INTM464050 - Transfer pricing: types of transactions

Transactions involving services

As well as tangible goods, the transfer pricing legislation applies to services provided between connected persons. The term 'services' is not defined in the legislation. A common sense approach, based on a complete review of the facts, is necessary in deciding whether a service has been performed and what the arm’s length price for the service would have been.

The guidance in this chapter covers the following issues:

• OECD Transfer Pricing Guidelines 
• Have intra-group services been provided? 
• Would an independent company pay for the service? 
• Are the activities shareholder activities? 
• Services combined with other transactions 
• What is the arm’s length price of a service? 
• Group treasury companies 
• Procurement services 
• UK deductions for recharged expenditure 
• Case study 

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OECD Transfer Pricing Guidelines

Chapter 7 of the OECD Transfer Pricing Guidelines considers particular issues related to the provision of intra-group services. The two main points are:-

• Whether intra-group services have been provided,
• That the transfer price for any such service should be calculated in accordance with the arm’s length principle i.e. the price which would have been charged between independents.

The Guidelines consider that the best way of charging an intra-group service is for the service providing company to operate a direct charge method. An example would be translating a legal document, which would generally be priced (in the manner that an independent would calculate a fee) according to the time taken for translation. However this method can be difficult to operate in practice because of the complexity of some intra-group services.

The Guidelines therefore sanction using an indirect charging method. This will involve using cost allocations and apportionments, often involving some degree of estimation or approximation. This is acceptable provided the price does take account of the benefit of the service to the recipients and the extent to which comparable services are provided between independent parties.

When calculating the arm’s length price, the Guidelines say that the price for the service should be calculated by reference to the perspective of both the provider and the recipient. The service must be of value to the recipient and the price must be one that an independent party would be prepared to pay. The service provider would take account of the cost of providing the services, but this is not necessarily a determining factor in every case. All the facts and circumstances must be considered.

Comparable uncontrolled price ('CUP') and cost-plus are considered the preferred methods for valuing the transfer price of intra-group services in many cases. The Guidelines also consider the circumstances in which a service provider might expect to make a profit on the transaction (from Para 7.5 onwards).

The Guidelines give some examples of intra-group services (some are duplicated)

• Legal, accounting, auditing, financing advice, training of personnel (OECD Guidelines 7.2)
• Marketing (OECD Guidelines 7.3)
• Planning operations, emergency management, technical advice or trouble shooting (OECD Guidelines 7.9)
• Administrative services such as planning, co-ordination, budgetary control, financial advice, accounting, auditing, legal, computer services; assistance in the fields of production, buying, distribution and marketing; services in staff matters such as recruitment and training; administration and protection of intangible property for all or part of the MNE group; research and development (OECD Guidelines 7.14)
• In certain circumstances it may be appropriate to make a charge for 'on-call' services in addition to a charge for actual usage of the service (OECD Guidelines 7.16 and 7.17)

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Have intra-group services been provided?

Review all of the facts to ascertain whether a service has been carried out.

Consider whether a company has received (or extended) a service or the use of intangible property. The OECD Guidelines recognise that in some cases it can be very difficult to determine where the exact border lies between the licensing of intangible property and the provision of services. The distinction can be very important, as generally services would be priced in relation to their associated costs, whereas intellectual property may be paid for by way of royalty or other turnover-based fee. The difference between the two can be significant. This distinction may affect both the arm’s length price and the manner in which it would be calculated.

For example, a large multinational enterprise provides management services to third parties. The business is conducted in each geographical market by wholly owned subsidiaries. The parent company provides a number of auxiliary services to the subsidiaries, including use of the brand name, for which the subsidiaries pay a royalty/fee of 5% of their gross turnover under a licence agreement with the parent. In 2001, the UK subsidiary has a turnover of £200 million, and pays a royalty/fee of £10 million. A full review of all of the facts establishes that the actual cost to the parent of these services (excluding use of brand name) to the UK in 2001 was £2 million and that the UK company attracts most of its business because of the reputation of its own consultants. The business derived from the use of the brand name is not significant because the brand name is unknown in the UK and so the turnover fee is in reality charged in return for the auxiliary services. It is very unlikely that an independent party would be prepared to pay for this bundle of rights and services under a licence agreement involving a turnover-based fee. A cost-plus mechanism is on the facts of this case a better way of calculating the arm’s length price.

