Most small and medium sized businesses are exempt from the UK transfer pricing rules under section 166 of the Taxation (International and Other Provisions) Act 2010 (TIOPA 2010). The exemption does not cover dealings with related parties in territories that lack a suitable tax treaty, it can be switched off by an election, and HMRC can override it for any medium sized enterprise by issuing a transfer pricing notice during an enquiry.

What do the transfer pricing rules actually do?

Part 4 of TIOPA 2010 applies where a provision is made between two persons by means of a transaction or series of transactions, one of them participates directly or indirectly in the management, control or capital of the other (or a third person participates in both), and the actual terms differ from those independent enterprises would have agreed. If the actual provision gives a potential advantage in relation to UK tax, profits and losses are calculated as if the arm’s length provision had been made instead. These are the basic pre condition and participation condition in sections 147 and 148.

A potential advantage exists under section 155 where taxable profits are reduced, or losses created or increased, because the terms were not at arm’s length. HMRC’s International Manual at INTM412010 stresses that the rule does not depend on whether the price was set for tax reasons, and that it only ever increases profits or reduces losses; a reduction can only come through a compensating adjustment for the other party. Section 164 requires the rules to be read consistently with Article 9 of the OECD Model Tax Convention and the OECD Transfer Pricing Guidelines.

The rules are not limited to companies. INTM412030 explains that “person” includes individuals, partnerships and other bodies, so a sole trader or partnership dealing with a connected overseas company can be within scope.

What is the arm’s length principle?

INTM412040 describes the arm’s length principle as replacing, hypothetically, the actual terms of a controlled transaction with the terms unconnected parties would have agreed, and recalculating profits on that basis. The usual examples in a smaller group are management charges, interest on loans between group companies, royalties for using a brand or software, and the price of goods or services bought from or sold to a sister company.

Two definitions widen the net. INTM412050 notes that “provision” covers all the terms and conditions of a transaction, not just the price, and that section 150 gives “transaction” a very wide meaning that includes arrangements, understandings and mutual practices whether or not they are legally enforceable. INTM412040 also confirms that transfer pricing does not apply in calculating a chargeable gain or allowable loss, apart from supporting a claim under section 174.

Who counts as a small or medium sized enterprise?

Section 172 adopts the definition in the Annex to European Commission Recommendation 2003/361/EC, with UK modifications. INTM412080 summarises the thresholds:

Category Staff headcount ceiling Annual turnover Balance sheet total
Small enterprise 50 €10 million €10 million
Medium enterprise 250 €50 million €43 million

An enterprise must meet the staff ceiling and at least one of the two financial limits. Staff include employees, seconded staff, owner managers and partners, with part time workers counted as a fraction. Balance sheet total means gross assets, not net assets, and euro limits are converted at the average exchange rate for the period of account.

The test is applied to the whole economic group. INTM412100 explains that all the data of linked enterprises (broadly, those under common control) is added in full, whether control is at 51% or 100%, and a proportionate share is added for partnership enterprises where one holds 25% or more of the capital or voting rights of the other. There are limited carve outs for venture capital investors and business angels, the latter only where their total investment in the enterprise is under €1,250,000.

Two UK modifications in section 172 often surprise people. The data is taken for the chargeable period itself on an annualised basis, and the rule in the Recommendation that status only changes after two consecutive periods over the ceilings is omitted. A growing group can therefore move from exempt to fully within the rules in a single year.

When does a small company lose the exemption?

Section 167 sets out two exceptions that apply to both small and medium enterprises:

  • Election. The business can elect for the exemption not to apply for a chargeable period. Under section 167(2) the election is irrevocable, and INTM412070 confirms it covers all transactions in that period.
  • Non qualifying territory. Under section 167(3) the exemption does not apply if the other party, or a party to a relevant transaction in a series, is resident in a non qualifying territory. Section 173 treats a territory as qualifying only if the UK has a double taxation agreement with it that contains a non discrimination provision, unless Treasury regulations say otherwise. HMRC lists the treaties it accepts at INTM412090 and notes that the agreements with Jersey and Guernsey do not meet the test.

For a small enterprise there is one further route. Section 167A lets HMRC give a transfer pricing notice, but only where the transaction is taken into account in calculating relevant IP profits for the patent box.

When can HMRC bring a medium sized company back into the rules?

Section 168 allows HMRC to give a medium sized enterprise a transfer pricing notice requiring it to compute profits at arm’s length for the provisions specified. The procedure is tightly controlled:

  • Section 169(3) says the notice may only be given after a notice of enquiry into the return for that chargeable period. See aspect and full enquiries for how enquiries open.
  • INTM412070 requires HMRC case teams to refer any proposed notice to the Business, Assets and International Transfer Pricing team.
  • Under section 170 an appeal against a section 168 notice can only argue that the company is not a medium sized enterprise, and it must be made within 30 days of the notice.
  • Section 171 gives the company 90 days to amend its return to comply, and HMRC cannot issue a closure notice on that return until the 90 days end or the return is amended.

The practical point is that a medium sized company is exempt when it files, because section 171(3) says its return disregards the transfer pricing rules, but it should still be able to explain its intra group pricing if an enquiry opens.

What changed from 1 January 2026?

Reforms in the Finance Bill 2025 to 2026, which received Royal Assent on 18 March 2026 according to INTM414020, generally apply to chargeable periods beginning on or after 1 January 2026. INTM414310 confirms that the SME exemption, its exceptions and the definitions in sections 172 and 173 were not amended.

The main changes are aimed at larger businesses. A new section 164A exempts qualifying provisions between UK resident companies chargeable at the same rate and using the same reference currency, subject to disqualifying conditions and an HMRC notice power to prevent a net loss of tax. New section 148A lets HMRC issue a notice treating the participation condition as met in some cases, and section 162A adds a participation test based on arrangements for common management. HMRC also plans a separate International Controlled Transactions Schedule, subject to a technical consultation in spring 2026.

How does this work in practice?

Illustration only. A UK company has 120 staff across its group and group turnover of €30 million, so it is a medium sized enterprise. It buys components from a sister company in Ireland and pays a £400,000 annual management fee to its parent, which is resident in a territory with no UK tax treaty.

  • The Irish purchases are covered by the exemption because Ireland is on HMRC’s list of qualifying territories. They come back into the rules only if HMRC opens an enquiry and issues a section 168 notice.
  • The management fee is outside the exemption under section 167(3). If an arm’s length fee would have been £250,000, the company must add back £150,000 in its own return.

If the group later grows to 260 staff, it is a large enterprise for that period and every cross border connected transaction needs arm’s length support, with no two year grace period.

What mistakes do smaller businesses make?

  • Measuring size on the UK company alone instead of aggregating linked and partnership enterprises.
  • Assuming the exemption covers every overseas dealing, when transactions with residents of non qualifying territories are always in scope.
  • Borrowing the two year rule from company law size tests, which section 172 switches off.
  • Making an election to apply the rules without realising it is irrevocable for the period and covers every transaction in it.
  • Confusing the transfer pricing participation test with the associated companies rules or the connected persons definitions, which serve different purposes.
  • Keeping no record of how intra group charges were set, leaving a medium sized company exposed if HMRC issues a notice during an enquiry.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.