The current transfer pricing environment in the banking and asset management sector, and the importance of regular review

The financial services sector remains firmly in the spotlight of global tax authorities and prudential regulators. Whether it is HMRC in the UK or the Internal Revenue Service (IRS) in the US, understanding how money moves between regulated entities and overseas affiliates is a hot topic. In this respect, regular reviews of how arrangements are priced, performed and documented is key. Transfer pricing documentation not only gives tax authorities the information they need to ensure that entities are paying the right amount of tax in the right location, but it also provides crucial information for regulators to ensure their regulated entities are being fairly compensated and that transfer pricing arrangements are not creating any potential capital adequacy issues.

More recently, the Organisation for Economic Co-operation and Development (OECD) and tax authorities globally are continuing to overhaul the international tax framework under Pillars 1 and 2. While banks and asset managers are generally not in the scope of Pillar 1, Pillar 2 is very much relevant which raises further scrutiny on their transfer pricing arrangements.

Furthermore, HMRC proposed reforms in January 2024 to update domestic transfer pricing legislation to make the rules more straightforward, more certain and better aligned with tax treaties. The proposed reforms would also improve alignment between domestic law and the OECD Transfer Pricing Guidelines. In addition, for periods beginning on or after 1 April 2023, the UK requires groups with revenue above €750m to have an master file and local file in line with the requirements of many other jurisdictions. For many groups this means that 2024 is the first year that this documentation will be compulsory.

What are the key challenges?

Documentation

A major challenge for large banks and asset managers is that while they may have global transfer pricing documentation, it may not be granular enough for the transfer pricing documentation needs of individual countries. Care must be taken particularly in jurisdictions that do not have large financial services sectors, as local inspectors may not be as familiar with business models that banks and asset managers may take for granted. As it is also a sector that regularly engages in reorganisations and new business initiatives, care must be taken to ensure that transfer pricing documentation accurately reflects the current activities of financial services groups.

Operational TP

Operational transfer pricing continues to be an area of focus for banks and asset managers, as often when errors occur they are not at the policy level, but at the operational / computation level of the transfer pricing models themselves. Ensuring controls and processes underpinning the actual computation of transfer pricing adjustments continues to be a significant time commitment for in-house finance teams.

TP policy choice and model design

As the world seems set on a higher interest rate environment, this will necessitate reviewing transfer pricing policies that may have been calculated on the assumption of lower interest rates. When assessing transfer pricing policies, financial services organisations should therefore not only be considering whether policies make sense from a legislative perspective but also whether they make sense in the light of these new business conditions.

Banks and asset managers are also seeing increasing scrutiny of historical cost-plus based arrangements, as tax authorities often consider profit splits to be more appropriate in the financial services space, particularly for activities that are perceived to be profit driving.

Advance pricing agreements

Advance pricing agreements (APAs) are a key tool for groups to gain certainty from tax authorities, particularly for material and complicated arrangements that can have a material impact on a group’s effective tax rate. Even for arrangements that could be considered to be broadly tax neutral, it may be appropriate to consider an APA to build in some certainty and operational resilience for future periods.

APAs that are due to expire pose another area of focus. Recent case law in the UK (Refinitiv Limited & Ors, R (on the applications of) v The Commissioners for HMRC) has confirmed that Taxpayers cannot assume that just because there has been a historical APA that the agreed methodology will be accepted on a going forward basis once the APA period has finished. By having regular policy reviews financial service organisations can ensure arrangements are defendable in future periods. 

Assess country-by-country reporting (CbCr) quality

Assessing whether a CbC report is robust enough to meet the calculations of Pillar 2 compliance obligations is vital. It is also important to consider whether or not the results in the CbCr are consistent to how the group understands its transfer pricing arrangements. banks and asset managers need to be confident that any Pillar 2 driven tax adjustments can be calculated accurately and that they are presenting a coherent explanation of transfer pricing arrangements, across both the transfer pricing documentation and the results presented in the Pillar 2 analysis. 

Conclusions

It is important to remember that transfer pricing is an area where individual tax authorities often use judgment, where scrutiny of policies and documentation can be subjective. For global banks and asset managers perceived to have deep pockets, transfer pricing policies and associated documentation must be reviewed regularly to manage potential risks in the event that tax authorities challenge existing transfer pricing arrangements.