The price you charge your own subsidiary is not your decision alone

It is the rule that connected companies must deal as independent ones would. Article 9 of the treaty applies where one enterprise participates in the management, control or capital of the other, or where the same people participate in both.

The test then looks at the terms. Where conditions differ from those independent enterprises would have made, the profits can be rewritten.

Wider ones than most groups expect. The article reaches direct and indirect participation in the management, control or capital of the other enterprise, so a plain shareholding is only the obvious case.

It also catches common ownership. Where the same persons participate in both companies, the two are associated even though neither owns the other.

So sister companies under a shared owner fall inside it. Groups often check the parent chain and stop there.

The authority rewrites the profits. Where conditions between the two enterprises differ from arm's length ones, profits that would have accrued but for those conditions may be included and taxed.

Notice the direction of that. It is not a penalty on the transaction. It taxes the profit the country says should have arisen.

Both countries can reach for this independently. Nothing requires them to act together, or even to know what the other one has done.

Only if it agrees, and this is the conditional nobody reads carefully. Where one state includes and taxes profits already taxed in the other, the second state shall make an appropriate adjustment to its own tax on those profits.

But that duty bites only where the second state agrees the profits would have accrued to the first on arm's length conditions. Disagreement leaves the duty dormant.

So the corresponding adjustment is a promise with a condition attached. Treat it as likely rather than automatic.

Most smaller groups escape the British rules. GOV.UK guidance sets out an exemption that applies to most small and medium sized enterprises.

A small enterprise has no more than 50 staff, together with either turnover or a balance sheet total below 10 million euros. A medium sized one has no more than 250 staff, with either turnover below 50 million euros or a balance sheet total below 43 million.

So a great many British groups sit outside the UK rules entirely. That is a real relief, and it creates the trap in the next section.

It is a British exemption from British rules. Qualifying as a small or medium enterprise for HMRC says nothing at all about what America expects of the subsidiary.

So a group can be outside the rules on one side of the Atlantic and inside them on the other. In our practice that asymmetry causes more surprise than any technical point about method.

Plan the pricing on the stricter side. Documentation prepared for the American requirement will satisfy a British enquiry comfortably.

So test both regimes separately each year. Growth can move a group into the British rules without anybody noticing the threshold pass.

The IRS maintains its own regime, summarised on its transfer pricing page. It applies to dealings between commonly controlled businesses regardless of where the parent sits.

There is also a reporting layer. A US corporation that is 25 per cent foreign-owned reports its transactions with related parties on Form 5472, which we cover in our guide to it.

The ones with no obvious market price attached. Management charges, head office recharges, brand royalties and intra-group loans all rest on a judgement rather than on a quotation, which is exactly where two authorities can reach different views.

Goods are easier, because comparable prices often exist. Services and intangibles are where most disputes begin.

So the weakest link is usually the recharge nobody documented, written as a round sum at the year end.

The method has to fit the transaction, rather than the other way round. A comparable price works where comparable transactions actually exist, and most flows of goods qualify comfortably on that basis.

Services and intangibles usually need something else. A cost-based approach with a margin suits routine support, while profit-based methods fit closely integrated operations.

So pick the method from the facts. Choosing one because it produces a convenient answer is exactly the pattern an enquiry looks for.

That the terms match what independents would have agreed. That means setting out what each company actually does, what it risks, and what assets it uses.

Comparables then support the figure. A charge defended only by saying it felt reasonable will not survive a serious enquiry on either side.

Still, keep it proportionate to the money involved. A modest recharge does not need the apparatus a major licence would justify.

Because independent businesses rarely agree a price in March for work done the previous June. A single round-sum entry at the year end looks like a result rather than a price.

So invoice through the year on a stated basis. The pattern of billing is itself evidence about the arrangement.

A stated basis also helps the subsidiary budget. Commercial sense and defensibility point the same way here, which is not always true in tax.

Pricing set in advance is far easier to defend than pricing explained afterwards. The analysis costs much the same either way, and the timing is most of what makes it credible.

So build UK to US transfer pricing into the year you are about to begin, rather than the one you have just closed. Groups that do this once rarely go back.

Interest gets the same treatment as any other term. The question is what an independent lender would have charged a borrower in that position, on those terms.

Two features matter beyond the rate. The amount borrowed and the repayment terms both affect whether an independent party would have lent at all.

So document the lending decision the way a lender would. An independent party would have asked about security, and about the ability to repay.

Then the corresponding adjustment never arrives, and the same profit sits in both tax bases at once. That is precisely the position the treaty dispute machinery exists to resolve, and it happens more often than groups expect.

Article 9 itself points that way. It says the competent authorities shall consult each other where necessary in determining the adjustment.

Our guide to the mutual agreement procedure covers that route, including the deadline that governs it.

It raises a parallel question rather than the same one. A branch is not a separate company, so Article 9 does not apply to dealings with it in the way it applies between parent and subsidiary.

Instead the profits attributable to a permanent establishment come from a separate article, which asks what a distinct and independent enterprise would have earned.

The economics rhyme, though. Both ask what independence would have produced.

So a group running both a branch and a subsidiary faces two parallel exercises. The questions differ in form, and they overlap heavily in substance.

Further than most groups assume, because each country applies its own enquiry windows rather than a shared one. A charge set casually three years ago remains open to challenge on both sides.

So keep the analysis with the year it supports. Reconstructing the reasoning for a closed-feeling year is the expensive version of this work.

Still, the practical limit is evidence rather than law. Memory fades faster than an enquiry window closes.

Take an illustrative case. A Manchester parent charges its Texas subsidiary a round 200,000 dollars a year for management services, set when the group was small.

The subsidiary has since grown and the parent's involvement has shrunk. The IRS disallows part of the deduction, saying an independent business would not have paid that much for what it received.

Britain taxed the full amount as income. Unless HMRC agrees the American view, the difference stays taxed twice, and the group is into the dispute route rather than a simple refund.

Notice where it went wrong. The charge was set once and never revisited, so it described a relationship that had quietly stopped existing.

The commonest is relying on the British size exemption and assuming it covers the group everywhere. It covers the British rules and nothing else.

The second is the undocumented recharge, usually a management fee nobody tested against anything. The third is setting prices once and never revisiting them as the businesses change shape.

After those comes treating the corresponding adjustment as automatic. It depends on agreement, and agreement takes time.

First we map the flows between the two companies, including the ones that never reach an invoice. Then we test whether the British exemption applies, and what the American side expects regardless.

Where an adjustment has already landed, we work out whether a matching one is realistic. Start with our treaty relief service, or reach us through our contact page.