In cases where it is established that the point at issue is the provision of services, the OECD Guidelines indicate it is not automatic that those services should necessarily be recharged. Even if an activity is carried out, or cost incurred; it does not naturally follow that intra-group services have been provided that should be recharged. It is it necessary to review what would happen at arm’s length. There are two main points to consider:

• Does the service provide the recipient with something of an economic or commercial value - something it would be prepared to buy from someone else?
• Are the activities shareholder activities?

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Would an independent company pay for the service?

Sometimes it will be easily apparent from the facts that a service has been performed which would be paid for at arm’s length. This will often be the case where the outcome of a service is easily identifiable. There will be other cases where the nature of the service is more difficult to ascertain, and the outcome not so easily defined.

For example, a UK subsidiary uses the services of senior personnel from its US parent to provide expertise on general market direction. The subsidiary is unlikely to be able to point to a particular outcome and say 'that is where they added value'. Any review would need to ascertain the facts and to ask whether an independent would have paid for what was actually received. There is a possibility that the facts might indicate that such a general service forms part of general shareholder activity - see below.

Such cases can get more difficult to assess when the service is provided to a number of different subsidiaries, or to the group as a whole. Some instances will be fairly straightforward - for example a group may have contracted independent IT personnel to review the group’s computer system as part of a plan of anti-virus protection. The parent alone may have been charged by the third party. Since each subsidiary had actually received a review of its IT, a re-charge of the cost would appear appropriate. This recharge would amount to what an independent company would pay for the service.

However, the arm’s length price becomes more difficult to judge if the facts show that a subsidiary had also paid a separate third party for a review of IT, or carried out one internally, and had no need of the service paid for by the parent.

Where such complexities become apparent, review the facts with these points in mind:

• What is being paid for?
• Would an independent pay for this?

Group companies will also obtain incidental benefits of belonging to a group, for example the cost of reporting finance, etc, data. These benefits should not generally be recharged; they arise as the result of the subsidiary belonging to a larger group, not because a service has actually been provided.

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Are the activities shareholder activities?

A group will be obliged to carry out particular activities and incur some expenses because of its responsibilities to its shareholders, or because of the parent company’s role as a shareholder in the subsidiaries. This type of expenditure should not be recharged. A third party would not require such services and so would not be prepared to pay for them. Examples quoted by the OECD Transfer Pricing Guidelines (at Para 7.10) include the cost of the juridical structure of the parent company (such as AGM’s, issuing shares and any supervisory board); costs relating to the reporting requirements of the parent (such as producing consolidated accounts or other reports for shareholders); and raising funds to invest in its subsidiaries.

Any system put in place to facilitate the reporting requirements for shareholders will fall within the definition of shareholder costs. There can be difficult borderline cases within what the OECD Guidelines refer to as the 'costs of managerial and control (monitoring) activities related to the management and protection of the investment as such in participations' (participations being, in this context, subsidiaries). Such systems might perform more than just the shareholder reporting function, although these other benefits may be just incidental.

The test in such circumstances is whether the activity is one that an independent party, under comparable circumstances, would have paid for. This will always depend on the facts and circumstances of a case. The current OECD Transfer Pricing Guidelines were approved for publication in 1995, but were based in large part on the previous Guidelines produced in 1979. The older Guidelines referred to 'stewardship' activities, as opposed to 'shareholder' activities. Stewardship is a broader term and would have included some activities that are now accepted as being rechargeable intra-group services (e.g. emergency management or technical advice).

