Transfer Pricing for UK Startups: When the SME Exemption Stops and Next Steps

Transfer Pricing for UK Startups: When You Need It

For a UK startup, international expansion is a clear sign of success. Setting up a US sales office for your SaaS product or an EU development hub for your biotech research means you are growing. It also introduces new financial complexities, one of which is transfer pricing. The term itself can sound intimidating, suggesting costly compliance and complex reports that feel disconnected from the day-to-day reality of managing runway and finding product-market fit.

Founders and early-stage finance leaders often worry about being caught out by rules designed for multinational corporations. The key question is a practical one: when does this actually become a mandatory problem for my startup to solve? For most UK startups, the answer is not right away. The UK has specific exemptions designed for growing businesses, and understanding the triggers is the first step towards managing this compliance risk effectively.

Understanding the UK's SME Exemption for Transfer Pricing

The best place to start is with the exemption. The UK provides a transfer pricing documentation exemption for Small and Medium-Sized Enterprises (SMEs). This is based on guidance from both UK law and the OECD. If your group of companies qualifies as an SME, you are not legally required to prepare the formal, detailed transfer pricing reports, known as a Master File and a Local File, that larger enterprises must maintain.

However, it is crucial to understand a key distinction. This is an exemption from preparing the documentation, not an exemption from the underlying principle. The arm's length principle can still be applied by HMRC even if a company is under the SME exemption thresholds. This principle states that the price for transactions between related companies should be the same as if they were transacted between two unrelated, independent parties.

So, while you may not need a 100-page report, you cannot simply move money between your UK and US entities without a commercial basis. You still need to demonstrate that your intercompany transactions are priced fairly and reflect where value is being created in your business.

The Thresholds That Trigger UK Transfer Pricing Documentation Requirements

This is where the details matter most. The SME exemption is not permanent and is tied to specific growth metrics. The rules are clear: a group loses its SME exemption in the period after it exceeds any two of the following thresholds for two consecutive accounting years.

The thresholds are:

• Turnover: €50 million
• Gross Assets: €43 million
• Headcount: 250 employees

A critical point often missed by founders is the scope of this test. It applies to the entire global group, not just the UK entity. You must aggregate the figures from your UK parent company and all its international subsidiaries to see if you cross the line.

Consider a synthetic example of a UK-based SaaS startup with international operations:

• UK Parent Ltd: 120 employees, €20M turnover, €15M in gross assets (including cash from a recent funding round).
• US Sales Inc: 30 employees, €25M turnover, €5M in gross assets.
• EU R&D Centre: 105 employees, €0 turnover (it is a cost centre), €3M in gross assets.

To test the thresholds for the group, you must combine these figures:

• Group Headcount: 120 + 30 + 105 = 255 employees
• Group Turnover: €20M + €25M = €45M
• Group Gross Assets: €15M + €5M + €3M = €23M

In this first year, the group has crossed the headcount threshold (255 is greater than 250) but remains under the turnover and asset thresholds. Because it only crosses one threshold, the exemption continues. However, if this situation, or one where any other two thresholds are met, repeats in the following year, the documentation exemption will cease to apply in the year after that. A scenario we repeatedly see is a large funding round unexpectedly pushing a group's gross assets over the €43 million threshold.

Master File and Local File: What HMRC Expects

Once your startup group no longer qualifies as an SME for transfer pricing purposes, the compliance requirements become formal and specific. The required documentation after crossing thresholds consists of a Master File and a Local File. This is not a task that can be handled with a few spreadsheets or managed by an outsourced bookkeeper alongside their regular duties.

The Master File is a high-level document. It provides a blueprint of your global group, outlining what your business does, your primary value drivers, your overall transfer pricing policies, and how you manage key assets like intellectual property. For a tech startup, this would describe where your IP is legally owned and where your R&D teams are located.

The Local File is specific to your UK entity. It provides a detailed analysis of the local company’s operations and, crucially, justifies the pricing used for every significant intercompany transaction it has. This involves economic analysis and benchmarking studies to prove the pricing is at arm's length. For example, it would justify the royalty rate paid by a US sales entity to the UK parent for the right to sell the software.

Failing to prepare these documents carries direct financial penalties. The initial penalty for failing to provide required documentation is £3,000 per file. More significantly, a tax-geared penalty of up to 30% of the potential tax understatement can be applied if pricing is adjusted and the company is found to be careless. The potential penalty and the management distraction of an HMRC enquiry are the primary risks to manage.

A Proactive Plan for Startup Tax Compliance in the UK

For a founder or COO overseeing finance, the goal is to manage this proactively without over-investing in compliance before it is necessary. Your approach should change based on how close you are to the thresholds.

If You Are Well Below the Thresholds

Your focus should be on good housekeeping, not formal documentation. This creates a solid foundation for future compliance and supports due diligence during funding rounds or an exit.

1. Use Simple Intercompany Agreements: For any recurring transaction between your group companies, like management services from the UK parent to a US subsidiary, have a simple one-page agreement. It should outline the parties involved, the services being provided, the pricing mechanism (e.g., cost plus 10%), and payment terms.
2. Track Transactions Clearly: In your accounting system like Xero or QuickBooks, create specific accounts for intercompany activity. Instead of posting a recharge to a generic 'Consultancy' account, use a dedicated 'Intercompany Management Fee Revenue' or 'Intercompany R&D Recharge' account. This makes the data easy to extract and analyse later.

If You Are Approaching the Thresholds

As your startup scales, your monitoring needs to become more formal. This is the stage where you transition from basic housekeeping to active risk management.

1. Monitor Group Metrics Quarterly: Do not wait for your year-end accounts. Start a simple spreadsheet to track your global, consolidated headcount, turnover, and gross assets every quarter. This gives you an early warning system and prevents surprises.
2. Plan Ahead for Documentation: If you forecast crossing two thresholds for a second consecutive year, you need to plan for producing a Master and Local File for the following financial period. This process can take several months, so starting the conversation with advisors early is essential. You can use our documentation checklist to understand what information you will need to gather.

For every startup, the exemption is a valuable safe harbour, but it requires active monitoring to ensure you do not drift out of it unprepared. The lesson that emerges across cases we see is that basic financial discipline from day one saves immense stress later, whether facing an audit, a funding round, or your first formal transfer pricing deadline. Building these simple habits now is one of the most effective risk-management steps a growing international startup can take. See the transfer pricing documentation hub for templates and checklists.

Frequently Asked Questions

Q: What is the arm's length principle in simple terms?
A: The arm's length principle is a standard used by tax authorities to ensure fairness. It means the price you charge a related company, like your US subsidiary, for goods or services must be the same price you would charge a completely independent, third-party customer for the same transaction.

Q: Do UK transfer pricing rules apply if my only other entity is a US sales office?
A: Yes. The thresholds for the UK's SME exemption are tested on a global group basis. You must combine the headcount, turnover, and gross assets of your UK parent company and all its international subsidiaries, including your US sales office, to determine if you need to prepare formal documentation.

Q: How much does transfer pricing documentation typically cost for a startup?
A: Costs vary depending on complexity, but startups should typically budget for a multi-thousand-pound project with a specialist advisor. This investment is often significantly less than the potential penalties from an HMRC adjustment and provides certainty for investors during due diligence, making it a valuable risk management exercise.

Q: Can we just charge a simple management fee between our UK and US companies?
A: You can, but it must be commercially justified. Even while exempt from formal documentation, you need a simple agreement defining the services provided, such as strategic guidance or HR support. The pricing must also be sensible, for example, charging for the cost of UK staff time plus a small markup of around 5-10%.