Management expenses: Transfer pricing in the spotlight

HMRC has recently issued nudge letters to certain companies, encouraging them to revisit how they are allocating and documenting management costs and head office charges. For international companies and groups, this is a timely reminder to revisit policies, ensure robust documentation and assess whether charges reflect the arm’s length principle.

The nudge letters appear to focus on two key areas:

• UK-headquartered groups where management costs are incurred centrally but not appropriately allocated to subsidiaries
• UK subsidiaries of foreign groups where charges are made, but the UK entity has not demonstrably benefited from the services

While UK-UK transactions are generally lower risk, and may soon be exempt from transfer pricing rules, cross-border charges within international groups remain high-risk – particularly where documentation is weak or allocation methods are unclear.

Management expenses (or head office costs) refer to charges made by a parent company, or head office, to its subsidiaries for services provided centrally. These may include finance, legal, HR, IT or strategic support – services that, if provided by a third party, would typically attract a fee.

However, not all costs incurred by a parent company are chargeable. The key distinction lies in whether the subsidiary receives a real and identifiable benefit. This is the essence of the OECD’s “benefit test”, and a core principle in HMRC’s revised approach.

Some costs, while incurred at the group level, are not considered to benefit subsidiaries and therefore should not be recharged. These are known as shareholder costs and typically include:

• Preparation of consolidated financial statements
• Group-level M&A activity not involving the subsidiary
• Costs of raising capital for the group

These activities are undertaken to protect the parent’s investment or fulfil its own legal obligations – not to support the operations of the subsidiary.

Where a benefit is received, the next challenge is how to allocate costs appropriately. This can range from straightforward to complex, depending on the nature of the service and the number of entities involved. Here are a couple of examples explaining the process:

• Simple example: A UK subsidiary receives legal advice from its parent on a local matter. The cost may be directly allocated to that subsidiary
• More complex example: Group-wide IT infrastructure supports multiple subsidiaries. In this case, an allocation key (eg headcount, revenue, usage) may be selected based on the facts and circumstances

The OECD guidelines provide flexibility in choosing allocation methods, but the onus is on the business to document the rationale and ensure consistency in application.

Whether or not you’ve received a nudge letter, now is a good time to review your approach:

Have you identified all relevant group costs? Are they being allocated to the correct entities?

Is your documentation up to date? Can you demonstrate that the benefit test is met and allocation keys are appropriate?

Are your policies being implemented in practice? Are charges consistent with your transfer pricing documentation?

The S&W transfer pricing team supports businesses that have received a nudge letter and need guidance on how to respond, as well as those seeking assurance that their current transfer pricing policies are appropriate and robust. With the increased scrutiny from HMRC, robust compliance is imperative.

Our integrated approach helps you stay compliant and optimised, so you can stay focussed on growing your business.