The design of a transfer pricing policy is not merely a formal or documentary exercise. On the contrary, it is a technical process that must accurately reflect the economic reality of the multinational group, its value chains, the effective allocation of functions, assets, and risks, as well as how value is generated and captured in each jurisdiction.
Tax administrations, especially in developed economies, have evolved from an approach focused exclusively on numerical comparability to a comprehensive analysis of transfer pricing policy design. In this context, the guidance issued by HM Revenue & Customs (HMRC) in the United Kingdom, particularly the section on Indicators of transfer pricing policy design risk, is highly illustrative of the criteria currently used by tax authorities to identify structures that are potentially inconsistent with the arm’s length principle.
From a specialized transfer pricing perspective, this article develops and elaborates on these risk indicators, incorporating a technical reading aligned with the OECD Guidelines and with the audit practices observed in Latin America and other relevant jurisdictions.
Risk in policy design: beyond formal compliance
A recurring mistake in multinational groups is to assume that the existence of a written policy, accompanied by benchmarking studies, is sufficient to mitigate tax risks. However, HMRC emphasizes that one of the main risk indicators arises when the transfer pricing policy does not correspond to the operational reality of the business.
In practice, this risk materializes when the theoretical design of the policy comes into conflict with the way decisions are made and executed within the group. It is common to see policies that classify certain entities as “low risk,” even though those entities are actively involved in commercial decisions, assume significant risks, or manage strategic assets. Likewise, the application of standardized margins without periodic validation against operational changes constitutes a structural weakness.
From a technical perspective, these inconsistencies erode the credibility of the functional analysis and enable the tax administration to question the central premise of compliance with the arm’s length principle.
Intangibles and profit allocation: a critical focus of taxation
One of the most sensitive areas in the design of transfer pricing policies is the ownership and exploitation of intangibles. HMRC identifies as a risk indicator those cases in which residual returns are allocated to entities that only hold legal ownership of the intangibles but do not perform DEMPE (Development, Enhancement, Maintenance, Protection, and Exploitation) functions.
From the perspective of the OECD Guidelines, the alignment between value creation and profit allocation is a structural principle of the transfer pricing system. Consequently, policies that concentrate significant profits in entities with little economic substance—especially in low- or no-tax jurisdictions—are often subject to intensive scrutiny by tax authorities.
In this context, a robust policy design requires, as a minimum:
- The precise identification of the DEMPE functions effectively performed by each entity in the group.
- A clear differentiation between legal ownership and economic ownership of intangibles.
- The allocation of returns consistent with the level of control and risk assumption.
The omission of this level of technical analysis is one of the most relevant risk indicators in contemporary audits, particularly in intangible-intensive industries.
Intragroup services: risk of overvaluation and duplication
HMRC places particular emphasis on the risks associated with intragroup services, especially when these are provided from regional or global centers. The focus of the audit is not limited to the valuation method, but extends to the economic justification of the service itself and the benefit actually received by the recipient entity.
From a technical perspective, the main risk arises when the services invoiced do not generate identifiable incremental value, duplicate existing local functions, or are remunerated through generic cost-plus margin schemes without a specific functional analysis. In these cases, the transfer pricing policy is often perceived as a mechanism for artificially reallocating results.
A properly designed policy must therefore distinguish between low value-added services and strategic services, apply methodologies consistent with that classification, and robustly document the economic benefit obtained by each recipient entity.
Target margin models and policy rigidity
Another relevant indicator identified by HMRC is the use of target margin models that do not reflect the actual evolution of the business. This risk is particularly common in structures where fixed returns are assigned to entities classified as routine, without considering substantive changes in their functions, assets, or risks.
In technical terms, excessive policy rigidity is often interpreted as a sign of design geared toward predetermined tax results, rather than as a natural consequence of the group’s economic dynamics. The absence of periodic review mechanisms, as well as the use of outdated comparability studies, reinforce this perception.
Therefore, a technically sound policy must be inherently dynamic, incorporate review clauses, and allow for reasonable adjustments when significant changes occur in the value chain.
Single-rate structures and franchises
Policies that group multiple elements under a single rate—such as brand use, know-how transfer, technical assistance, and certain intragroup services—are a recurring focus of risk from HMRC’s perspective. The main difficulty lies in demonstrating that the aggregate price reflects arm’s length conditions for each of the components included.
From practical experience, this type of scheme is only defensible when it is supported by a detailed analysis that identifies the economic nature of each element and its specific contribution to value creation. In the absence of such a breakdown, the tax authorities often question the reasonableness of the overall payment and, in some cases, reclassify the nature of the consideration.
In these cases, it is particularly important to assess:
- The individual identification of each component included in the fee.
- The correct characterization of the payment (royalty, service, cost reimbursement).
- The consistency between the calculation basis used and the economic reality of the transaction.
Offshore purchasing centers and value allocation
Finally, HMRC analyzes the risks associated with offshore purchasing centers, especially when they concentrate disproportionate profits relative to their actual functions. In many cases, these entities act as administrative intermediaries without assuming significant commercial risks.
A well-designed policy should assess whether the purchasing center:
- Makes strategic decisions about suppliers.
- Assumes inventory, credit, or market risks.
- It brings real economic efficiencies to the group.
Otherwise, the returns allocated should be limited to remuneration for support services.
Conclusion: policy design as a tax defense tool
The risk indicators identified by HMRC reflect a clear trend: tax administrations evaluate the design of transfer pricing policy as a central element of tax auditing, not as an ancillary document.
In this context, a technically consistent policy, aligned with operational reality and properly implemented, becomes a key tax defense tool. At TPC Group, we approach transfer pricing policy design from a comprehensive perspective, combining in-depth functional analysis, regulatory knowledge, and experience in complex audits.
Anticipating risks, rather than reacting to adjustments, is now the expected standard in transfer pricing.
Source: GOV.UK