest restriction rule	The UK is already developing its own interpretation.
Restrictions on state aid	The European Commission has begun applying transfer pricing rulings and APAs to infer very large underpayments of tax.
Draft proposals for a Common Consolidated Corporate Tax Base (CCCTB)	This would replace the international arm’s-length principle of transfer pricing.
EU impact assessments	The UK must perform EU impact assessments to ensure that any proposed change to UK tax legislation is in conformity with EU law.
European Court of Justice (ECJ) judgments	There is a possibility that ECJ judgments may require changes in UK transfer pricing legislation.

More generally, the UK may choose to comply with certain relevant Directives in order to avoid EU sanctions, or a post-Brexit deal with the EU may require the UK to accept certain EU Directives and/or the jurisdiction of the ECJ in certain matters. This would be the case, for example, if the UK were to pursue either of the following routes:However, the impact of Brexit on UK transfer pricing might not be too dramatic. This is because the EU’s Directives which bear on transfer pricing are broadly designed to implement the OECD’s guidance in this area, which itself is explicitly embodied in the UK’s transfer pricing legislation.

A bilateral agreement with the EU, similar to the series between Switzerland and the EU. The UK would negotiate the best deal that it could achieve with the EU – for example, in addition to not being subject to EU tax rules, Switzerland is not subject to EU state aid rules.

It should be noted, however, that the EFTA is not an EU-affiliation mechanism, amounting only to a free trade agreement between its four members (Iceland, Liechtenstein, Norway and Switzerland) for goods and services, together with some coverage of areas such as investment and the free movement of persons. Thus, even if the UK were to join the EFTA, it would still be obliged to negotiate its relationship with the EU within one of the two mechanisms outlined above (EEA or bilateral).

Depending on market sentiment after a Brexit, relative confidence in the UK economy may cause companies to move their assets or operations to or from the UK, with transfer pricing implications and requirements that could include the following:

Debt capacity and interest rate reviews for new investments;
Comparison of alternative intellectual property (IP) holding jurisdictions, IP valuation and transfer and royalty rate reviews;
Supply chain reviews including risk allocation and centralisation of high value functions; and
Resolution of existing transfer pricing audits or litigation.

Other implications for funds include debt capacity and interest rate reviews for new private equity investments and banks and financial institutions may require due diligence of multinational borrowers’ after-tax financial forecasts.

In terms of an immediate transfer pricing response to what is still only the possibility of Brexit, and a Brexit that could take a wide range of forms, we recommend that businesses should prepare for the possibility of having to replace or top up third party finance with related party finance. In addition, they should also begin (as a precautionary measure) to consider alternative locations for their IP and their activities, taking into account a lower UK exchange rate and tax rate, but potentially less access to European markets and a higher cost of capital. Finally, they should consider whether transfer pricing bench marking studies might need to be updated sooner than planned.

For more information, contact Danny Beeton, Managing Director, at +44 207 089 4771, Shiv Mahalingham, Managing Director, at +44 207 089 4790 and Richard Newby, Managing Director, at + 33 014 006 4065.