A Startup Founder’s Guide to Low-Value Adding Services and the 5% Mark-Up

A Simplified Approach to Low-Value Adding Services

Your first international hire marks a major milestone. Suddenly, you have a UK parent company managing payroll, HR, and IT for a new US subsidiary, or vice versa. While the focus is on growth, this new cross-border relationship creates an immediate tax compliance need: transfer pricing. When one part of your company provides a service to another across a border, tax authorities like the UK’s HMRC and the US’s IRS expect an arm's length price to be charged. For a founder juggling product, sales, and fundraising, the thought of a complex international tax study is overwhelming. This is a common challenge for UK startups. Fortunately, for routine support activities, there is a globally recognized and much simpler path forward.

What Are "Low-Value Adding Services"? A Foundational Guide

When your UK-based finance person spends a few hours a month processing invoices for your new US entity, that’s an internal support service. It’s necessary for operations, but it isn’t your core, value-creating business. This is the essence of a low-value adding service.

The term 'low-value adding services' was officially defined by the Organisation for Economic Co-operation and Development (OECD) to describe services one group member provides to another that are supportive in nature, are not part of the core business, and do not involve unique, high-value assets or significant risks (Citation: OECD). These are the routine, administrative tasks that keep the business running smoothly in the background.

To help startups and multinational companies manage this, the OECD transfer pricing guidelines provide a globally recognized 'safe harbor' for these qualifying services (Citation: OECD). Think of it as a compliance shortcut. Instead of engaging in a costly and time-consuming analysis to determine the market price for internal HR support, this simplified approach gives you a clear, defensible formula. Crucially, this simplified approach avoids the need for a complex, expensive benchmarking study, saving precious time and runway for early-stage companies (Standard: OECD Simplified Approach). For guidance on documenting policies, see the simplified safe-harbor approach in our transfer pricing policy guide. This becomes a key part of your transfer pricing compliance for founders.

Part 1: Does Your Service Qualify? The "Support vs. Core" Test for Routine Intra-Group Services

Identifying which services qualify for this simplified method is the first and most critical step. The core distinction is between activities that support the business versus those that *are* the business. A service is not low-value adding if it’s a primary, revenue-generating function, a high-level strategic activity, or involves unique intellectual property.

To determine if a service qualifies, ask these fundamental questions:

• Is this a core part of our product or service? For a SaaS startup, the UK-based team writing code for the platform is a core activity. However, that same team’s IT helpdesk support for the US sales team’s laptops is a low-value adding service.
• Does this activity involve unique intangibles or high risk? For a Biotech company, the actual R&D conducted in a UK lab is a high-value, core function. But the centralized UK finance team that administers grant funding paperwork for a US research partner provides a support service.
• Is this a strategic, C-suite level decision? A UK-based CEO deciding on the US market entry strategy is a high-value strategic function. The administrative work to register the US entity, handled by a UK paralegal, is a routine intra-group service.

Common Examples of Qualifying Services

The pattern across early-stage startups is consistent: the services that typically qualify are administrative in nature. Common examples of these routine intra-group services include:

• Human Resources: Administering payroll, managing benefits, and handling onboarding paperwork for an overseas employee.
• Finance & Accounting: Centralized bookkeeping, invoice processing, and expense report management recorded in QuickBooks or Xero.
• IT Support: General helpdesk services, software license administration, and routine network maintenance.
• Legal & Administrative: Routine contract management, corporate secretarial tasks, and compliance filings.

If the service you’re providing falls into these categories and doesn’t represent your company's core value proposition, it likely passes the test for the OECD transfer pricing safe harbor for support services.

What Does Not Qualify?

Just as important is understanding what falls outside this category. The simplified method cannot be used for services that are central to your company's ability to earn profits. These include:

• Core research and development (R&D) activities.
• Manufacturing and production operations.
• Sales, marketing, and distribution functions.
• High-level strategic management and corporate governance.
• Financial transactions involving significant risk, such as hedging or treasury functions.

These activities create significant value and must be priced using more comprehensive transfer pricing methods.

Part 2: Calculating the Charge with the 5% Mark-Up Rule

Once you’ve identified a qualifying service, the next step is calculating the charge. This is where the simplified approach becomes powerful. The safe harbor allows for a standard 5% mark-up on the costs of providing the service (Threshold: 5%). This rule provides a clear and defensible price without needing external benchmarks. The calculation involves three key steps: determining the cost base, choosing an allocation key, and applying the mark-up.

Step 1: Determine the Total Cost Base

First, you need to pool all the costs associated with providing the service. This includes both direct costs (like the salary of the person performing the task and software licenses they use) and a reasonable portion of indirect costs (like office rent, utilities, and general IT overhead for that person). For instance, if your UK HR manager in London supports the US team, you’d include their salary, benefits, and a pro-rata share of the London office overhead in your cost pool. You can pull this data from your accounting software, whether it's Xero for the UK entity or QuickBooks for the US one.

Step 2: Choose a Fair Allocation Key

Next, you must split that total cost pool fairly across all the entities that benefit from the service. The allocation key must be logical, easy to track, and consistently applied. For startups, the simplest and most common keys are:

• Headcount: Best for services like HR or general IT support, where costs are generally driven by the number of employees.
• Time Spent: Ideal for legal or finance support where one person might dedicate specific, tracked hours to different entities. This requires diligent time tracking, often in spreadsheets.

Step 3: Calculate the Charge and Apply the Mark-Up

Finally, apply the allocation key to the cost base to find the portion of costs attributable to the receiving entity. Then, add the 5% mark-up to that allocated cost.

