Transfer Pricing for Startups: Key Differences, Documentation and Practical Defenses

UK vs US Transfer Pricing: Key Differences

For a scaling startup, expanding internationally is a sign of success. Whether you are a UK SaaS company opening a US sales office or a US biotech spinning up an R&D team in the UK, creating a new legal entity is a major step. With that step comes an often-overlooked complexity: transfer pricing. While it sounds like a problem for large corporations, the tax rules governing transactions between your own entities apply from day one.

Missing the differing UK and US thresholds can trigger steep penalties and significant founder-level distractions, pulling focus from product and growth when you can least afford it. Understanding the core differences between HMRC and IRS expectations is not about becoming a tax expert; it is about protecting your runway and staying compliant.

Foundational Understanding: What is Transfer Pricing (and When Does it Matter)?

In simple terms, transfer pricing refers to the prices your company sets for goods, services, or intellectual property (IP) transferred between its own related legal entities across different countries. For example, if your US parent company provides management, finance, and HR support to its UK subsidiary, it must charge a fee for those services. Transfer pricing rules dictate how that fee is calculated.

The foundational rule is the 'Arm's Length Principle'. Both UK (HMRC) and US (IRS) tax authorities require intercompany pricing to be set at 'arm's length'. This means the price should be the same as it would be if the two parties were completely independent and unrelated. This principle prevents companies from shifting profits to lower-tax jurisdictions by artificially setting high or low prices.

For early-stage companies, this most commonly applies to management service fees, shared engineering costs, or royalties for using parent-company IP. The need to address it is triggered the moment you have cross-border transactions between related entities, even if formal documentation is not yet required.

First Question: Are You Small Enough to Be Exempt?

Uncertainty over whether your early-stage group qualifies for an exemption is one of the biggest initial hurdles for international tax documentation. The answer depends entirely on whether you are assessing your UK or US obligations, as their approaches to transfer pricing rules for startups are fundamentally different.

The UK's SME Exemption: A Clear Safe Harbor

In the UK, there is a formal, statutory exemption for smaller businesses (HMRC guidance). UK groups qualifying as Small or Medium-Sized Enterprises (SMEs) are generally exempt from core UK transfer pricing rules. This provides a clear safe harbor for many startups. The specific thresholds are what matter. According to the Finance Act 2022, the UK SME thresholds are: Fewer than 250 employees AND either a turnover of under €50 million OR a balance sheet total under €43 million.

A critical detail here is that the entire worldwide group must be evaluated. You cannot just look at your UK entity in isolation. If your US parent company has 300 employees, your small UK subsidiary with 10 people will not qualify for the exemption. For SaaS, e-commerce, and professional services firms experiencing rapid headcount growth, this is a key metric to track in your HR system alongside revenue in QuickBooks or Xero. See our practical checklist for UK startups.

The US Approach: A Practical but Unofficial Safe Harbor

The US approach is different and can cause confusion. This is a critical distinction. The US IRS does not have a broad SME exemption similar to the UK. The arm’s length principle technically always applies, regardless of your company's size. However, there is practical relief from the burdensome documentation requirements.

In practice, US documentation requirements are not imposed on groups with less than $50 million in annual gross receipts, though the arm's length principle still applies. For most pre-seed to Series B startups, this means the immediate risk of penalties is for having non-compliant pricing, not for failing to produce a specific report. What founders find actually works is focusing first on establishing a reasonable, documented pricing policy, even if it is just a simple internal memo. Practical steps for US startups are here.

Documentation Requirements: Master File, Local File, and CbCR

If your startup grows beyond the SME and safe harbor provisions, you will eventually face formal documentation requirements. The global standard, driven by the OECD Transfer Pricing Guidelines, is a three-tiered documentation package. These documents provide tax authorities with a comprehensive view of your global operations and transfer pricing policies. Here again, the UK and US have different monetary thresholds that determine when these filings become mandatory.

• Master File and Local File: This set of documents explains your global business (Master File) and details the specific intercompany transactions within a particular country (Local File). The UK threshold is a global turnover of €750 million, while the US threshold is a global turnover of $850 million.
• Country-by-Country Reporting (CbCR): This is a high-level report detailing revenue, profit, tax paid, and other economic indicators for every country you operate in. The UK threshold is a consolidated revenue of €750 million, and the US threshold is $850 million.