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Services combined with other transactions

The facts may indicate that certain intra-group services are linked with the transfer of valuable intangible assets. For example, the grant of a licence agreement, under which valuable patent and know-how rights are made available to a subsidiary, may involve the provision of technical services, such as helping to set up a new manufacturing process. Such services would generally be covered under the payment of royalties. However licence agreements concluded between independent parties may put a limit on the services provided (e.g. by way of number of hours or man-days); any additional services would be subject to a separate charge.

There is a distinction to be drawn between services that might be provided under a licence agreement (and calculated by reference to turnover), and services that would be provided under some other form of contract, as discussed under the section 'Have intra-group services been provided?' above. One would have to review all of the evidence and decide what would happen at arm’s length.

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What is the arm’s length price of a service?

A review of the evidence should indicate what price would be charged between independents for the service. A whole range of commercial factors would influence the price. A transfer pricing methodology is unlikely to reflect these complexities; it should be applied using common sense and judgement, without being formulaic or prescriptive.

The enquiry should be predicated on the basis that the arm’s length price should be charged for any service. Between independents, a complex interaction of commercial factors combine to determine the price. These factors might include:

• The costs of providing the service
• The costs of an alternative
• The expected benefit
• The state of the market
• The financial position of the provider or recipient.

The price will depend on the nature of services provided and the businesses of the companies providing and receiving the services. The examples below however give an indication of the possible criteria that might be used in different situations.

1. A company provides services that are integral to the group’s business as a whole. For example a firm of civil engineers may have specialists in a particular field based in the UK. The firm’s subsidiary in South Africa wins a contract to design and oversee the construction of a new power station. The UK supplies specialist employees critical to the success of the project. A suitable method of valuation of the services provided by the UK might be an independent firm providing similar services.
2. A group company provides services only to other group companies. For example a group manufactures and sells electrical equipment. It established a subsidiary whose business is to provide legal, accountancy, human resources and IT services to all the group companies. A review of the facts might lead to the conclusion that this service provision falls within the scope of the guidance on centrally provided services at INTM464055, and so a cost-plus method can be applied.

In all enquiries, the facts must be established to show the exact nature of the service, the functions and costs involved in supplying it and the extent of the benefit to the recipient. The arm’s length price would be influenced by all of these factors.

The costs themselves will consist of direct and indirect costs. The direct costs will include employee costs such as salaries, bonuses, pension provision, travel and subsistence costs, support costs such as secretaries, broadly costs that relate directly to the service being provided (which usually is the services provided by a person, or group of persons). Indirect costs will include for example office accommodation and a share of utilities and other overheads.

These costs would affect the price charged between independents.

When applying the cost-plus method, the OECD Transfer Pricing Guidelines (at para 7.35) recommend that when looking at comparable transactions or independent companies supplying comparable services, one should be aware of differences in overhead (indirect) costs between the case under review and the comparables. Adjustments to the cost base may be needed .

The OECD Transfer Pricing Guidelines also consider when it would be appropriate for the service provider to make a profit (paras 7.33 to 7.36). There may be occasions when a service provider is content only to cover costs although, in the normal way of business, companies intend to make a profit, and charge accordingly. Review the full facts and consider what would happen at arm’s length. In such a situation the recharge should not exceed what an independent would pay. Where a group company has acted as an agent or intermediary in incurring expenditure on behalf of someone else, it may be appropriate to just recharge the expenditure without a profit margin (para 7.36).

Any charge should equal that which would have arisen between independents. While cost-plus may be the method that has to be used in the majority of cases, there should be evidence to demonstrate the benefit of the service to the recipient.

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Group treasury companies

A group treasury company may provide a number of services to group companies, e.g. finance, hedging, debt factoring, etc. To the extent that the company is only providing expertise, a fee-based reward might be appropriate. For example a subsidiary may decide to hedge an upcoming purchase of goods, the price being in US dollars. The subsidiary faces a number of ways of hedging the transaction such as a forward currency contract. It asks the group treasury company to advise on the best method of hedging and to arrange the purchase of the appropriate financial instrument on its behalf.

