The UK R&D tax regime is a highly valuable incentive to businesses that are developing intellectual property (IP). However, creating IP in the UK that will be accessed overseas requires businesses to maintain a robust approach to transfer pricing.
In the face of complex and evolving R&D tax and transfer pricing legislation – together with increased scrutiny from tax authorities around the world – companies need to consider these important documents in unison.
Value creation refers to the process of generating economic value through the deployment of resources. In a business context, value-creating activities contribute to the overall prosperity and success of the organisation.
Demonstrating value creation is one of the critical elements required to support the qualifying nature of your R&D activities in a UK R&D tax claim. This requires a thorough and well-documented statement on the nature of the R&D activities being undertaken. Providing detailed information about the technical advancements, IP being generated, and innovation arising from the R&D activity is essential to support a claim. It also demonstrates how your R&D activities contribute to overall value creation for the business and the wider economy.
The concept of value creation is also fundamental to determining how the profits of multinational enterprises (MNEs) should be allocated among different entities within the group. Value creation influences the allocation of profits among related entities, based on their respective contributions to the generation of economic value.
Understanding how value is created within an MNE and appropriately applying transfer pricing principles is critical for ensuring compliance with tax regulations, ensuring arm's length outcomes in related party cross-border transactions.
The description of value creating activities in the R&D claim and value creation in the transfer pricing documentation can therefore be perceived as ‘two sides of the same coin’.
HM Revenue and Customs' (HMRC) R&D tax specialists have the authority to request a wide range of documentation when assessing the merits of an R&D claim. This could extend to the transfer pricing policy and transfer pricing documentation.
A mismatch or ambiguity between the description of value creation in these documents can therefore create a tax risk.
Proposed reforms to UK transfer pricing rules include the requirement to report cross-border, related party, transaction data to HMRC. This is to help facilitate better identification of transfer pricing risk and allow for more targeted enquiries. In addition, there continues to be tax authority scrutiny on cross-border taxation and withholding taxes.
Recent changes to the R&D tax legislation will also impact many business’ ability to claim overseas R&D costs for accounting periods beginning on or after 1 April 2024.
This is part of an increased focus on ensuring R&D is driven from within the UK. As part of this, HMRC is likely to consider several indicators, including where IP is held and where key R&D personnel sit internationally.
Businesses should therefore expect an increasingly data-driven approach with cross referencing of information from multiple sources, including the R&D claim and transfer pricing documentation/disclosures.
Overlooking how the R&D tax claim and transfer pricing documentation are interconnected through value creation could expose your business to significant tax risk. Establishing a joined-up approach can help mitigate these risks. Practical considerations towards a more holistic approach could include:
Our team of senior and experienced R&D and transfer pricing experts together with international tax colleagues can support you with the above.
For further insight and guidance, contact Antoinette Quinlan, Nick Warth or Joseph Groenen.