For a growing company, these thresholds may seem distant, but a scenario we repeatedly see is a company crossing them unexpectedly after a high-growth year or an acquisition. To make this concrete, consider a UK-based SaaS subsidiary receiving support from its US parent. Even if not formally required, a simple UK Local File memo might contain:

• Entity Overview: Description of the UK company, its market, and its role in the group (e.g., sales and marketing for the EMEA region).
• Management Structure: A simple organizational chart showing the reporting lines from the UK entity to the US parent.
• Intercompany Transactions: A clear description of the services received from the US parent (e.g., executive oversight, finance, HR, legal support) and the value of these transactions for the year.
• Functional Analysis: A brief explanation of who does what. For instance, the US team handles strategic direction and core R&D, while the UK team handles local customer acquisition and support.
• Pricing Methodology: A statement explaining the chosen method, such as "A cost-plus model is used, with a 7% markup on the allocated costs of providing the services."

Defending Your Pricing: Benchmarking for SaaS and Biotech Startups

Proving your intercompany pricing is 'arm's length' is the core challenge of transfer pricing compliance for startups. For large enterprises, this involves formal benchmarking studies using professional databases. These studies can be prohibitively expensive for startups and are often overkill. The reality for most early-stage startups is more pragmatic: you need a defensible rationale, not a 100-page report.

The most common and straightforward method for service-based charges is the cost-plus model. This involves calculating the total cost of providing a service and adding a reasonable markup. A common defensible markup for a cost-plus model on management services is 5-10%.

Here’s a practical example of a cost-plus calculation for a UK subsidiary of a US parent:

1. Identify Costs: The US parent's CFO and CEO spend 10% of their time on UK subsidiary matters. Their combined salary and benefits attributable to this time are $50,000. Add a share of overhead (rent, utilities for their office space), say $5,000.
2. Calculate the Cost Base: The total cost base is $50,000 + $5,000 = $55,000.
3. Apply the Markup: Choose a markup within the defensible range, for instance, 8%. The markup is $55,000 * 0.08 = $4,400.
4. Determine the Charge: The total management fee charged to the UK subsidiary for the year is $55,000 + $4,400 = $59,400.

This calculation, documented in a spreadsheet and referenced in board minutes, provides a solid defense against potential transfer pricing audits for early-stage companies.

For deeptech and biotech startups, the challenge is often pricing intellectual property. Consider a pre-clinical biotech with a UK entity holding the core IP for a drug compound. It licenses this IP to its US entity, which will manage future clinical trials and commercialization. Setting a royalty rate is complex. Without a budget for a formal study, the company could create a memo that documents the R&D costs incurred in the UK, researches public royalty rates for similar assets, and selects a rate consistent with that research, documenting the rationale. This approach demonstrates a good-faith effort to comply, which is far better than having no justification at all.

Practical Takeaways for Stage-Appropriate Compliance

For founders managing finance on spreadsheets alongside QuickBooks or Xero, the goal is not immediate perfection but progressive, stage-appropriate compliance. Transfer pricing compliance for startups should be a process, not a one-time project.

Pre-Seed and Seed Stage

Your first step is to determine if you fall under the UK SME exemption or the US practical documentation safe harbor. Carefully check the worldwide employee count and revenue against the thresholds. If you qualify, your main obligation is to ensure the price of any cross-border transactions UK US is reasonable. Create a simple, one-page internal policy memo that outlines your intercompany charges and the logic behind them. See our transfer pricing policy template for a simple starting point.

Series A and B Stage

As you grow, monitor your worldwide metrics against the exemption thresholds each quarter. If you are approaching them, it is time to formalize your process. Use your accounting system to more rigorously track and allocate the costs that form the basis of your service fees. Ensure intercompany agreements are in place. This is not about commissioning expensive studies yet, but about having the data ready and the rationale clearly documented, which de-risks future audits and investor diligence.

The key lesson is that tax authorities are looking for a logical and consistent basis for your pricing. For an early-stage company, having a defensible, documented rationale is infinitely more valuable than having nothing. Taking these small, practical steps early can prevent major cash flow hits and distractions down the line. For a practical hub on next steps, see transfer pricing documentation.

Frequently Asked Questions

Q: What's the most common transfer pricing mistake startups make?

A: The biggest error is focusing on the UK SME exemption based on local entity size alone, forgetting the worldwide group rule. This can lead to non-compliance when a US parent's headcount grows. In the US, the mistake is assuming the documentation safe harbor means the arm's length pricing principle can be ignored.

Q: Do transfer pricing rules apply if my startup isn't profitable?

A: Yes. Profitability is not a factor. Tax authorities require that cross-border transactions between your entities are priced at arm's length from day one. This is to ensure costs and future profits are allocated to the correct country, regardless of your group's current bottom line.

Q: Is a simple cost-plus markup always safe for intercompany services?

A: A cost-plus model with a 5-10% markup is a common and defensible starting point for routine administrative or management services. However, it may not be appropriate for high-value services or intellectual property licensing. The key is documenting why you chose that method and markup for your specific cross-border transactions.