Introduction: Transfer Pricing When You Own Both Sides of the Atlantic
Transfer pricing is the single most misunderstood exposure facing Americans who own a company in Britain and another in the United States. Most owners assume the rules apply only to household-name multinationals. That assumption costs them dearly. Furthermore, the assumption survives because their UK accountant tells them, quite correctly, that HMRC exempts them. The trouble begins when nobody checks the American position.
Why Transfer Pricing Applies to Owner-Managed Groups
The arm's length principle governs every price set between connected businesses. Therefore, when your UK company invoices your US company, the invoice must reflect what independent parties would have agreed. Neither tax authority cares that you own both sides. Indeed, they care precisely because you do.
Transfer pricing catches management charges, development fees, royalties, loans, guarantees and the informal recharges that owner-managed groups make without paperwork. Consequently, a founder with an £800,000 intercompany charge sits inside the same legal framework as a listed group. Only the enforcement risk differs, and it differs less than most owners expect.
The Two Rulebooks You Must Satisfy
Britain applies Part 4 of the Taxation (International and Other Provisions) Act 2010. America applies section 482 of the Internal Revenue Code. Both transfer pricing regimes adopt the arm's length standard, and both follow the OECD transfer pricing guidelines in broad terms. However, they diverge sharply on one point: who gets excused.
That divergence is the heart of this article. Specifically, the UK excuses small and medium-sized businesses. The United States excuses nobody. Accordingly, a group that is entirely outside UK transfer pricing can still face a six-figure adjustment from the IRS on exactly the same transactions.
The UK Exemption That Survived the 2026 Reforms
HMRC consulted throughout 2025 on removing the medium-sized exemption, and much of the professional commentary written that year told readers it was going. It is not. The consultation outcome confirmed that the exemption for medium-sized enterprises remains, and Finance Act 2026 left it untouched. Nevertheless, a great deal of published guidance still describes the abolition as settled. Check the date on anything you read.
How the SME Exemption Works Under Section 166
Section 166 TIOPA 2010 exempts most transactions carried out by a small or medium-sized enterprise from UK transfer pricing. A small enterprise has fewer than 50 staff, plus turnover or gross assets no greater than €10 million. A medium-sized enterprise has fewer than 250 staff, plus turnover no greater than €50 million or gross assets no greater than €43 million.
Crucially, you test the thresholds across the whole group, not the single company. HMRC sets out the definition as a modification of European Recommendation 2003/361/EC. Therefore, a modest UK company owned alongside a substantial American business can fail the test on the American numbers alone.
The Exceptions That Pull You Back In
The exemption is generous but conditional. HMRC's guidance at INTM412070 confirms three routes back into the regime. First, you may elect out irrevocably. Second, transactions with a related party in a non-qualifying territory stay within the rules under section 167. Third, HMRC may serve a transfer pricing notice on a medium-sized enterprise under section 168.
The United States is a qualifying territory, because the treaty contains an appropriate non-discrimination article. Consequently, the second exception rarely bites on a US-UK group. The third matters more. HMRC can compel a medium-sized company to apply transfer pricing to a specified provision, and it does so where the numbers look aggressive.
The New UK-to-UK Exemption in Finance Act 2026
Schedule 6 of Finance Act 2026 inserted section 164A, which switches off transfer pricing for qualifying UK-to-UK provisions. The relief carries eight conditions. Both parties must be UK-resident companies throughout the period, both must face identical corporation tax rates, and both must use the same reference currency. Additionally, excluded companies such as banks, REITs and securitisation vehicles cannot use it.
This is welcome simplification for purely domestic groups. However, it does nothing for you. Your provision crosses a border, so section 164A cannot apply. Schedule 6 also tightened the treatment of guarantees and introduced a statutory concept of implicit support, both effective for chargeable periods ending on or after 1 January 2026.
Why Section 482 Gives You No Such Relief
Here is the fact that reshapes the planning. The Internal Revenue Code contains no small business exemption from transfer pricing whatsoever. The IRS applies section 482 to every controlled transaction, regardless of turnover, headcount or the size of the charge. A husband-and-wife group with two employees is inside the regime.
The Arm's Length Standard and the Burden of Proof
Section 482 lets the IRS distribute, apportion or allocate income between commonly controlled businesses to prevent evasion of tax or to reflect income clearly. Notably, the burden sits with you. Once the examiner proposes an adjustment, you must demonstrate that your price was arm's length. You do not get to insist that the IRS prove otherwise.
Smaller groups are, in practice, easier targets. Larger businesses hold benchmarking studies, intercompany agreements and functional analyses. Owner-managed groups frequently hold a spreadsheet and a memory. Therefore, the examiner meets no resistance.