Between independents this fee might be built into the cost of the instrument. Where the cost of the instrument and any financial risk is borne by a company, they may have already paid in part for the provision of the service. In this case, the group treasury company would be justified in charging a fee for advising and arranging the financial instrument, based on the fee a broker would charge.

The provision of services such as loan finance, leasing and debt factoring, and underwriting or providing financial instruments can be complex and is considered in more detail in the chapter on Intra-group funding at INTM500000 onwards.

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Procurement services

Procurement services might include a fee for negotiating contracts or a charge for providing the facility to buy products at a discount.

Consider how a similar function would be rewarded at arm’s length. The evidence might reveal that it was the bulk buying power of the distribution companies which dictated any discount, not the negotiating skills of the procurement company. This would limit its reward accordingly.

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UK deductions for recharged expenditure

There may be an apparent tension between an arm’s length payment for the benefit of a service and another part of the UK tax code which prohibits a tax deduction for a particular class of expenditure. An obvious example is a company being recharged particular costs that are deemed to be entertaining.

A particular issue that has arisen in recent years is the recharge of the cost of share-based remuneration, in particular share options. Employees of a subsidiary may receive share options through a group scheme run by, or on behalf of, the parent company - instructions on dealing with this are dealt with under INTM464140. Here however the concern is with the recharge of employee costs where those employees are providing services to different group members. In some cases (particularly US groups) the service fee charged to subsidiaries includes a charge to cover share options.

For accounting periods ending before 31 December 2002, a recharge of such costs, based on the difference between the option and exercise price (£6 million) would not be considered arm’s length. A recharge based on a reasonable hedging strategy will be acceptable. For a discussion of hedging strategies please see INTM464140.

For accounting periods ending after 31 December 2002, a recharge based on the full spread would still not be arm’s length, notwithstanding the new legislation governing deductions for share options. The statutory deduction is given as part of the Government's policy of encouraging the use of share options. There is no suggestion that it is simultaneously representing an arm's length price.

Where a company is providing services using employees who have received options, that company will receive a statutory deduction when the employees exercise the options. In pricing the services to its affiliate, however, the treatment of the deduction is not relevant. Instead a hedged cost should be recharged. If the services being provided are those that it would be proper for the company to charge at a mark-up, then the hedged costs should marked up as well.

Businesses that trade by providing services do not generally set their prices solely by reference to the cost of those services. They will take these costs into account, but will price the services by reference to many factors: what the market will bear, or at a discount in order to attract business.

However, the provision of share options is a valuable service, which at arm's length a third party would pay for, and the logical method is to recharge the costs. Where employees are remunerated by share options there may be no actual cost to the parent company. However services provided by employees who are paid £100 cash plus 100 options are likely to be more valuable than services provided by employees who are paid simply £100 cash. The price paid should therefore reflect the existence of share options, and the question remains as to how to price the options. As explained in INTM464140the arm's length price will rarely be the profit made by the employee.

There is unlikely to be any actual physical cost to the parent company (whether based in UK or not). It may simply issue new shares to cover the options granted. The fact that a country has a domestic tax code which permits deductions based on the profit made by employees on exercising the options cannot be used as justification for effectively passing on that deduction to another country. A distinction needs to be drawn between statutory deductions (whether in the UK or in other countries) and the arm's length price. Failure to make the distinction can result in the importation of a non-arm's length price into another tax jurisdiction; and that can be resisted on general transfer pricing principles.

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Case study

The following case study looks at a number of issues involving intra-group services.

Bodgit & Scarper is a multinational enterprise with the parent company based in Ruritania. Its business includes the manufacture and sale of electrical goods, toys and branded clothes. There are a number of group companies in the UK, headed by Bodgit & Scarper UK Holdings Ltd. The UK holding company was charged the following fees during the year ended 31 December 2000. The fees were passed on to other UK group companies, apportioned by turnover.

