What is transfer pricing and when does it apply?
Answered 11 March 2026
Transfer Pricing: Definition and Application in the UK
What the law says
The UK transfer pricing rules are contained in Part 4 of the Taxation (International and Other Provisions) Act 2010 (TIOPA 2010). The basic rule in TIOPA 2010 s.147(3) and (5) requires a person's profits and losses to be calculated for tax purposes by substituting an arm's length provision for an actual provision if certain criteria are met:
- A "basic pre-condition" is satisfied (TIOPA 2010 s.147(2)(a)); and
- The actual provision confers on the person or persons a potential advantage in relation to UK taxation (TIOPA 2010 s.147(2)(b) and (4)(b)).
The participation condition (TIOPA 2010 s.148) must also be met — broadly, this requires one party to participate in the management, control or capital of the other, or for a third party to participate in both.
Exemptions exist under the legislation:
- Small and medium-sized enterprises (SMEs): TIOPA 2010 s.166 provides an exemption, subject to exceptions in ss.167 and 168. A medium enterprise must have no more than 250 staff and either turnover below €50 million or a balance sheet total below €43 million. Where a company is part of a group, the limits are applied to the entire group.
- Dormant companies: TIOPA 2010 s.165 provides an exemption for dormant companies.
Notably, transfer pricing legislation does not apply to the calculation of a chargeable gain (or allowable loss), except to facilitate a claim under TIOPA 2010 s.174 where there has been a transfer pricing adjustment on the other party.
HMRC guidance / practice
What is transfer pricing?
Transfer pricing arises because the trading arrangements and pricing policies under which multinational groups operate can result in terms considerably different from those which would be seen between independent parties. OECD member countries have agreed that, to achieve a fair division of taxing profits and to address international double taxation, transactions between connected parties should be treated for tax purposes by reference to the amount of profit that would have arisen if the same transactions had been executed by unconnected parties — this is the arm's length principle.
The arm's length principle is applied to a controlled transaction by:
"replacing (hypothetically) the actual terms (price, etc.) under which a transaction was done with arm's length terms and (for tax purposes) recalculating the profits accordingly."
The arm's length principle is endorsed by the OECD and enshrined in Article 9 (the Associated Enterprises Article) of the OECD Model Tax Convention.
When does it apply?
Where someone has transactions with a connected party, transfer pricing rules may require tax to be calculated on the basis of what the arm's length provision would have been — if the actual provision confers a tax advantage compared with the arm's length result.
Importantly, the rules apply to both UK-to-UK and cross-border transactions (extended to domestic transactions by FA 2004).
The transfer pricing governance covers, among other things:
- Transfer pricing of goods and services
- Thin capitalisation (post-return)
- Private equity leveraged buy-outs
- Attribution of profit to permanent establishments
- Advance Thin Capitalisation Agreements
SME exemption in practice: There is no requirement for businesses classed as SMEs to make transfer pricing adjustments, however one of the parties may elect to apply the transfer pricing rules.
Citation sources
At the same time as FA 2004 extended the provisions of Sch28AA to UK-to-UK transactions, it introduced new exemptions (para 5A and B of Sch 28AA - now s165 and s166 of TIOPA 10) from the Transfer Pricing rules available for small and medium sized entities and also for pre-existing dormant companies. In respect of small to medium sized entities, provided the entities meet the size criteria, and provided the transactions are not with a connected entity in a territory without a double taxation agre
TIOPA10/S147(3) and (5) contains the basic transfer pricing rule, which is founded on the arm's length principle (see INTM412040). The rule requires a person’s or persons’ profits and losses to be calculated for tax purposes by substituting an arm’s length provision for an actual provision if certain criteria are met, which are that a ‘basic pre-condition’ is satisfied (TIOPA10/S147(2)(a)) and the actual provision confers on the person or persons a potential advantage in relation to UK taxation
It should be noted that transfer pricing legislation does not apply to calculation of a chargeable gain (or allowable loss) except to facilitate a claim made under TIOPA10/S174 where there has been a transfer pricing adjustment on the other party. See INTM480520.
OECD member countries have agreed that to achieve a fair division of taxing profits and to address international double taxation, transactions between connected parties should be treated for tax purposes by reference to the amount of profit that would have arisen if the same transactions had been executed by unconnected parties. This is the arm's length principle. For a variety of reasons, the trading arrangements and pricing policies under which multinational groups operate can result in terms
There have been no amendments to the other exemptions or the exceptions to those exemptions. In summary: TIOPA10/S165 (Exemption for dormant companies) and TIOPA10/S166 (Exemption for small and medium-sized enterprises (“SME”)) provide exemptions to the UK transfer pricing rules. TIOPA10/S167 provides for exceptions to the SME exemption. There have been no amendments to the related definitions at: TIOPA10/S172 - Meaning of “small enterprise” and “medium-sized enterprise” TIOPA10/S173 - Meaning
The transfer pricing governance (see INTM481030) applies from 1 April 2008 to any enquiry or potential enquiry where TIOPA10/Part 4 (formerly ICTA88/SCH28AA) or the arm’s length principle may be invoked, so it covers transfer pricing of goods and services post-return thin capitalisation private equity leveraged buy-outs attribution of profit to permanent establishments (but not the question of whether a permanent establishment exists) Advance Thin Capitalisation Agreements The transfer pricing g
Where someone has transactions with a connected party, then transfer pricing and thin capitalisation rules may require tax to be calculated on the basis of what the ‘arms length’ provision would have been - if the actual provision confers a tax advantage in comparison with the ‘arm's length’ result. The rules apply to transactions between UK taxpayers, as well as cross border transactions. There is an exemption for most transactions by small and medium-sized enterprises (as assessed on a ‘group’