The Penalty Bands Under Section 6662(e)
Section 6662(e) adds a 20% accuracy penalty for a substantial valuation misstatement. That arises where the price charged is 200% or more, or 50% or less, of the correct arm's length price. Alternatively, it arises where the net section 482 adjustment exceeds the lesser of $5 million or 10% of gross receipts.
The penalty doubles to 40% for a gross valuation misstatement. That threshold is 400% or 25% on the transactional test, or a net adjustment above the lesser of $20 million or 20% of gross receipts. Importantly, these penalties sit on top of the tax and the interest, not instead of them.
Contemporaneous Documentation and the Thirty-Day Rule
You can switch the penalty off. Section 6662(e)(3)(B) provides a documentation defence, but the timing is unforgiving. The analysis must exist when you file the return, not when the examiner writes. Furthermore, you must produce it within 30 days of the request.
Documentation for an owner-managed group need not resemble a Big Four study. In our experience, a focused file covering the principal charges, the method chosen, the reason for rejecting alternatives and a simple benchmarking search will hold up. What fails is the file created after the letter arrives.
The Transactions HMRC and the IRS Actually Challenge
Enforcement clusters around a short list of arrangements. Recognising yours on that list is the fastest way to price your risk.
Management Charges and the Services Cost Method
Management and service charges attract more transfer pricing challenge than any other category. The classic pattern involves a UK company paying a large fee to an overseas parent with no written basis for the number. HMRC scrutinises low-substance recipients closely. Meanwhile, the IRS examines whether the service conferred a genuine benefit on the payer.
The regulations offer a practical route for routine support. The services cost method under Regulation 1.482-9(b) allows certain low-margin covered services to be charged at cost. Consequently, back-office functions such as payroll processing and IT support can often be recharged without a mark-up, provided you document the election properly.
Intercompany Loans and Implicit Support
Founders lend between their companies constantly, usually without interest and rarely with an agreement. Both transfer pricing regimes will impute an arm's length rate. Moreover, Finance Act 2026 sharpened the UK analysis by codifying implicit support, meaning the incidental benefit a borrower derives from group membership.
The consequence is counterintuitive. A UK subsidiary of a strong American group may be treated as a better credit than its own accounts suggest. Therefore, the deductible interest rate falls, and the UK deduction shrinks.
Intangibles, Brands and the Commensurate With Income Rule
Where the group owns software, know-how or a brand, ownership drives the profit split. Section 482 requires that income from a transferred intangible be commensurate with the income attributable to it. Accordingly, the IRS can revisit a royalty years after the transfer if the intangible proves more valuable than expected.
Many American founders incorporate in Britain and let the UK company develop code that the US company sells. Subsequently, they charge a thin cost-plus fee. That structure works only if the functions, assets and risks genuinely sit where the contract says.
What an Adjustment Does to Your Foreign Tax Credit
An adjustment is not simply extra tax. It is extra tax in one country with no automatic relief in the other, and that asymmetry is where owner-managed groups lose serious money.
One-Sided Adjustments and Economic Double Taxation
Suppose the IRS reduces your US deduction by $2 million. Your American tax rises immediately. Your UK company, however, has already paid corporation tax on that same $2 million of profit. HMRC does not refund it because an American examiner formed a view.
The result is economic double taxation on a single slice of profit. Furthermore, the mismatch cannot be solved through the ordinary foreign tax credit, because the UK tax was paid by a company and the adjustment lands on a different entity's return.
The Mutual Agreement Procedure Under Article 26
The treaty provides the answer. Article 26 of the US-UK treaty allows you to present the case to the competent authorities, who then negotiate a correlative adjustment. The IRS explains its side of the process, and HMRC explains the methods of giving relief at INTM423070. Procedures for the US competent authority sit in Revenue Procedure 2015-40.
Watch the clock. You must present the case within three years of the first notification of the action giving rise to the double taxation. Miss that window and the relief disappears permanently. Alternatively, an advance pricing agreement under Revenue Procedure 2015-41 fixes the method before the dispute arises.
How NCTI and Subpart F Change the Arithmetic
Your UK company is a controlled foreign corporation. Consequently, shifting profit into Britain does not shelter it from American tax. Net CFC tested income, the successor regime to GILTI, taxes that profit currently in your hands, and the deemed-paid credit for the underlying UK tax is limited to 90%.
That limitation matters enormously here. In effect, some UK corporation tax is simply lost. Therefore, a pricing policy that pushes profit into the UK company can raise your combined burden rather than lower it, even before any examiner opens a file.
A Worked Case Study With Real Numbers
Nothing clarifies transfer pricing like arithmetic. The following case reflects the pattern we see most often among American founders in London.
The Facts
Marcus is a US citizen living in Kensington. He owns 100% of a Delaware C corporation that licenses his software to American customers, and 100% of a UK limited company that employs his 18-strong development team. The UK company has turnover of £3.0 million and gross assets of £900,000, so it is comfortably a small enterprise.