The enquiry into the fees produces the following information

1. The costs of the Board have been calculated by Bodgit & Scarper Ruritania and are shown in the following table. They are not the amounts shown in the glossy accounts. They also include for example share options, where Bodgit & Scarper Ruritania obtain a deduction for these costs, but there is no actual expenditure as new shares are issued on exercise of the options.

Board duties - the various members of the Board are all based in Ruritania and have the following responsibilities and duties

• Mr H Bodgit is the managing director. He is not involved in the day-to-day operations of the subsidiaries, but along with the rest of the board provides strategic direction and targets for different economic regions (US, Europe, Asia, rest of the world).
• Mr L T S Scarper is the executive chairman of the group. His main duties are strategic direction of the group and liaising with major shareholders and the group’s brokers and bankers. Each year he conducts a tour of the regions. In 2000 he spent a week in the UK (further questions establish that two days were spent at Wimbledon, a day sight seeing and four days touring factories and offices, meeting staff).
• Mrs O’Donnell is the finance director. She spent no time in the UK in 2000 and was not involved in the day-to-day finances of the UK subsidiaries. These are carried out by the UK finance director and his team.
• Ms H Boot is the director (developments). She oversees new product development and launch. During 2000 she spent 6 weeks working on the introduction of the new range of recordable DVD players in the UK market, using her expertise gained from the launch of the products in Ruritania the previous year. This involved several visits to the UK (3 weeks in total) to help smooth over the marketing launch.
• Mr K Pierce is the director (operations). He overseas the day-to-day running of the group. He agrees the targets and performance indicators for the UK group following negotiation with the UK directors. He does not usually become involved in the UK operations, but during 2000 he spent 2 weeks working to help solve an industrial dispute in the UK, involving a 3-day visit.

Share options - the costs are the difference between the market value and the exercise price of share options that were exercised by the board members in 2000.

Direct costs - include provisions for payments into individual retirement benefit plans, other benefits (e.g. medical insurance) and support costs such as secretaries and PAs.

Indirect costs - these relate to the costs of renting and running the 25 floors of a large skyscraper in Ruritania City, which amount to £20 million in 2000. The costs are apportioned by taking the total remuneration costs of all the employees in the building, which amounts to £180 million in 2000. The Board’s costs at £36 million account for 20% of the personnel costs. The Board and their support staff actually occupy the top two floors.

Total costs - are apportioned between all the companies in the Bodgit & Scarper group on the basis of turnover. Group companies outside Ruritania are charged a service fee calculated at cost-plus 10%. UK turnover was 10% of total turnover in 2000.

In every enquiry the facts must be established. The group has provided some information, but further enquiries may be needed. On the facts as presented, the following arguments could reasonably be put forward.

Services provided by the board members have been recharged on the basis of their costs, plus a profit margin of 10%. While an independent may be prepared to pay for some of the services, they would question any charge and consider the benefit being received

1. Looking first at the individual board members, Mr Bodgit, Mr Scarper and Mrs O’Donnell do not appear to be providing specific services to the UK. While Mr Scarper did visit the UK, he does not seem to have done any work for the UK subsidiaries. Instead his visit is more of a PR exercise for the employees - showing that the senior executives are interested in the work they do, and (probably more importantly) to ensure that the UK as an investment is performing in line with group aims. The group might argue that there is a benefit to the UK in boosting employee morale. This may or may not be the case, but if the UK company were independent, would they pay for it? Mrs O’Donnell performed no services for the UK company; moreover there is a UK finance director who seems to carry out all the functions required by the UK companies.

Ms Boot and Mr Pierce do appear to have provided specific services to the UK subsidiaries; services that the UK company would have been prepared to pay for. For Ms Boot’s work the first step is to consider a CUP. A consideration of a CUP might reveal what a third party would pay. The group should be asked to try and find such evidence. If no CUPs can be found then a cost-plus method could be considered. Mr Pierces work, falls within the scope of the guidance on Centrally provided services (INTM464055) and a cost-plus method can be used without considering other methods. The next step is to consider how the charge should be calculated.

