The majority of countries now have legislation in place governing the pricing of transactions between companies that are related. These are normally tax rules forming part of the State Administration of Taxation, but they are nevertheless based on the basic legal requirement that companies should account for the sale or purchase of goods and services, whether these transactions are with third parties or other subsidiaries.

Many countries also have informal or formal compliance rules; for example, the format of transfer pricing documentation and also penalise those involved for non-compliance.

The OECD has adopted what is called the ‘arm’s length’ principle as a guideline for this type of transaction and detailed guidelines have been published on its application. The UK has incorporated these principles into its tax laws, which were revised in 2009.

The arm’s length principle has become one of the cornerstones of the current approach, both in the OECD and countries such as China. This simply means that a transfer price should not be affected in any way by the fact that the two companies are related; it should be as if they are two independent companies.

Despite the rather informal name, the arm’s length principle has been incorporated into the OECD Model Tax Convention; it can be found in Article 9 of the convention. It forms the framework of all bilateral agreements between OECD countries and even many that do not belong to the organisation.

Transfer pricing rules in the UK apply to a whole range of transactions, including between British companies and between companies or partnerships and individuals and charities.

At least theoretically, the rules cover virtually everything from purchase or sales of services and goods to intellectual property, deemed transactions, which are not reflected in accounting records, and debt.

This is a very complex field, which interacts closely with other areas of tax law. The Taxes Acts contain a number of special sets of transfer pricing rules covering specific circumstances.

The complexity of transfer pricing issues has resulted in very few cases actually reaching UK courts. To prove that a company has made been guilty of mispricing products or services is indeed very difficult. This is probably why the majority of transfer pricing disputes in the United Kingdom are normally resolved through negotiation between the taxpayer and the HMRC; until quite recently there was virtually no case law.

In what was probably the first substantive case regarding transfer pricing in the UK, the tax tribunal found DSG Retail guilty of breaching the law in the 2009 case of DSR Retail and Others versus HMRC.

As a general rule, the tax authorities in the UK use a self-assessment system, whereby companies have to use the arm’s length principle to determine whether their pricing system would have had an impact on their tax liability. If that is the case, they have to adjust their pricing system.

Whether the legislation really has had the desired effect is difficult to determine. To the extent that it works, it ensures that the tax authorities receive their fair share of taxes, which in turn benefits the country as a whole.