Example: UK SaaS Company Providing HR Support to its US Subsidiary

Let’s walk through a common scenario. A UK-based SaaS company with 20 employees provides centralized HR support to its new US subsidiary, which has 5 employees.

1. Identify the Total Cost Pool (Annual):
   • HR Manager Salary + Benefits: $90,000
   • Share of Office Rent & Utilities: $8,000
   • Share of HR Software & IT: $2,000
   • Total Annual HR Cost Pool: $100,000
2. Choose the Allocation Key:
   • Headcount is the most logical key. Total company headcount is 25 (20 UK + 5 US).
3. Calculate the Allocated Cost for the US Entity:
   • US Share = 5 employees / 25 total employees = 20%
   • Allocated Cost = $100,000 (Total Cost) * 20% = $20,000
4. Apply the 5% Mark-Up:
   • Mark-Up Amount = $20,000 * 5% = $1,000
   • Total Annual Charge to US Entity: $20,000 + $1,000 = $21,000

This $21,000 is the defensible amount the UK parent should charge its US subsidiary for the HR services provided. This is a core component of simplified transfer pricing methods.

This calculation must also satisfy the “benefit test,” meaning the receiving entity must have genuinely needed and received a service it would have otherwise had to perform itself or procure from a third party. In this case, since the US team has employees requiring HR support, the test is clearly met.

Part 3: Audit-Ready Documentation for Cross-Border Service Charges

A defensible calculation is only half the battle. You also need the right documentation to prove your methodology if questioned by tax authorities. Relevant tax authorities include the UK's His Majesty's Revenue and Customs (HMRC) and the US's Internal Revenue Service (IRS) (Citation: HMRC, IRS). For specific HMRC guidance, you can review the international manual on intra-group services: HMRC INTM440090. You can also see the UK vs US transfer pricing comparison for practical differences.

For a startup, this doesn’t mean a 50-page formal transfer pricing study. The reality for most Pre-Seed to Series B startups is more pragmatic: you need a simple, organized file that proves your process was logical and consistent. This is one of the most valuable aspects of the OECD transfer pricing safe harbor for support services. It simplifies not just the pricing but the documentation burden as well. To be audit-ready, you can prepare a straightforward “Three-Part File.”

Your Three-Part Documentation File

1. The Intercompany Agreement: This is a simple, one-to-two-page document signed by both entities. It should clearly state the nature of the service (e.g., “HR and payroll administration”), the pricing method (e.g., “total annual costs plus a mark-up of 5%”), how costs will be allocated (e.g., “based on relative headcount”), and payment terms (e.g., “invoiced quarterly”).
2. The Calculation & Evidence: This is the spreadsheet you used for the calculation, as shown in the example above. It should clearly list the items in the cost pool, state the allocation key used, and show the final marked-up charge. Keep source data handy, like payroll reports or overhead costs from Xero or QuickBooks, to support your numbers.
3. The Invoices & Proof of Payment: These are the actual intercompany invoices sent from the provider to the recipient, generated from your accounting software. The invoiced amount must match your calculation spreadsheet. You should also be able to show the corresponding bank transactions proving that payment was made. This closes the loop and demonstrates that the arrangement was not just on paper but was executed financially.

For a checklist-style template to build this file, see our transfer pricing documentation checklist. This three-part file provides a clear, logical, and evidence-backed narrative of your cross-border service charges. For a startup, this level of preparation is typically sufficient to satisfy scrutiny for low-value adding services and demonstrates good governance to potential investors and acquirers.

Practical Takeaways for Founders

For a founder expanding internationally, managing transfer pricing for support services doesn't need to be a source of anxiety or a drain on resources. The OECD’s simplified approach provides a clear and globally accepted framework for compliance.

The process boils down to three manageable steps:

1. Identify: Use the “support vs. core” test to confirm your service qualifies as low-value adding.
2. Calculate: Pool your direct and indirect costs, choose a simple allocation key like headcount, and apply the standard 5% mark-up.
3. Document: Create your “Three-Part File” with an intercompany agreement, your calculation spreadsheet, and the corresponding invoices and payments.

By following this pragmatic approach, you can meet your obligations to both HMRC and the IRS, maintain clean financial records, and focus your energy on what truly matters: building your company. Find templates and policies at the transfer pricing documentation hub. This is one of the most effective safe harbor rules for startups to leverage.

Frequently Asked Questions

Q: What happens if a service doesn't qualify for the simplified method?
A: If a service is part of your core business or involves high-value intangibles, you must use a standard transfer pricing method. This typically requires a more detailed functional analysis and a benchmarking study to determine an arm’s length price, which is a more complex and costly process.

Q: Can we use a mark-up other than 5% for low-value adding services?
A: The 5% mark-up is the designated "safe harbor" rate. While you can use a different mark-up, doing so requires you to provide evidence and benchmarking to justify it, which defeats the purpose of the simplified approach. Sticking to 5% provides certainty and minimizes compliance risk for qualifying services.

Q: How often do we need to update these calculations?
A: You should review and update your cost pools and allocation keys annually. Your costs, headcount, and other business metrics will change as you grow, so the allocated charges must be recalculated each fiscal year to remain accurate and defensible. Consistency in methodology is key from year to year.

Q: Is a formal intercompany agreement legally necessary?
A: While not always a strict legal requirement for the service itself, it is essential for tax defense. An agreement demonstrates to tax authorities like HMRC or the IRS that the arrangement was planned, deliberate, and commercially grounded from the start, rather than an afterthought to shift profits.