Their total costs are made up of four elements. While the salary and direct costs would be acceptable as part of the base cost, the share option costs are not under the current basis of calculation. The share option costs would need to be recalculated using a suitable hedging method, before being included in the base cost.

Potentially the indirect costs can form part of the cost base, but is the method of calculation correct? The indirect costs are building costs - rent, utilities, etc. The costs have been apportioned by reference to staff salaries, share options and direct costs. On this basis the board of directors account for 20% of the staff costs in the building and so are allocated 20% of the building costs. However, they only occupy two out of the twenty-five floors. In this case a more suitable method of calculating the indirect costs would be on the basis of space occupied - not the employees’ remuneration packages.

Once the base costs have been agreed, consider whether the method of allocating those costs is acceptable. At present, the costs are allocated between all the countries in the group, based on turnover. This would be acceptable, provided the method is applied consistently, and shareholder activities are excluded. As board members, the directors will have duties and carry out activities that relate to Bodgit & Scarper being a good and sound company to invest in, as well as providing services directly to subsidiaries. The group would need to be questioned further to establish the extent of these activities. The diaries of the board members are likely to be helpful. For example, it may emerge that Mr Scarper, as chairman, spends 100% of his time on shareholder activities, Mr Bodgit 50%, and the remaining directors 25%.

Alternatively the costs can be allocated on the basis of the time actually spent providing services to the UK subsidiaries. This should provide a more accurate figure. The time spent should not just be restricted to time spent in the UK. Remember though that if this method actually increases the amount of recharge to the UK, the recharge should not actually be increased, because transfer pricing adjustments can only increase, not decrease, profits. In this case, the services are provided by the individual directors and their teams. It is important in all cases to establish who is providing what services and what they do. The place of performance of the services is not generally an issue. However, if there are doubts about the benefits and value added by a particular intra-group service, the location of the service providers may help decide the issue. For example genuine day to day management may be difficult to perform if the manager is permanently based halfway around the world, even in the world of modern communications.

1. Bodgit & Scarper NV is a group company resident in Belgium, whose role is to provide particular services to the European, Middle East and African markets. The charge to the UK for IT and accountancy is based on the total costs of these divisions of Bodgit & Scarper NV (including overheads), apportioned by turnover among the group companies within the three regions. Bodgit & Scarper NV provide other services, such as consultancy, but there is no recharge to the UK this year. Bodgit & Scarper NV apply a mark-up of 8% to all costs. (£750,000 plus 8% mark-up is £810,000.)

The charge for IT (£600,000 excluding mark up) relates to the cost of running and improving the group’s in-house computer system. Without this system the whole group would quickly find it difficult to conduct its business. There are IT people employed by the UK companies, but they deal with local problems that can be fixed easily. Any major problems require input from NV personnel (and sometimes Ruritanian personnel, for which NV is recharged). There were two major incidents in 2000; in both cases a team of 5 engineers were sent over to the UK straight away and spent a total of 3 weeks dealing with the problems.

If it were a case of the Belgium company just providing technical assistance to deal with major problems, a better form of recharge would be based on the engineers' actual costs. However, here Belgium seems to offer more, such as improvements to the global computer system. Unless Belgian employees are spending significant amounts of time on particular countries (e.g. helping set up the IT system in a new subsidiary), the method of recharge is likely to be acceptable. As with all transfer pricing enquiries, do not assume. Ask for facts. The group should be able to provide a functional analysis to demonstrate what the Belgian employees actually do.

The business of Bodgit & Scarper NV is providing services, part of which are IT services; a mark-up on costs would be appropriate. A study of comparable companies will help determine whether cost-plus 8% is reasonable. Do bear in mind though that on costs of £600,000 a difference of 1% in the mark-up rate is only £6,000.

