Creating Your First Transfer Pricing Policy: A Simple, Defensible Guide for Founders

Understanding Transfer Pricing: When Does This Actually Matter?

As a founder, you need to think about transfer pricing at a specific moment: when you have multiple related legal entities in different countries that transact with each other. The critical distinction is between having a single legal entity operating abroad versus separate, related companies.

For example, if your UK-based company hires employees working remotely from the United States, that is primarily a payroll and human resources issue. However, if you establish a UK-incorporated parent company and a separate US-incorporated subsidiary, any transaction between them falls under transfer pricing rules. This is a crucial concept covered in our startup transfer pricing basics guide.

The entire system is built on one core idea: the arm's length principle. Tax authorities like the UK’s HMRC and the US’s IRS require that transactions between your own companies are priced as if they were between two completely independent businesses. Think of it this way: what would you charge a random third-party customer for the same service? That is your arm's length price. The goal is to prevent companies from artificially shifting profits to countries with lower tax rates to reduce their overall tax burden.

For growing startups, several types of intercompany transactions are common:

• Development Services: A UK deeptech entity, which employs your core R&D team, builds a new software feature. The US parent company, which will ultimately sell the product, pays the UK entity for these development services.
• Management and Administrative Services: A US parent company provides executive leadership, finance, legal, and HR support to its UK e-commerce subsidiary. These central services have value and must be charged for appropriately.
• Sales and Marketing: A US sales entity is established to sell into the North American market. It earns a commission or service fee from its UK SaaS parent company for generating local sales and managing customer relationships.
• Intellectual Property (IP) Licensing: A US biotech parent company owns the core patents for a new drug. It licenses this IP to its UK subsidiary to conduct preclinical research, and in return, the UK entity pays a royalty.

These transactions must be properly recorded under local accounting standards. For US companies, this typically falls under US GAAP, while UK startups generally follow FRS 102. Understanding these rules is the first step in building a robust transfer pricing compliance checklist.

How to Set Up Transfer Pricing for Startups: A 3-Step Framework

At the pre-seed to Series B stage, you do not need a hundred-page formal transfer pricing study from a Big Four accounting firm. That level of analysis is often premature and expensive. What you do need is a simple, defensible policy that documents your logic and shows you have acted in good faith. For most early-stage startups, a clear internal memo is a significant step toward good governance and risk management. This proactive approach demonstrates to tax authorities that you have considered the rules and established a reasonable basis for your pricing. Here is how to create that framework.

Step 1: Map Your Intercompany Financial Flows

Before you can price anything, you must first identify what you are pricing. The initial step is to map and list every single transaction that occurs between your related legal entities. This does not need to be a complex analysis. A simple list or spreadsheet is perfectly sufficient. The most common pattern for early-stage companies is that founders overlook internal services that have real, tangible value, such as occasional management advice or administrative support from the parent company.

Create a simple map that clarifies the following for each transaction:

• Provider Entity: The company delivering the service or asset.
• Recipient Entity: The company receiving and benefiting from the service or asset.
• Transaction Description: A clear, one-sentence summary of the activity.
• Proposed Pricing Method: The logic you will use to price it (more on this next).

For example, imagine a UK-based SaaS company that has just set up a US sales office. The intercompany flows might look like this:

• Transaction 1: The UK Parent Ltd provides ongoing software development and maintenance to support the product being sold in the US. The proposed pricing method would be the Cost-Plus method.
• Transaction 2: The new US Sales Inc. provides sales and marketing services to win customers in the US market. The UK parent would compensate it for these services, likely using a Cost-Plus or commission-based method.
• Transaction 3: The UK Parent Ltd provides centralized management, finance, and administrative support to the US subsidiary. Again, the Cost-Plus method is a suitable choice here.

This simple exercise provides essential clarity. It also forms the foundation for your future intercompany agreements for startups, which formalize these arrangements in a legal contract.

Step 2: Select a Simple, Defensible Pricing Method

Once you know what the transactions are, you need to determine their price. While there are five official OECD methods for calculating an arm's length price, early-stage startups can almost always start with the most straightforward one: the Cost-Plus Method.

The logic is straightforward. First, you calculate the total costs the provider entity incurred to deliver the service. This "cost base" includes both direct costs, like the salaries and benefits of the developers working on a project, and a reasonable allocation of indirect costs, like their share of office rent, utilities, and software licenses. In accounting software like QuickBooks or Xero, you can use tracking categories or classes to tag these specific expenses, which makes calculating the cost base much easier.

Next, you add a "markup" to this cost base. The markup represents the profit element. It is the amount the provider entity would reasonably expect to earn for its effort and risk if it were selling the same service to an independent customer. For many routine services, you do not need to commission an expensive benchmarking study. For low-risk support, administrative, or development services using the Cost-Plus method, a markup in the 5% to 15% range is a common and defensible starting point. This range is generally seen by tax authorities as reasonable for standard, low-complexity services.

Step 3: Draft Your One-Page Transfer Pricing Policy Memo

Finally, you consolidate your logic into a simple internal memo. This document is your primary evidence that you have proactively considered your transfer pricing obligations. It should be clear, concise, and easy for anyone to understand, including a future CFO, investor, or tax auditor. This memo becomes your go-to guide for how to document related party transactions.