During the year, the UK company invoiced the US company £3.0 million for development and management services. The underlying UK cost base was £1.15 million. Marcus set the figure himself, and no agreement or benchmarking file existed. All conversions below use an exchange rate of $1.32 to the pound.
The UK Position
The UK company sits within the section 166 exemption. Therefore, it prepared no transfer pricing documentation, and HMRC raised no enquiry. The company simply paid UK corporation tax at 25% on its profits, including the generous margin it had earned from its American sister.
Marcus's UK accountant did nothing wrong. Indeed, the UK filing position was entirely correct. The exemption, however, is a UK exemption, and it settles only the UK question.
The US Position
The IRS examined the US company and applied the comparable profits method. The examiner concluded that an arm's length charge for contract development services of this kind was £1.35 million, roughly cost plus 17%. The actual charge of £3.0 million was 222% of that figure.
Because the charge exceeded 200% of the arm's length price, the substantial valuation misstatement penalty applied. The adjustment came to £1.65 million, or $2,178,000. Additional US corporation tax at 21% was $457,380, and the 20% penalty added $91,476.
Where the Money Actually Lands
The UK company had already paid corporation tax at 25% on that £1.65 million, amounting to £412,500, or roughly $544,500. Without a treaty claim, Marcus therefore bore $457,380, plus $91,476, plus $544,500. That is $1,093,356 of tax and penalty on $2,178,000 of profit, an effective rate above 50%.
Marcus filed a mutual agreement procedure claim inside the three-year window. HMRC granted correlative relief and repaid the £412,500. Consequently, his cost fell to $548,856, and a single treaty claim recovered $544,500. Contemporaneous documentation would have removed the $91,476 penalty as well.
Getting Your Filings Right Before HMRC or the IRS Ask
Prevention is dramatically cheaper than correction. Moreover, the paperwork that protects you is the same paperwork that supports a sensible commercial structure.
The Returns That Disclose Your Related-Party Dealings
Your related-party dealings are already visible. Schedule M of Form 5471 reports transactions between you and your controlled foreign corporation in detail. Additionally, Form 5472 reports reportable transactions where a US corporation is 25% foreign-owned, and it carries a $25,000 penalty for each failure.
Britain adds its own layer. Your UK accounts disclose related-party transactions, and HMRC's guidance on connected company transactions explains what officers look for. Meanwhile, Statement of Practice 2 (2010) sets out how HMRC conducts transfer pricing enquiries.
Catching Up If You Are Behind
Many owners discover their transfer pricing problem while fixing something else. Missed US tax returns, missed FBAR filings and unreported UK accounts frequently surface in the same conversation. Fortunately, the IRS Streamlined Filing Compliance Procedures remain available where the failure was non-wilful.
Sequence matters. Correct the returns and the FBAR and FATCA reporting first, then set the pricing policy prospectively. Otherwise, you risk locking in a defective position across amended years. Professional bodies including the ICAEW and HM Revenue and Customs publish current guidance that your adviser should be reading.
How TaxYork Can Help
TaxYork prepares US and UK returns for company owners whose businesses straddle both systems. We are a tax preparation and compliance practice, and we model both jurisdictions before you set a single intercompany price. Furthermore, we build the contemporaneous file that switches off the section 6662(e) penalty.
Our work typically begins with a functional review of what each company genuinely does. Subsequently, we select and document a transfer pricing method, draft the intercompany agreement and align the figures across your US tax returns and your UK filings. Where an adjustment has already landed, we prepare the competent authority claim.
We also handle the wider position that surrounds transfer pricing for American business owners in Britain. That includes treaty and foreign tax credit optimisation, controlled foreign corporation reporting and, where returns are outstanding, IRS Streamlined Filing. Clients come to us because one adviser now sees both halves of the picture.
Conclusion
Transfer pricing rewards owners who act early and punishes those who act late. The UK exemption under section 166 is real, valuable and unchanged by Finance Act 2026. Nevertheless, it stops at the water's edge, and section 482 waits on the other side with no equivalent relief and a 20% penalty attached.
Set your prices deliberately, document them before you file, and keep the treaty in reserve. Marcus recovered $544,500 because he claimed inside three years. Ultimately, the owners who lose money on transfer pricing are rarely the aggressive ones. They are the ones who never realised the rules applied to them at all.
Contact Us
Speak to a specialist who prepares both returns. Email hello@taxyork.com or telephone 020 3488 8606, and we will review your intercompany arrangements before your next filing deadline. Alternatively, book a consultation and we will tell you candidly whether your current pricing would survive an examination.
Disclaimer
This article provides general information about transfer pricing for US and UK business owners and does not constitute tax advice for any particular person or company. Tax law changes frequently, and the treatment of any arrangement depends on its specific facts. You should obtain professional advice before acting. TaxYork accepts no liability for action taken in reliance on this article.