The accountancy charge for 2000 was £150,000 (excluding mark-up). This relates to the Belgium in-house accountancy team who draw up consolidated accounts at a European level for the group, help prepare reports for various Ruritanian regulatory bodies (such as the Ruritanian stock exchange), and provide figures and analysis for the board. They do not prepare the UK company accounts; nor are they involved in day-to-day accounting issues in the UK.

All the activities of the Belgian accountancy team relate to shareholder activities. They are not actually providing any services that are of direct benefit to the UK companies; they are not services that the UK companies would seek to buy if they were independent. No recharge is appropriate. An adjustment of £162,000 should be sought (the costs of £150,000 plus the mark-up of 8%).

1. The human resources division has charged the UK £275,000. The UK group have their own HR department who deal with most staff issues such as hiring/firing, promotion and grievances. The Ruritanian department is responsible for the hiring of all senior executives globally (as well as the hiring of all other Ruritanian staff). The Ruritanian HR department was not involved in the resolution of industrial action in the UK in 2000. The costs of the division are recharged by apportioning the costs on the basis of global turnover. The costs recharged are marked up by 10%, so the actual costs are £250,000.

The UK have their own human resources department, so the beneficial services that Ruritania can provide are likely to be limited. Indeed it seems such services will only relate to senior UK employees. While a recharge might be appropriate for services in respect of these individuals, the method of apportionment is unacceptable; it does not bear any relationship to benefits the UK receives. The group should be asked to provide a more accurate way of calculating the benefit to the UK. This might be by reference to time actually spent by Ruritanian personnel on UK human resources issues, or perhaps by headcount for the number of UK employees the Ruritanian division actually has responsibility for. Once the base costs have been established, a cost-plus method will be acceptable, as this service provision falls within the scope of the guidance on Centrally provided services (INTM464055).

1. The tax advice relates to a global transfer pricing report prepared for the group by a major firm of accountants. The costs of the report have been allocated to group companies on the basis of turnover. On enquiry it is established that the UK felt that the global report, when delivered, would not address the UK in sufficient detail, as it was to concentrate on Europe as a region. The UK commissioned their own report to ensure its transfer pricing policy satisfied the arm's length principle.

The OECD Transfer Pricing Guidelines indicate that the provision of a service that duplicates a service already purchased by the transferee should not be the subject of a recharge. The report commissioned by the UK provides what it needs - the global report will at best duplicate the UK report. The recharge should not be accepted.

Note that the recharge was not subject to a mark-up. If the recharge had been acceptable (say for example the UK used the report and did not commission its own) a mark-up would not have been appropriate as Ruritania is essentially sharing out the cost of service purchased from the a third party; it has not added anything of value itself.

1. The UK has been granted a licence by Bodgit & Scarper Singapore Pte Ltd to manufacture and sell branded DVD players in the UK. Under the terms of the licence the UK pays a royalty; in return it is provided with the technical know-how to manufacture the DVD players and the right to use the 'Naff' name and logo. The charge for technical assistance relates to four employees of the Singapore company who came to the UK in 2000 to help set up the manufacturing line, using their knowledge and know-how from installing and running the manufacturing line in the Singapore factory. The four engineers were each in the UK for two months.

First of all the licence agreement should be looked at closely, together with copies of correspondence, etc. that took place when the agreement was being negotiated. This type of technical assistance is likely to be covered under the royalty payments to be paid by the UK. If this turns out to be the case, the charge of £1 million should not be accepted.

If it turns out the services are not covered, then the UK group should be asked to supply evidence that the price charged is arm’s length. The charge works out at £125,000 per engineer per month. This could well be excessive. The Singapore company is unlikely to be carrying on the business of consulting engineers; the provision of these services is likely to be peripheral to their main business. If a CUP cannot be found then a cost-plus method should be used. A realistic recharge would be based on their salaries, expenses relating to their visit to the UK, and a reasonable proportion of overhead costs. The costs should be marked up by reference to the results of suitable comparables.