Here is a mini-template you can adapt for your `transfer pricing policy template`:

1. Purpose: To establish a policy for pricing intercompany transactions between our entities that complies with the arm's length principle, as required by tax authorities including HMRC in the UK and the IRS in the US.

2. Parties Involved:

• [Your UK Company Ltd], a company incorporated in the United Kingdom.
• [Your US Company Inc.], a company incorporated in the United States.

3. Intercompany Transactions Identified: Based on our current operational structure, the primary intercompany transaction is the provision of software development and R&D services from [Your UK Company Ltd] to [Your US Company Inc.].

4. Chosen Methodology: Cost-Plus Method. We have selected the Cost-Plus method to price these services. This method is appropriate because it is a low-risk, routine service where the value is directly related to the costs incurred in its provision.

5. Markup Applied: A markup of 10% will be applied to the total cost base. This cost base will include all direct and allocated indirect costs associated with the R&D team in the UK. This markup is considered to be within the arm's length range for these types of services.

6. Implementation and Record-Keeping: All relevant costs will be tracked in Xero using a dedicated tracking category. An intercompany invoice will be raised on a quarterly basis from the UK entity to the US entity. Payment will be settled via bank transfer within 30 days. All calculations, invoices, and this policy memo will be stored centrally for compliance purposes.

Putting Your Policy into Action: Practical Steps and When to Escalate

Creating the memo is the first half of the process. The second half is implementation and knowing when you have outgrown this simple policy. Getting this right is about good governance and risk management, not aggressive tax optimization.

Practical Takeaways for Founders

• Execute the Transactions: A policy is meaningless without action. You must actually create the invoices in QuickBooks or Xero, record them properly in both entities' books, and have the cash move between the respective bank accounts. This demonstrates to tax authorities that your policy is operational and not just a theoretical document.
• Document Everything: Keep your policy memo, the spreadsheets you used to calculate the cost base, and copies of all intercompany invoices together in a secure folder. This packet is your evidence. An incomplete understanding of HMRC and IRS `transfer pricing rules UK USA` is a common pain point, and this documentation is your best defense in an audit.
• Keep it Simple and Consistent: Your goal at this stage is compliance, not complexity. You are creating a defensible position that shows you made a reasonable effort. The approach should be logical, easy to explain, and applied consistently every quarter or year.

When to Escalate to a Specialist Advisor

A DIY policy memo is a perfect starting point, but it has its limits. Almost every growing startup reaches an inflection point where a more formal, expert-led approach is necessary. You should consider engaging a specialist transfer pricing advisor when your business hits one of these triggers:

• You transfer valuable IP: If you are formally licensing or selling your core patent, algorithm, or brand from one entity to another, a simple cost-plus method is no longer sufficient. Valuing and structuring how you transfer valuable IP requires specialist analysis to determine an appropriate royalty rate.
• Transaction volumes become significant: As your intercompany revenue or balances grow into the millions of dollars or pounds, the level of potential scrutiny from tax authorities increases significantly. Higher stakes require stronger evidence.
• You expand into more countries: A simple UK-US structure is one thing. Adding entities in Germany, Singapore, and Canada creates a complex web of transactions that requires a more robust, globally consistent policy.
• You are preparing for a Series B or C round, or an exit: Sophisticated investors and acquirers will perform detailed due diligence on your tax and legal structure. Having a formal transfer pricing study from a reputable firm demonstrates operational maturity and reduces perceived risk, making the deal smoother.

Conclusion: A Proactive Step Toward Good Governance

For an early-stage founder, transfer pricing should not be a source of fear or complexity. It is a logical component of responsible international expansion. By focusing on the fundamentals, you can create a policy that is both compliant and practical for your startup's current stage. The process is simple: map your internal transactions, apply a reasonable pricing method like cost-plus, and document your logic in a concise policy memo. This proactive step provides a clear audit trail and establishes a solid foundation for future growth. For more resources, visit our transfer pricing documentation hub.

Frequently Asked Questions

Q: Can we just charge a flat "management fee" from the parent company without a detailed policy?
A: It is highly discouraged. Tax authorities can easily challenge arbitrary fees that lack a clear calculation methodology. A policy based on the Cost-Plus method, showing how you arrived at the fee based on actual costs, provides a much more defensible position against scrutiny.

Q: Do we need a formal intercompany legal agreement in addition to the policy memo?
A: Yes, it is best practice. The policy memo explains your pricing logic internally, while an intercompany agreement is a legal contract that formalizes the relationship and obligations between your entities. This agreement is what third parties, like auditors and tax authorities, would expect to see for a true arm's length arrangement.

Q: What happens if we get the markup percentage slightly wrong?
A: If you have a well-documented policy and a reasonable basis for your chosen markup, tax authorities are more likely to propose an adjustment rather than issue severe penalties. The key is demonstrating a good-faith effort to comply. A 10% markup might be adjusted to 12%, but having no policy at all is a much greater risk.

Q: How often should we review our transfer pricing policy?
A: You should review your policy annually or whenever a significant business change occurs. This includes launching a new product line, opening an entity in a new country, or undertaking a new funding round. Keeping your documentation current is a critical part of maintaining compliance as you scale.